Friday, October 2, 2009

Explaining New Zealand's Property Disaster

Andrew D Atkin:

If you have 10 families but only 9 available homes, then those families must compete against each other, with all that they have, to not be the family that misses out. The result being that house prices are bidded-up to the maximum of what people can afford, and over-crowding and the creation of a poverty-class becomes unavoidable. And the landlord's get rich.



New Zealand's property bubble has been dependant on 3 fundamental variables:

1. The inflation of demand.
2. The restriction of property supply development.
3. The facilitation of credit.

Over the last several years, under the Clark government, there has been a major restriction in the development of land supply [see "Smart Growth?"], which has in turn seen the price of land in New Zealand dramatically increase, in response to increased immigration rates (increased immigration = inflation of demand). The result has been that the cost of sections for houses has gone from around the $50k mark to nearly $200k on average. A massive price inflation.

The cost of building houses has also been inflated by 'parasitic' regulations that have been imposed on the process of housing construction. However, land price inflation has been the dominant (if not exclusive) inflationary factor affecting final home prices, because in the context of a major under-supply of developable land we would also see that any reduction in housing construction costs will only subsidise further inflation of land prices i.e. swapping one cost for another. (explained later, this occurs via the dynamic of house prices increasing to the maximum of what the average home-buyer can afford, in the context of a major under-supply)

Property price inflation has also been dependant on the home-buyers access to credit. This is because you can only sell a house for what people can pay for it in the first place. Hence the third variable supporting house price inflation (access to credit) has been controlled by the banks. New Zealand banks, in recent times, have facilitated 'easy credit' by providing relatively low interest rates (compared to what we had in the eighties), and by providing very low and even no deposit-down loans.

Because houses are considered a fundamentally important asset to so many New Zealanders, house prices, as a consequence of the under-supply, have been able to rise to the maximum of what people can afford....because when it comes to houses in New Zealand people are generally prepared to pay whatever they can afford. And as the banks have increased people's access to credit, they have functionally increased the amount of money that people can afford to borrow for a house; and this, finally, has allowed New Zealand property prices to inflate dramatically in response to the under-supply of houses.

In short: New Zealand's national government pumped in too many people too soon through immigration to fuel excessive demand, and local councils choked off supply development in response to this demand by employing restrictive land zoning policies. This, in turn, has driven property prices up to the maximum of what people can afford, as the home buyers are forced to compete aggressively amongst themselves for a now inadequate supply of houses (the property market -like all markets- is basically like a large-scale auction i.e. the buyers compete for what's on offer.). The banks have hugely driven up the 'maximum affordability limit' by increasing home buyers access to credit. As you can see, the New Zealand property bubble is a "three headed monster"; each factor, as I originally outlined, has been necessary to create this hugely destructive bubble.

Note: The fact that the property bubble has been dependant on 3 highly specific co-functioning variables is curious in itself. It suggests that the formation of the bubble may have been deliberate, as it is highly coincidental that each dynamic has been introduced at essentially the same time*. It is also curious that the dynamics driving the property bubble have been repeated in so many other areas of the world as well, and also at the same time. I am not being a "conspiracy theorist" in saying this. I am simply making a rational assertion in response to the facts. Suspicion in this case is rational.

The bubble effect:

In principle, the real value of an asset can be determined by its yield, and the risk associated with the sustainability of its yield. A low-risk investment might provide a return of, say, 7%, whereas a more risky investment might provide a return of 12% (a yield which could somewhat easily collapse in the future, for whatever given reason). In a bubble the market price of an asset becomes detached from its 'rational' yield-based value. We often call this kind of inflation 'capital gains', but really it is just the effect of speculation. As I will soon show, when it comes to bubbles.. what goes up, must eventually come down.

What has happened in New Zealand is that people have seen property prices rise dramatically due to the factors previously shown, and they have decided to buy houses (and second 'investment' homes) on the presumption that their sale-prices will just keep on going up i.e. "capital gains", and likewise they have become speculators. As this has happened, people have been enthusiastically buying up houses based on those 'paper money' capital gains, and not the yield. Indeed, people have been buying up investment properties that have rental yields which, in themselves, can only justify about half the amount of money that they originally paid for their house.

And this is how you know that you are looking at a bubble. When the "madness" of valuing a product on the basis of its projected speculation-based value starts to kick in (detached from its "real" yield-based value), then its market price can rise to ridiculous levels of which have no grounding in real natural values. And again this is when we can know that we have a bubble; and likewise, we can know that the bubble must eventually collapse...because the sale-price cannot go on rising forever, because home-buyers cannot get access to an ever larger amount of credit, forever.

So! What happens when the capital gains run out? What happens when the price stops rising, as it eventually must? From that point you are left with a huge number of people holding onto an asset which must be (because it only can be) valued on the basis of its real yield-based value: because yield-value is in turn the only profit-making value remaining. Likewise, those people owning property at the peak of the bubble will see that their $500k house is giving them a yield akin to what they would expect from a $250k house, and so the rational response then becomes to sell their house and put their money elsewhere - that is, where they can get a 'proper' yield for their $500k. But the problem is, as you would expect, that people don't want to buy an over-valued house (that they know is not appreciating) for the same reason why the property owner now wants to sell it. In turn, the bubble bursts. The price collapses as the over-valued asset must finally answer to its real yield-based value.

So who wins from the bubble? All the people who sold out at the peak of bubble (they are the careful speculators who know what they doing, and already clearly understand what I am talking about...You can make a killing from speculation if you do your homework and know how to play the bubble). And the losers are, of course, the people who bought in at the peak of the bubble. They're the guys who received all that poor or even corrupt advice from people who wanted to make money out of property trade, and also all those people who substitute "common knowledge" for understanding.


New Zealand's property prices have not properly retreated to historic values today because we have, in part, no longer got a bubble. This is because rental yields have increased as a consequence of the under-supply of houses.

Also, property owners wanting to sell have recently been in denial about real property values, and have been refusing to sell their houses for a reduced amount. They are hoping that the price will just inflate again in time, because they still believe the erroneous mantra "property prices can't fall", at least not in the medium or long term. The result of the latter has been a major decline in property sales, which is an expression of sale prices set unrealistically too high. This is a very risky game for these sellers to play: because the longer they wait for a buyer (and likely not get one) the worse the price will be that they can finally get for their home in the future.

The macro-economic effects:

The economic effects of New Zealand's property bubble have been terrible for the New Zealand economy.

As people have felt richer from their house price inflation (On the macro-scale level, or national level, bubble wealth = fake 'paper money' wealth), they have in turn been confidently going into debt, borrowing off the backs of their houses to boost their consumption. This has created an artificial (debt-based) input into the economy, which has seen debt-financing replacing and substituting real national earnings from [otherwise] tradable productivity (Bad!).

New Zealand's productivity growth over the last several years has been lame or even negative, and the nation as a whole has been going deeper into debt. We have been describing our debt-fuelled spending binge as "economic growth" but really it is just spending growth, NOT earnings growth.

Alas, those debts have to eventually be paid down. This almost certainly requires a recession; that is, a recession of the false debt-funded section of the economy, which in turn liberates resources for the enhanced development of the productive sector of the economy. Essentially, this is what a recession is: a corrective adjustment. It hurts employment for a time as people have to lose their jobs, as jobs must be relocated throughout the adjustment.

The Clark government has done serious damage to the New Zealand economy for political convenience due to the property bubble's "economic growth" effect (and it cannot be overstressed that this is really just consumption growth). Even today people celebrate Helen Clark as one of New Zealand's greatest political leaders because they believe she presided over a highly successful economy. She did not. She presided over debt, not true (productivity-based) economic growth. And this is not just my opinion, it is a monetary fact. We have the trade balance, poor productivity growth, appalling national debt levels, and now the threat of a serious recession -or even depression- to prove it.

The Clark government failed to outlaw local restrictive land zoning laws, inflated demand with exaggerated immigration, and failed to take emergency action to directly restrict the amount of money that New Zealanders could borrow from the banks. The Clark governments actions have been totally irresponsible. The have sold the long-term health of the economy out for the sake of allowing themselves to install socialist-leaning policies into New Zealand, during their tenure. This government has been either seriously corrupt or grossly incompetent.
I know this is a harsh appraisal, but should our governments not be accountable for their actions/inactions?

What New Zealand needs to go through now is a recession to adjust, and pay down its debts. We have to hope that the current National government does not merely delay the recession in the name of an excessively "soft landing", because that will only allow us to move even deeper into debt, demanding an even more severe recession (or depression) in the future.

Already there are concerns that a corrective recession will not happen. There are indicators suggesting that New Zealand immigration rates will continue to be too high, that policy reform to facilitate more property development will take too long to have an appreciable effect, and that the banks are ready to make borrowing credit much easier again. Alas, the last thing New Zealand needs as another property bubble charging up. That would, in time, truly devastate the country.

The social cost:

Aside from the economic cost, the inflated property market also has a major social cost. It drives up the cost of living for renters, and leaves home-buyers with truly crippling mortgages. I have highlighted the far-reaching impact of all this in my "Smart Growth?" article [see "Smart Growth?" in the June index].

Note: Governments can talk about the importance economic growth and "rising living standards" until they are blue in the face, but the fact remains that when you install policies that have the direct effect of restricting supply of base-need items/services, so that there develops a real under-supply of what is essential, then you can only end up with a poverty class regardless of net national productivity.

Explaining: If you have an under-supply of houses, as my example, then it will not matter if everyone in your country is earning a million dollars a year: in these conditions you functionally must have over-crowding and/or homelessness because money cannot buy what does not exist. The result would in turn be incredibly high rents as people are forced to hand whatever money they have over to the landlord, to avoid living under a bridge or in over-crowded conditions etc. Again, the market is like an auction: you have to compete with other buyers for whatever is available.

Likewise, you can see that one of the most irresponsible and anti-egalitarian things that a national (or local) government can do is facilitate the development of an under-supply of base-need items; items such as food, water, electricity and housing etc. If the under-supply is substantial and serious then, in these conditions, it is virtually impossible to avoid creating a poverty class with respect to real living standards.


*If the property bubble is in fact a deliberate creation, then that would open up new questions as to how New Zealand's political structure ultimately works: because we are then looking at unusual co-ordination between central and local governments, and possibly the financial sector.


UPDATING: 13-11-09

The following was posted (by me) on John Key's (the New Zealand Prime Minister) public blog. So far, the National government has done nothing material that I can see to stave off another property bubble which is already beginning to charge up.

As follows:


#10 - Andrew Atkin said:
2009-06-15 15:57 - (Reply)

Hello Mr Key, I just read an interesting yet probably very important article in a New Zealand building magazine. It stated that with respect to the current outlook we could be looking at another property bubble charging up soon. The well written article made a lot of sense. They noted significant increases in population growth as international's looked to "escape" to New Zealand (directly inflating property demand), the fact that your governments reformed RMA will not help enough, in time, to achieve a polarising supply-development to that demand to stave off another bubble, and that falling interest rates and reduced deposits demanded from the banks (they currently demand about 20% according to the article) will all inevitably drive up property prices again.

And they are right. If those variables hold static, and banks provide easier access to credit again, then there is only one way those property prices can go. That is serious. The absolute last thing New Zealand needs is another property bubble. We'll end up more like America with an economy chronically based on debt as opposed to productivity, and in time we will have to look at a severe--or even profound--depression. Like America is today. I hope you will consider slamming the brakes on immigration, at least temporarily, to stave off demand until we sort out the supply in houses. Or even make it illegal for banks to lend more than, say, 40% on a buyers household income as another possible anti-bubble emergency policy. Again the last thing we need is another round of Clark-government style economic growth. It will drive us even deeper into debt while leaving productivity growth to rot. With concern, Andrew Atkin

#11 - Andrew Atkin said:
2009-06-15 16:48 - (Reply)

Correction: I apologise for not being clear. When I said "40% on a buyers household income" I meant that the banks should not be able to lend more than what would equate to the household yearly income equaling only 40% of the amount borrowed. So if you earned $40k a year, you could then only borrow $100k in this example.


The National party has thus far made clear statements showing that it understands the property problem, like I understand it and have so far explained it. I will wait to see if something substantial happens about it. If not, then I recommend to anyone to wait for their home (if they have one) to inflate to an approximate maximum, then sell out and put your money overseas or in secure exporting industries, because when the property market collapses--assuming we do get that second bubble--it will end up taking out the whole New Zealand economy with it.

I will not hold my breath with respect to what the National government will do. If it does the worst and simply allows the property market to seriously re-inflate, then it will be an interesting education for me on the New Zealand government and how it works (or does not work) on the whole.


Addition: 19-11-11:

David Willmott provides an excellent and well spoken talk relating to the dynamics that are destroying housing affordability in New Zealand, with his focus on Auckland. He was a candidate for the Auckland mayoralty and would have won if it were not for the fact that elections are won by money and propaganda rather than facts.


  1. Mate that is the best article/blog I have read in a long time. Maybe the property reporters at the NZ herald should leave and you can write for them. Would you let me post this article on my website? with reference to your blog of course.

    And I agree with what you are saying. Except to be more clear on prices falling back down to meet true values.... The values have moved up as a result of yields/income. This is why property has trended up and up since the begging with the spikes and pits obviously.


  2. Hi Mitch, and thanks for your nice words!

    Sure you are welcome to publish this article on your website.

    Yes about the yield-increase effect - yields have increased which have in turn reduced the 'bubble' - well, technically.

    In my view, the most "natural" value of a property (and just about anything) relates to what it costs to bring into supply in the first place. This is what the most long-term value should relate to.

    I think it's ultimately possible to turn ourselves into a country with forever costly houses and forever costly rents, based on artificially increasing the cost of supply development. And that of course would be (and is!) a disaster.

    Unfortunately the baby boomer's don't want to know about it because they're loving the free lunch, and there are so many of them that the government doesn't want to do what knows it should. In my view we are looking at democracy at its worst: one half of the country using political forces to (basically) rip the other half off - maybe not intentionally, but that's the basic situation.