How the Reserve Bank’s New Toy can Affect Home and Investment Property Ownership

Just like cooking programs dominate our TV space, articles on property occupy our print media. Not that there's anything new in this. There's nothing so dear to Aucklanders' hearts as real estate and the desire to discuss and critique all things property.  What is somewhat new, however, is the proposed macro prudential tool the Reserve Bank intends to introduce which will affect all potential purchasers of property and all existing property owners.

As we know, one of the Reserve Bank's functions is to regulate monetary policy and keep inflation within certain parameters. In undertaking these tasks, the Reserve Bank constantly scans the economic environment and assesses its stability. It also evaluates potential threats to such equilibrium.  

Recently, the Reserve Bank has identified the possibility of a housing bubble occurring. It thinks that if house prices continue to climb at the rate they have been going up, a housing bubble would form and then, like all bubbles, eventually burst. Consequently, lots of home owners would be left in the unenviable position of possessing large debt home loan balances with homes that are over-valued. In other words, they would owe more than what they actually own. That state of affairs is clearly undesirable, as it can place substantial financial stress on individuals. Additionally, it can result in significant economic disruption to the economy as a whole, if such lending is not repaid.  Echoes of sub-prime markets spring to mind.

In an attempt to ward off a potential housing bubble, caused in part by easy accessibility to credit and low interest rates, the Reserve Bank is intending to act. It proposes to introduce a new policy which will require all banks to adhere to what is known as a loan-to-value ratio, or 'LVR' when making loans.  

When the Reserve Bank's new instrument of choice is implemented, it will mean the amount of funds a  financier is permitted to advance, cannot exceed a certain percentage of the value of the property being used as security. For example, if the LVR was set at 80% and a property was being purchased for say $700,000, the lender would not be able to advance more than $560,000 against that property to enable its purchase.  

Like many a balance sheet, what looks good on paper doesn't necessary equate to reality. The policy is no exception to that sentiment. Several tensions exist and I have my doubts that the objective of the policy will actually be met.



1. The LVR tool is meant to reduce demand because there will be less people able to meet the borrowing criteria and, therefore, less demand for credit. This is meant to translate into less demand to purchase realty.  

Houses are no different from any other necessary economic good.  When demand for the good outweighs supply, an imbalance occurs and prices tend to climb. In Auckland, current demand for property far outstrips supply.  

Whilst LVRs may reduce some individuals' ability to borrow and thus may diminish the demand for credit by those individuals, it does not follow that a demand-supply balance will result. Those who do not have equity or a large enough deposit (e.g. first home buyers) will not be in a position to purchase, but there will be those who are financially able to buy another slice of Auckland - and buy they will.  After all, this has been the traditional Kiwi way to fund retirement. Accordingly the demand-supply imbalance will continue to exist and prices will continue to rise. To damp down house prices where a demand imbalance exists, one needs to increase supply.  Attacking demand solely will be of no benefit. I've canvassed this issue in previous blogs and vlogs and in particular, in my Auckland Unitary Plan vlog.

2. Tackling the demand side of the equation by the introduction of LVRs will also hurt those attempting to get a toe on the property ladder. One can see the poor getting poorer and the richer getting fatter. Not exactly the Kiwi way. Those that cannot afford to buy, will simply have to rent. In my country of origin, generation after generation rent – for life.  Many never entertain the idea of home ownership, knowing it is well beyond their means. This is not a good thing. It has huge community social-cultural consequences. Loss of the dream of home ownership is not beneficial to the individual concerned either. It can cause stress due to a sense of not being in control of one's own living environment, a dent in self-identity because one does not have a financial asset, and a feeling of social inequality as a consequence of not possessing a financial status comparative to others.

3. On the basis that individuals will be just able to meet LVR requirements, their home purchases will tend to comprise more of what we know as rental stock. They will tend to buy only what they would have otherwise rented because this is all their purchasing power will permit. This is despite the anticipated changes to the KiwiSaver scheme. When this occurs, one would expect the pool of people who have rented to decrease (i.e. they will now be home owners) thus providing more rental stock. However, given that migration into Auckland is expected to continue to increase and assuming there will not be an immediate supply of rental houses being built, the pool of houses available to rent will decrease. Thus, the demand-supply imbalance will persist. This will permit landlords to increase rental prices, causing the lengthening of the rental cycle by renters.  Renters for life here we come.

4. Requiring the implementation of LVRs by lenders may also bring about the financial instability the Reserve Bank wants to avoid. This could happen, as those who would not ordinarily qualify for credit go to those who are inventive and creative. Yes, undoubtedly some parties will step forward with some "interesting" schemes to "assist" those who need to increase their equity and deposit and thus comply with LVRs.  Vendor loans, 2nd and 3rd tier mortgages at astronomical interest rates, and the use of credit cards for cash withdrawals here we come. We've seen this before and I fully expect the same but different arrangements will occur again. If all is above board, no harm will be done but if the arrangement is not forthcoming, borrowers and guarantors alike could be financially hurt. If this occurs on a wide enough scale, the financial risk which the "ingenious" practice has masked will be revealed and a financial economic instability could result.

5. Finally, we need to be mindful that data shows us the demand-supply imbalance and consequently high rate of price increases is occurring only in the geographical areas of Auckland and Christchurch. A lot of New Zealand is still playing catch-up cricket. So even if LVRs did bring about the desired objective of reducing property prices, it will be at the cost of inhibiting economic momentum in areas past the Bombay Hills. This may have further effects such as pushing profitability of business downwards in provincial areas and pushing unemployment up in those very same locations. Consequently, those who can, would move to a city (probably Auckland) in an attempt to find paid work and thus, add further to the supply imbalance problem of either rental or ownership of property.


From reading the above, you should have developed a sense that the introduction of an LVR by itself will not bring about the Reserves Bank's desired intention. Furthermore, it will have widespread community and individual social and economic consequences – not all good in nature.


THOSE WHO ALREADY OWN PROPERTY

The tool is yet to be officially implemented but several banks are already in the process of tightening their criteria, readying themselves for its introduction. Accordingly, if you are wanting to purchase property in the near future and you already own realty, ensure you get your properties valued right now and you get bank pre-approval immediately. This could put you in a very strong position should lending criteria shift suddenly.


THOSE WANTING TO OWN PROPERTY

For those who do not want to get left behind and want to venture into the world of property, be it home ownership or investment landlord,  or for those simply wanting a little competitive edge, you might take the step of acquiring new knowledge.  In an effort to help people increase their property ownership understanding and increase their property ownership opportunities, we are bringing to you GRA Property School.  Our School will cover the basics of property ownership and investment.  It's a 7-module course, and full details can be found on our website. We'll cover all the things you'll want to know if you are intending to buy property. To enrol for this course, simply register online, or contact us at info@gra.co.nz or by phoning (09) 522 7955.