Housing market heads for freefall this year

The law of supply and demand is the key to housing prices and it suggests the downward spiral will start sooner rather than later, writes GREG NINNESS.

The residential property boom rolls on, leaving predictions of an imminent bust in its wake. But research by the Sunday Star-Times suggests the market is perilously close to the crest of a hill. Once prices do start to fall, it’s not clear how steep their descent will be.

Whether we are heading for a crash at the bottom of the property cliff or a gentle levelling out of the market, the figures show the current boom cannot last beyond the middle of the year.

Many economists and commentators have been warning of a slowdown as the effects of declining immigration, rising interest rates and a flood of new homes start to be felt. But the real estate industry, grown fat on the commissions of the past couple of years, has its heavy foot firmly on the accelerator.

Late last year, it seemed the economists had it right. There were signs the market had peaked, particularly in Auckland – a bellwether for overall direction. But in March, boom conditions returned.

Whether the edge has come off the boom is difficult to tell from the figures used to indicate where the market is headed.

The figures usually cited are compiled by the Real Estate Institute of New Zealand (REINZ) and show the number of homes sold each month and the prices achieved. But they tell only part of the story.

That’s because they are compiled only from sales handled by licensed real estate agents. However, many new homes coming on to the market for the first time are not sold by real estate agents.

Many developers of new subdivisions find it more efficient to employ their own sales staff to sell direct than to hire a real estate agency to do the job.

Similarly, many private developers of apartment blocks and terraced housing employ their own sales staff. And when private individuals contract directly with a builder to construct a home, a real estate agent is not usually involved.

None of these sales is included in REINZ’s monthly figures. And yet the number of new homes sold each month has a huge impact on the liquidity of the market because it affects the supply of housing stock to satisfy demand. If too few new homes are built, the market tightens, prices rise and it’s boom time. Too many new homes and buyers become picky, prices fall and it’s bust.

The table, above right, shows how the balance between supply and demand for housing has shaped up over the last three years. The first column shows the estimated increase in demand for housing, calculated by taking the increase in the population from migration and adding it to the natural increase from births exceeding deaths. This gives the total increase in the population for the quarter.

To estimate demand for homes, the total increase in population is divided by the average number of people per home (2.7 at the last Census). Supply of new homes is taken from the number of new residential dwelling consents issued each quarter, allowing a year for completion. The difference between these two figures is either an over or under-supply.

The table shows that in the three months ended March 2001, low population growth created a demand for an additional 1169 homes. But the market supplied 5209 homes, an over-supply of 4040. Not surprisingly, the housing market was in a slump.

But the market turned in the September 2001 quarter when demand picked up, driven by a big increase in immigration. The over-supply dwindled and by the December quarter, the 4000 home over-supply had turned into a 2000 under-supply.

This housing shortage peaked in the March 2003 quarter, when a massive surge in immigration resulted in a shortfall of more than 8000 homes. It is little wonder that the housing market went into boom mode with demand far outstripping supply.

The boom has continued because, although immigration has subsided, reducing demand, the building industry has been struggling to catch up.

Between the December 2001 quarter and the March 2003 quarter – a mere 15 months – there was a cumulative housing deficit of 13,424 homes.

Even with migration and demand declining, however, the building industry still hasn’t caught up with the previously high levels of demand.

The accumulated demand from the December 2001 quarter to the March 2004 quarter was for an extra 61,152 homes. But over the same period only 55,961 homes were built, leaving a remaining shortfall of 5191 homes.

So when will the market get back into equilibrium and will boom turn to bust?

The supply side of the equation is easy to estimate because we know how many dwelling consents were issued last year and it’s a fairly safe bet that most of those will turn into new homes this year. That should result in another 23,465 becoming available by year’s end.

Estimating demand is less certain. Since the September 2003 quarter, demand has been fairly stable at about 5400 additional homes per quarter. If demand continues at that level, supply should finally catch up with demand some time in the final quarter of this year. By then, the building industry will be producing some 2500 surplus homes per quarter and the market should start to soften.

The wild card is migration. The number of new immigrants arriving is fairly stable but the number of New Zealanders leaving to settle overseas increased dramatically in March. This caused a net loss from migration for the first time in three years.

If that trend continues, demand for new homes will halve to about 2600 per quarter and the market should hit equilibrium by about mid-year. Thereafter, supply will exceed demand by about 5500 homes per quarter, which will be a far greater over-supply than during the last property slump four years ago.

If that happens, the market will turn to custard by Christmas.