Micro-Economic Look at the Auckland, NZ Property Market
AT MAY 2014, THE AVERAGE AUCKLAND HOUSE SALE PRICE NOW SITS AT A RECORD HIGH OF $697,454. THIS FIGURE IS UP 12% FROM THE SAME TIME LAST YEAR, WHICH INDICATES STRONG MARKET FORCES OCCURRING THROUGHOUT THIS PAST YEAR.
Demand within the Auckland Property Market has been steadily increasing over recent years. This is attributed to the facts that incomes have risen, desperation to enter the market has grown and consumer numbers have blown up.
The largest demand-driver is the consumers with increased incomes looking to acquire Auckland property. Auckland’s continuous, prosperous economic growth has led to an increased derived demand for skilled professionals to bring their trades to Auckland. This results in higher incomes and therefore increased purchasing power, of which these consumers with increased incomes demand Auckland property with. For example, New Zealanders who emigrated to Australia for job opportunities are now returning with ‘deep pockets’ and a thirsty demand for Auckland property.
There are many consumers from within and outside the Auckland property market who look to invest as soon as possible, citing positive inflationary expectations. This creates a desperate demand to enter the market which results in high debt to equity ratios as investors borrow large sums to cover their purchases. The inflated ratios indicate that the investors are risking possible bankruptcy, by gambling with property.
Now, property within the Auckland market is known as a ‘Giffen Good’. Named after the famed economist, Robert Giffen, a Giffen good is a good for which demand increases as the price increases, and falls when the price decreases. This directly applies to the housing market because as house prices look to increase, investors swoop in and increase demand. Yet as the housing market looks to recess, demand for the properties decreases accordingly. A Giffen good has an upward-sloping demand curve, unlike the law of demand which states that the quantity demanded of a good decreases as the price increases resulting in a typical downward slope of the demand curve.
Substitutes for purchasing property are also becoming more prominently consumed. New Zealand has historically low interest rates which means there are lower cost mortgages available for the consumers. Yet, as rental rates continue to rise, these low cost mortgages appear quite affordable to the average Auckland property consumer. These low-costing mortgages result in a higher demand for consumer occupancy of Auckland properties. With higher occupancy rates come higher rental rates, as renting a house in Auckland is a substitute for taking out a mortgage and owning a property.
Additionally, the wildly-increasing consumer numbers within the Auckland property market are a huge factor of demand. For example, Chinese investors look to broaden their investment portfolios internationally, and Auckland being an internationally-recognized hub of business and affluence will attract them. Internal migration of Kiwi’s from heartland New Zealand also play a large factor in the increasing consumer numbers - as consumers are attracted to Auckland for the higher income opportunities and to escape the rural downturn. As the nature of the NZ productive sectors - such as Dairy - is changing, there becomes less demand for work in heartland NZ, and more in tertiary sectors in locations such as Auckland.
In contrast, there is a certain degree of immobility within New Zealand, as some Heartland New Zealander’s may lack the transferable skills for jobs within tertiary sectors. For example, a dairy farmer ‘born in bred’ in Southland back-country may encounter a decreased demand in products produced from the Dairy farm he works on. Thus he may seek work in Auckland - in the corporate Agriculture industry - but can’t land a job as he can’t transfer his skills and knowledge into the boardroom. This dilemma is known as ‘Occupational Immobility’ and is becoming more frequent throughout New Zealand.
Additionally, if the said dairy farmer owned a small bungalow in Southland’s rural area, he may not be able to purchase a house in Auckland. His Southland house may be worth $100,000 due to the impoverished economy of his community and thus would not serve as a significant deposit for an average or even lower end house in Otahuhu (Auckland) in which house prices are quadruple that of his back home. Therefore, the farmer encounters the problem known as ‘Geographic Immobility’ as he does not posses the means to migrate to Auckland.
The tastes and preferences of consumers will affect the demand for Auckland properties. For example, wealthy families in Auckland will demand property in suburbs that reside around the schools that they want to enroll their children in, such as Pakuranga (St. Kentigerns, $15000/yr education (upwards of $50,000/yr for boarding)) or Epsom (Epsom Girls Grammar School, $19000/yr education (upwards of $35,000yr for Homestay)). So, wealthy individuals with intentions to enroll in wealthy educational institutions will demand higher-value property.
Finally, compliment factors influence the increased consumer numbers within the Auckland property market. As house values in Auckland appreciate the relative size of the mortgage shrinks, meaning the size of the ‘real debt’ decreases. The owner of this appreciated property can now use this as leverage to raise further mortgage finance and allows investors to purchase multiple properties, as demonstrated by the immigrant Chinese looking to broaden their investment portfolio.
More desirable loan-to-value ratios result in increased demand of rental properties for those unable to afford a property, meaning there is an increased ROR (Rate Of Return) for those who own the rental properties, as well as the fact that there will be more properties in the hands of individuals, resulting in increased inequality between property owners and those without the means to own a property. So, it is easy to see that the increased prices within the Auckland property market will offset other factors that rely on or compliment property values.
These factors - increased incomes, substitutes, inflationary expectations, consumer numbers, compliments and preferences - will all drastically affect demand for Auckland housing. Fluctuation of any factor can offset flow-on effects that may increase or decrease demand for properties, accordingly. Therefore if all factors show growth, the Auckland property market will also display growth.
During May 2012 to April 2013, 348491 residents immigrated to NZ and during May 2013 and April 2014, 361591 residents immigrated to NZ. The period between May 2013/April 2014 is a 3.759% increase over the same yearly period of May 2012/April 2013. Also, the period of May 2013/April 2014 yielded a 12% increase in house prices within Auckland. These statistics present a price elasticity of 0.31325. This figure is less than 1, meaning that the demand for properties within the Auckland property market is price inelastic.
For example if price elasticity for an object is equal to one (percent), then demand for that object is considered unit elastic. An elastic demand implies that a relatively small increase in price will result in a large decrease of quantity demanded. So, because the price elasticity for Auckland properties is smaller than one (percent) - 0.31325 -, the demand for Auckland properties is considered price inelastic.
The necessity of housing will perpetually create demand within the property market. Having a roof over one’s head is a basic need and thus will constantly attract people from not only within, but also from outside the market location to purchase property. This factor of elasticity is also limited by time adjustment. Say if rental rates increased at a higher,more unreasonable rate, then households will have to adapt and economize in other areas that affect their ability to pay that increased rental rate. Although the rental rates are not currently rising too wildly, they have still increased which means that households may have to have economized and cut-back to a certain extent. For example, a household in Parnell (Auckland) may rent a fairly comfortable house for $750 a week. If that rental rate increased to $900, the income earner of that household may seek to work additional hours or look for higher paying jobs in order to generate the finances needed to meet the increased rental rate.
The increased house prices also mean that people who currently reside in Auckland may not be as inclined to move/purchase a new property. As a result of this, these households explore substitutes, such as renovation - so as to improve not only the aesthetics of their own home but also to hopefully improve selling prices when said household is ready to do so. Because households within Auckland are busy renovating, the local businesses have been benefiting. In an article published by scoop.co.nz it was said that renovation has increased exponentially over the past year; “...reporting a 62% increase in the number of home renovation and repair jobs posted in the year to March 2014. Auckland growth was in line with the national average at 63%, with the hot housing market encouraging many to renovate before selling.” This is recognized as the most popular substitute to purchasing a new house alongside renting a property.
As Auckland housing prices increases so will the demand for renovation resources, ceteris paribus.
The percentage of total expenditure will also affect price elasticity. With mortgages and rent payments making up between 30-50% of total household expenditure, there is little left to save and purchase a new or additional property after other expenses. Therefore, those with less income have less expenditure, as a higher proportion of their income is put towards housing costs, while those who are more affluent may be able to afford better quality housing or additional property. The recent mortgage interest rate rises mean that the households with lower income and a mortgage will be harder hit as the cost of the mortgage takes a larger proportion of their expenditure. This increase will be inelastic, and will be absorbed because as inconvenient as it is, it is still a necessity, as mentioned above.
The housing supply is relatively inelastic in the short-run. This begins with construction companies being unable to plan and build new homes in Auckland when there is an increase in demand. This is due to planning regulations and other constraints on housing construction, as well as the restriction of available skilled labour and capital equipment both used to construct the properties. Then, the largely increased house prices don’t lead to increases in subdivisions and land made available to build housing upon.
In the long-run, supply of property - land and dwellings - is not entirely elastic. Because of the time it takes to plan and build a property, it takes a relatively longer time for supply to adjust within the market relative to the ever-changing demand.
If Auckland property prices continue to rise, housing construction firms and property developers will continue to increase their quality supplied. With this, the Auckland council may wish to subdivide farmland to build on, rezoning areas. There will also be an increased uptake in construction and development training/courses/apprenticeships as individuals want to take advantage of the boom, accompanied by an increased in foreign construction tradespeople migrating to NZ to do the same and capitalize on the market.
Multiple factors each have a prominent effect on the level of supply of property to the Auckland property market - Supplier numbers, Producer Substitutes, COP and the Law of Supply.
Firstly, the number of suppliers willing and able to produce and supply the Auckland market with property is limited, due to 3 parties; Pensioners, Developers and the Auckland council. The Auckland City Council is and has been reluctant to re-zone and develop farmland with a potential for property construction. Factual reason can not be found, but there are many possible reasons for this reluctance that can be speculated. Because of this, the Auckland property market is missing out on a certain increase in real estate available to the market. With this comes land developers, of whom are also reluctant to build when they manage to acquire property to develop. These ‘land-banking’ developers have every reason to develop and construct on their land but like the City Council, they also seem reluctant. They may be so because of appreciating land prices - seeing land banking as an investment - or because it may not be viable to build in an area that is not ‘zoned’ or significantly developed already.
Lastly, the older generation - 70-90 year old individuals - are not moving to more suitable, smaller properties, primarily and most obviously because they want to continue their superannuation (pension) payments. Because they have been residing in what have now become ‘quality’ locations for a number of years, their properties are seen as rather valuable.
So certainly, these 3 parties all restrict supply of properties to the Auckland Property market.
The price of related goods also puts a limit on property production. If the price of plasterboard increased by 50% - the GIB manufacturers see that the Auckland property market is booming and want to capitalize on it -, the supply of properties would decrease, because suppliers would have to cut back in order to meet the increased costs of production. This upward pressure of scarce production resources or increased costs means that there is increased inflationary pressures. So if the price of the average Auckland property increases, resource suppliers may increase the cost of related goods and producer substitutes resulting in increased costs of production therefore a fall in the quantity of properties supplied. Factor mobility will also place a limit on the supply of property. The producers should be able to mobilize their workforce around the region and/or country, and will do so according to how expensive it may be to do so.
The rate of return is favorable in property investment. Investing in property creates a ‘real economy’ investment, unlike shares or bonds. Unfortunately property is easy to over-invest in and being underproductive capital, it limits future economic growth. This is because once a house has been invested in, it takes a considerable amount of time to appreciate or depreciate. Because of the time constraint, the economy may not benefit as well as if a family had have purchased said house, due to the fact that an investor essentially purchases and ‘banks’ the property, doing little to stimulate the economy. Low savings interest rates - 3.5% on average -, risky share markets and government saving programs - Kiwisaver - are unfavorable investments when compared to investing in the housing market, with it’s near-guaranteed capital gains. Albeit a housing investemnt ay take time to mature, but within the Auckland property market, doing so would be considered a safe and wise acquisition.
Finally, the Law of Supply dictates that an increase in price results in an increase in quantity supplied. This is applied to the Auckland property market in the situation in where the rising rental prices result in increased demand for property. Additionally, there is an increased rate of return on rental properties as the rental rates are increasing. So, rental agents are offering a higher quantity of properties to supply the market with.
Currently, there is pressure on the Reserve Bank to raise the interest rates across the board in order to slow down market demand. As mentioned earlier, mortgages are a compliment good, so if they should increase in price the demand for them will decrease. This is also met with a rising exchange rate, which can seem to dampen areas of the Auckland economy such as overseas investment.
These factors are not good for the economy over the long run, as they do not stimulate or initiate growth.
There is also pressure on the government to increase minimum house purchase deposits. This places a quota on the market that the government applies to, which results in a limit of avaliability for cheaper - possibly sub-prime - mortgages. The NZ government will now increase the minimum deposit price which will affect the Auckland property market's demand for purchasing houses, as lower income families may not be able to afford the deposit.
A way to possibly combat this problem may be that the Reserve Bank of New Zealand raises interest rates. This will result in an increased producer surplus, meaning that there is a higher profit to be made on properties, encouraging families to invest in a new property alongside the increased minimum deposit values.
Another issue that presents itself to investors within the Auckland Property market is Capital Gains tax. This means that any profit made on the resale of your property is taxed. A result of this tax is that there are increased costs to investment and the sale of property, which could lead to property owners and investors holding onto/banking their property. If owners hold on to properties it means that there is a decreased supply to the market.
To work around this issue property owners may look for financial management/financial managers. For example, they may employ a lawyer that can place the property in a Trust which will void certain taxes that may be issuable to the property otherwise. Doing so is an increasingly more common work around of the Capital Gains tax, but will not make the property totally immune to tax.
If the property owners decide to sell the property, they will most probably factor in the Capital Gains tax value into the sale price of the property. Although with current deterrents within the market, lower income families are less likely to sell their Auckland property as it is too costly and not viable for them to do so. These solutions will more likely apply to high income households and property investors as they can afford the costs of sale and purchase within the Auckland property market.
Because of the earlier mentioned increased rental prices and rent controls, there is a fall in the quantity supplied of housing. This results in a deadweight loss within the market as there is a maximum price set for rent (rent control) within the Auckland market.
This means that the rental market is not allocatively efficient - some households/families/individuals will miss out on renting a property.
This results in the production of a 'black market' within Auckland. Landlords may offer rental properties 'under the table', not meeting regulations and rules set. Although somewhat illegal, this black market may create housing opportunities for Auckland families.
Finally, with the implementation of NZ government housing subsidies, some households are able to house themselves more easily than without. This is known as an 'accomodation supplement' and allows typically lower-income households without a house to find a property and hold onto it. This also creates better (increased) rental affordability as households with high housing expenditure proportions - of their incomes - can now afford to rent within the price controlled Auckland property market. The increased affordability obviously leads to an increased demand for Auckland property.
If the NZ government and Reserve Bank continue to supplement the market with housing subsidies, there will be an almost certain increased producer surplus. This eventuates to market failure - which is far from desirable -, leading to supply and demand straying far from their equilibrium. The subsidies may also create further inequality between consumers (families/households and investors) and producers/suppliers of the property.