Yesterday the Reserve Bank issued its May Financial Stability Report. The report identified three systemic risks facing the New Zealand financial system. The Reserve Bank also announced changes to the loan-to-value ratio (LVR) policy in response to the growing housing market in Auckland. The proposed changes have received significant media coverage but what do they actually mean?
The three systemic risks facing the New Zealand financial system that are identified by the report are:
- Auckland’s median house price is 60 percent above its 2008 level, and house prices in Auckland have been rising rapidly since late last year.
- The dairy sector is experiencing a sharp fall in incomes due to lower international prices. Many highly leveraged farms are facing negative cash-flows.
- Low interest rates around the world are encouraging investors into riskier assets in the search for yield. Prices of both financial and real assets are becoming overextended in many markets.
The Reserve Bank announced changes to the LVR policy in response to the growing housing market in Auckland. The policy changes will:
- Require residential property investors in the Auckland Council area using bank loans to have a deposit of at least 30 percent.
- Retain the existing 10 percent speed limit for loans to owner-occupiers in Auckland at LVRs of greater than 80 percent but relax the speed limit for loans outside of Auckland by increasing it from 10% to 15% of new lending.
These adjustments to the LVR policy will directly target investor activity in the Auckland region, where house prices relative to incomes and rent are far more elevated than elsewhere in New Zealand.
Most banks, commentators, and other interested parties acknowledge that the main issue with the Auckland housing market are supply related. It is beyond the Reserve Bank’s powers to address those issues. However, the Reserve Bank can take steps to mitigate short-term risks to the financial system in the Auckland housing market.
Why target property investors?
Since November last year Auckland House prices have risen rapidly, and as the Reserve Bank noted they are now 60% above 2008 levels.
The graph below is taken from Box A in the Financial Stability Report which provides information about investors and the New Zealand housing market.
Housing investors have consistently accounted for over one-third of property purchase transactions over the past decade, with the share rising slightly following the introduction of LVR restrictions in October 2013. However, sales to investors in the Auckland market have picked up in line with the rise in sales activity since November, and the Reserve Bank considers that is likely to be contributing to recent strength in Auckland house prices.
Additionally during a financial crisis, defaults on investor lending tend to be significantly higher than for owner-occupiers during severe downturns and this risk will be one of the reasons the Reserve Bank has proposed the measures that it has to address the short-term risks.
It will be interesting to monitor the effect that these restrictions have on the Auckland housing market, particularly as the Government struggles to address the significant shortfall in supply. Let us know what you think would be the best options for addressing some of the Auckland housing prices in the comments section below.