House arrest: Will New Zealand face a construction bust before a housing bust?by Pattrick Smellie
As the property market slows right down, Pattrick Smellie examines fears we’ll have a construction bust before a housing bust and looks at what should be done.
New Zealand has long had a boom and bust building industry, but the busts usually occur at the bottom of the cycle. That last happened in 2007, when a local recession was followed by the global financial crisis.
Achieving a bust at the top of the cycle would be quite a feat, but that’s what independent economist and Generation Rent author Shamubeel Eaqub reckons we’re heading for.
For many builders, the problem is simply this: more than a year ago, they signed fixed-price contracts that are turning out to have been underpriced as rampant demand creates project delays and the costs of staff, building materials and finance rise sharply.
Even the big players can be caught out. Fletcher Building, one of the country’s largest companies, warned last month of an unforeseen $110 million hole in its profit projections because it underbid on two major contracts, one of them probably SkyCity’s New Zealand International Convention Centre in Auckland.
“Contractors are so busy that if something happens and you’re two weeks late, then you are six months late and you go to the back of the queue,” says Helen O’Sullivan, chief executive of Ockham Residential, one of the few large-scale developers in the market. “That puts a strain on financing.”
Developers relying on presales to finance their project can quickly find they’ve sold for less than the cost of construction. That didn’t matter so much when the value of Auckland housing was going through the roof. The expected capital gain made up for the under-recovery on construction costs.
For now, however, that music has stopped. Although the city still tops the national league table by a country mile, with a 91% increase in the average house price since the market last peaked in 2007, values fell 0.4% in the first three months of this year and are expected to remain stalled.
Screws go on the money supply
New Zealand’s trading banks are getting so nervous about both the escalating cost of building and the unaffordability of existing homes, particularly in Auckland, that they’re tightening up on lending well beyond the stricter loan-to-valuation-ratio (LVR) restrictions imposed by the Reserve Bank last September.
In the past, second-tier finance company lenders might have stepped into the gap, but that sector was all but wiped out post-2008.
Also adding to the loss of momentum is a Chinese Government clampdown late last year that has slowed to a trickle the flood of private money previously flowing to property in such cities as Auckland, Sydney and Vancouver.
With average household indebtedness close to 10 times household income – making New Zealand the world’s most overvalued property market, according to the Economist last month – and interest rates starting to rise, this moment was always coming.
Andrea Rush, at government-owned Quotable Value, says values in cheaper parts of Auckland favoured by investors are still too expensive for many first-home buyers. “Prices are still too high mostly and there are reports that some deals are falling over at the finance stage due to stricter criteria from banks.”
The effect is most marked for property developers. “Even though we have an acute housing shortage in Auckland, the most difficult to find funding for now is new developments,” says Eaqub. “When the banks pull away credit, the first thing that goes is the riskiest elements of the market.
“We are going to have a construction bust before we have a housing bust. We haven’t built enough houses for a long time. And if we’re going to keep not building enough houses, I’m not confident that whatever correction we have in the housing market is going to last.”
In other words, is the current slowdown in both house-price inflation and construction a permanent change or a breather?
Labour’s housing spokesman, Phil Twyford, thinks it’s the latter. “The fundamentals are still: very low interest rates, very high immigration and this entrenched shortfall of housing,” he says – about 35,000 to 40,000 too few houses in Auckland now, getting worse by 6000 a year. “None of those things have changed. If we are seeing a pause, it’s only going to be temporary.”
For its part, the Government sees a huge bow wave of building activity coming to fruition, with consents for new homes in Auckland last year topping 10,000 for the first time in 12 years and 40 houses being built in the city every working day, “four times what it was when we were elected”.
Realtors Colliers International certainly see a wave of new apartments coming to market in the next few months, with 2270 apartments due for completion this year, the highest number since 2005, after which there was a marked slump, and 3840 apartments on the books for completion in 2018.
While all this may not be enough to fully meet demand any time soon, Building and Construction Minister Nick Smith has described this rate of expansion as being “as fast as you can practically grow a sector as large and as complex as construction without compromising quality”.
Biggest single policy issue for voters?
Whether long or short term, the current pause is occurring in election year.
The assumption that rising house prices are the National Party’s primary bulwark against discontent over other issues, particularly high immigration, might start to peel away if house-price inflation doesn’t continue.
That makes housing the biggest single policy issue for voters, suggests Oliver Hartwich, director of the business-backed New Zealand Initiative think tank, which has spent much of its five-year existence examining how we got into this mess. “Housing is the central issue. House prices are ridiculous,” says German-born Hartwich. In his home country, house prices remain at 1970s levels.
However, he fears another election campaign based on arid debates and stereotypes. “It’s a double challenge. To the Government: ‘Show us you care and aren’t tired’; and to the Opposition: ‘Show an interest in new ideas and evidence-based research.’”
He believes Labour has moved a long way in its policy thinking. Twyford has convinced the party to adopt a policy that does away with urban-rural boundaries – a big step further than the belt-easing in the current Auckland Unitary Plan – and champions the creation of infrastructure bonds and new financing arrangements for city councils facing huge costs for new roading, sewerage, water, public transport and other costs associated with housing developments.
On top of this, Labour’s KiwiBuild policy targeting construction of 10,000 affordable houses – costing about $600,000 each – each year for 10 years represents a major difference from National, which is far less willing to use the Crown’s balance sheet to accelerate house building.
Twyford concedes that KiwBuild will take time to ramp up, citing the likes of Mike Greer Homes’ innovative prefabricated house building as part of the answer, along with a need for temporary skilled migrant workers to help meet demand while a larger New Zealand workforce is trained.
And like almost every politician in Parliament, Twyford is ready to begin the long, complex process of replacing the 26-year-old Resource Management Act (RMA) with new urban planning and environmental law.
The only place Labour won’t go is the vote-killing policy of a capital gains tax, although negative gearing, which allows property investors to deduct mortgage interest costs from their taxable income, is unlikely to survive. Party leader Andrew Little told The Nation that negative gearing will be “pretty much” gone under Labour. “We’re going after those negative gearing rules. There’s no need for them.”
National points out that with interest rates at about a 50-year low, a family with a $300,000 mortgage is paying about $300 a week less “than when we were elected”. Its latest housing policy is a $1 billion Housing Infrastructure Fund in high-demand areas for infrastructure such as roads and water needed to support new housing. However, this fund is a good example of how local government funding needs reform – Auckland Council doesn’t want to access this money because it goes on its balance sheet as a loan and makes life difficult with the credit rating agencies.
Housing is a “big, complex thing”, Prime Minister Bill English recently told Radio Live. “No one person has the answer, because if they did, we would have solved all the problems.”
It’s not just the RMA
Yet the housing problems are about so much more than that old bogey, the RMA, the lack of a capital gains tax or the “plannerism” so reviled by English as a big contributor to the poverty caused by the lack of affordable housing.
All are problems – both the RMA and urban planners have had in-built tendencies to stifle rather than allow growth in Auckland – but none is the whole problem.
Nor is it just about rampant immigration – although that’s not helping and Aucklanders overwhelmingly think it’s a primary cause.
Labour’s environment and regulatory reform spokesman, David Parker, says the influx of migrants to Auckland is so great that “Auckland now suffers a net loss of New Zealand-born residents to other parts of New Zealand”.
“Blaming the RMA and planners for Auckland is politically dishonest,” says Parker. “There is no doubt that National’s deliberately high rate of economic immigration – among the highest in the world – has thrown fat on the fire of Auckland house prices and homelessness.”
Eaqub disagrees, saying immigration is only a small part of the story, but the combination of rising public concern over high housing costs and high immigration is a politically potent mix that will be useful if Labour is negotiating a coalition deal with anti-migrant party New Zealand First later this year.
In part, the housing shortfall is also about central government failing over most of the past 26 years to use RMA powers to direct national standards and goals. Local councils have been left to make decisions with national implications, but in response mostly to local political pressures, aka Nimbyism.
“Wealthy people look after themselves in almost any circumstances,” says Murray Sherwin, chairman of the Productivity Commission, which has just delivered groundbreaking recommendations on urban planning and environmental law reform. “For poor people, the welfare losses and costs are very profound and long-lasting.”
Urban planning law needs to presume that population growth will occur and be provided for, he says. It may come as a surprise to many that it does not do so now.
The housing shortfall is also about the failure to train a workforce that can build houses quickly and well, and about the absence of a competitive, highly productive building industry.
Instead, the construction industry is a drag on New Zealand’s already low productivity rates, which see the economy as a whole growing at 3%-plus a year while output per head of population is static or falling.
And when the Government invited German plasterboard giant Knauf to provide materials to the Christchurch rebuild and compete with the entrenched position of Fletcher Building-owned Winstone Wallboards, Knauf lost money and lasted barely a year.
Crucially, the housing shortfall is also about a broken local government financing system that actively discourages councils from pursuing growth because, as currently structured, growth doesn’t pay for itself, when ideally it should.
This article was first published in the April 22, 2017 issue of the New Zealand Listener.
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