The three key risks are rising interest rates, a recession and falling property values (yes, it can and has happened).
Residential property investors are chasing capital gains rather than rental income. Auckland rents have risen 35% since late 2007, less than half the rate of increase in house prices. Average gross rental yields in Auckland are just 3-3.5%, which is not enough to cover the cost of interest, insurance, rates and maintenance, says Mark Lister, head of research at Craigs Investment Partners.
Lending to property investors has been growing rapidly, and 55% of new loans to investors are on interest-only terms, notes ANZ economist Cameron Bagrie. That compares with 30% for other buyers. Household debt is now 163% of disposable income, above the previous peak reached in 2009.
For investors who have been feasting on cheap debt and totting up their capital gains, it might feel as if nothing could possibly go wrong. But any number of things could tip highly leveraged landlords into strife, says Lister. The three key risks are rising interest rates, a recession and falling property values (yes, it can and has happened).
What might cause conditions to sour? The record-breaking migration flows that have been keeping the housing market boiling and the economy rocking could fall back if, for example, Australia’s economy again started luring New Zealand workers westwards across the Tasman, instead of causing them to stay put or come home as it is now.
Or some kind of global economic shock could batter the New Zealand economy and increase the price of debt. By definition, such shocks are often not foreseen, says Lister, but he lists a few that are within the realms of possibility: fallout from a serious downturn in China, which is “up to its eyeballs in debt”; further bad news in Europe, such as other countries following the UK out of the EU; a biosecurity crisis or major natural disaster hitting New Zealand; disruption to the booming tourism sector, which, like immigration, has been puffing up the economic growth figures.
“If one of those happens and all of a sudden you saw unemployment rising, wages falling or people struggling to pay their bills, it would flow through and you would start to see downward pressure on [house] prices. Those are the medium-term risks, and when you have a lot of debt sitting behind [housing assets], as we do now, you don’t have much of a buffer to ride out the rough periods.”
Residential property investors are less resilient to falling prices than owner-occupiers, who tend to hunker down and find a way to keep paying the mortgage. “But investors who are highly leveraged and dependent on these exceptionally good conditions for things to stack up are arguably at a little more risk because they have become very reliant on these ongoing capital gains to make this whole house of cards work for them …
“The behaviour you are seeing in property markets is similar to what we have seen in all those other areas of over-exuberance in history, like the internet shares in the early 2000s, the sharemarket in the 1980s and before the global financial crisis.
“The earnings and cash flow that an asset generates should be the No 1 factor that determines whether you buy it or not. When people start ignoring their earnings and cash flow and start blindly buying because they think prices will continue increasing, then you know you are getting into dangerous territory.”
Follow the Listener on Twitter or Facebook.