By Gordon Edginton

The long overdue downturn is here.  Signs of a softening started in October/November 2007 and has been cemented in place in the first three months of this year with very low turnover – down a whopping 46% from the same time last year.  January-March 2008 sales volume is averaging 1,700 sales per month compared to 3,145 averaged last year .

March is usually the best month for residential sales turnover with an average annual turnover in the last six years of 3,000 sales per month.  However, with current sales figures down between 1,700 to 1,800 per month, this March is shaping up as one of the worst in 15 years.  Days to sell are dramatically up from 2007 when the average was 30 days but are now at 47 days, which is 57% longer to sell and likely to get worse through winter when compared to the 10 year average of 37 days to sell.

History Repeats

House turnover of 1,800 per month is nothing new.  In the last two housing slumps of 1998 to 2000 and 1990 to 1993, monthly turnover was at a similar level, trending around 1,500 to 1,800 sales per month.  The catalyst to those slumps, as now, were high interest rates, a flagging economy and poor net migration.

The market has been running at unsustainable levels for too long.  This boom started October 2001 and has run pretty much unabated for six years, petering out November 2007.  This is the longest boom in my memory.  A correction should have come in to play two years ago.  The fact it didn’t and the market has kept going for so much longer, probably sets house prices up for a bigger fall than what has occurred in the past.

In the last downturn, prices contracted by (on average) less than 10%.  The downturn prior was more severe (remember the “mother of all budgets”) with a drop on average, up to 15%.  The current downturn could be as bad as that seen in 1992.

Some commentators are predicting falls of up to 30%.  While this may be possible in selected classes of property or suburbs, it is very unlikely across the board.

In our view, property types at most risk include apartments (mainly the small cramped rental variety), high end luxury homes, and low cost housing in the least favoured suburbs.

House Prices Fall

There are good reasons not to invest in property at the moment as the outlook for capital gain is non-existent.  In fact, falling house prices are pretty much a certainty as the market goes into a tailspin. 

The previous two downturns each lasted around 2-3 years.  The early 1990’s “bust” was from late 1990 to mid 1993 – about two and a half years.  The early 2000’s “bust” was from 1999 to mid 2001, lasting only two years.

I would be forecasting another two year downturn this cycle – i.e. 2008 and 2009.  By 2010 things should be improving.  Assuming no major overseas collapse.

Auckland’s median price has already fallen to $427,000 in February 2008.  This is a decline of 7% from the peak price of $460,000 achieved in December 2007.

Prices were plateauing throughout 2007 anyway as the median sat between $440,000 and $450,000 for most of the year.  The speed of the fall to date is surprising and will result in most property remaining on the market for extended periods.  In fact, as activity is likely to slow further this winter, much of the property currently listed will probably be withdrawn as vendors will be unable to reduce their expectations sufficiently to meet the market – unless the vendor is getting desperate.

There are undoubtedly numerous under capitalised investors and first home buyers who will be feeling the pinch of the high mortgage interest costs and negative cash flows.  With no capital gain on the horizon for the next two or more years, many of these investors will be wanting to exit the market quickly.  An avalanche of investment property may well hit the market this winter as investors bail out.  Many will be distressed sellers and there may be some very good buying to be had by the canny investor with cash in his pocket. 

Migration and Interest Rates

So what has happened to turn the market this suddenly?  In a nutshell, interest rates and migration.

Primarily, high mortgage interest rates with floating rates at 10.5% and two year fixed rates of 9.5% to 9.7% – well above the past five years levels.  The Reserve Bank is showing no signs of loosening monetary policy just yet as there is still strong inflationary pressure through the economy.  So the current interest rates look set to remain for most of this year.

Coupled with this, the liquidity crisis in worldwide financial markets and sub- prime mortgage fiasco in the US, have tightened lending criteria and increased interest rates.  Numerous second tier lenders and finance companies have failed and finance for developers is now more difficult (and costly) to find.  Borrowers who have relied on this source of funding will be left high and dry.

Net migration gains have stalled and could well turn negative this year.  Migrants are still coming to New Zealand but more Kiwis are leaving than ever before – mainly to Australia where higher wages, strong employment, a booming economy and more affordable housing (not everywhere) are attracting Kiwis in their droves.

Without the past migration growth, the property market looks set for a very weak phase.  When we think back to the 2003-2004 period when New Zealand had a net migration gain of 40,000 a year and fixed interest rates were only 7.5%, it is not hard to see why the real estate market was booming. 

Other factors at play include the drought and high exchange rates affecting the rural sector with flow on effect from reduced spending and investment.

Because of all this, consumer confidence has hit negative territory for the first time since June 2000.  It has always been a precursor to the housing market which is following the same negative dive.

Rising food and petrol prices, high mortgage interest rates, drought, falling house prices and a global financial crisis are all to blame.  Insulating these negative aspects are good wage growth, low unemployment and an economy that is still growing, albeit at a more muted level.

But the outlook for the economy is looking much weaker, not helped by worsening perceptions of consumers own financial position.  The more doom and gloom talk there is, the greater the chance of the economy becoming very bad.  It becomes a self fulfilling prophecy.

The Outlook

Its not all doom and gloom though.  These property cycles are inherent in our economy with typical 7-8 year ebb and flows.  The current boom has just gone on a bit longer than normal.  The downturn was long overdue and expected from the unsustainable high levels of turnover and sales prices.

A two year trough can now be anticipated with many good buying opportunities likely to arise.  Getting back to the fundamentals of property investment looking at rental return as a function of price rather than chasing capital gain should be an investor’s primary focus now.

Rental growth is being achieved in housing.  There should be a growing demand for rental accommodation due to the current unaffordability issues with house prices and a slow down in construction activity and hence the overall supply of housing stock.  New dwelling construction is slowing currently and this will mean reduced supply coming on stream.  Furthermore, many developers will shut up shop due to lack of finance, again shelving housing/apartment projects and constraining supply.  The outlook for rental investors could actually look quite sound.

Increasing wage growth from the very tight labour market will help to underpin the opportunity for rental growth.  Coupled with this, the high degree of job security with very low unemployment will give people some security as times get harder.

Moreover, tax cuts have been signaled for late this year or 2009 which will give some optimism and interest rates should start falling by next year at worst.  This will boost spending and people’s willingness to take on more debt.

Property has historically always been seen as a safe bet and a good hedge against inflation.  Sure, there may be some small losses now and again, but over time property has kept well ahead of the rate of inflation.  In times of increasing concern about inflation, property should be one of the first assets an investor should turn to.  The trend line below is interesting to follow, indicating the next boom is likely to be much weaker than in the past.

Gordon Edginton, the author of the Residential and Commercial Property Review, is a Director of Prendos. He is a Registered Valuer and has a Bachelor of Commerce degree from Lincoln University. He has been the author of this newsletter for the past fourteen years and is the principal compiler and analyst behind the graphs produced. Gordon regularly makes presentations and advises various major lenders on the state of the Auckland property market. Gordon completed a Certificate in Plant Machinery Valuation which he passed with distinction.