When Will The Dam Burst?

In property, as in all forms of investment, it’s important to have a long-term view and bear in mind lessons from the cycles we’ve been through before.

The voices of alarm we’re hearing from some pundits now, takes me back to 2011. Then, we were four years into the life of Erskine + Owen and in the depths of a recession. It wasn’t the easiest time to be extolling the virtues of property investment! Some people were running around like Chicken Licken thinking the sky was about to fall. Now, we all understand what caused that crash – if you haven’t watched the movie The Big Short, have a look – it explains everything in simple terms (and Christian Bale is a great actor). People thought the economy, financial markets and property markets had fundamentally changed. We didn’t agree.

So off I trotted to New York and London to talk about the New Zealand property market. We’d spent hours and hours analysing the data – and after being cross-eyed, it started to come into focus for us. It seemed really, really simple. If there are more people than houses – then surely something has to give. Surely at some stage people will start to buy again. It wasn’t that people didn’t want to buy, it was just that they were 1) nervous about their jobs (consumer confidence), and 2) finding it much harder to get finance.

In these presentations I put up a picture of a dam. My pitch went something like this: ‘Look at this small little river… just a trickle of water. But it’s not that there isn’t more water there – it’s just sitting behind the dam. At some point, if the lake level keeps rising, that water will be released, or it will spill over.’

Many people thought I was on drugs. ‘Don’t be ridiculous,’ they responded. ‘The affordability gap is just too big – prices won’t go up again like that, there will a 30% correction’. But other people agreed, and we helped them build portfolios. Those investors have enjoyed huge capital growth.

With the benefit of hindsight, this looks very obvious. It seems clear that the market was going to have to turn at some point. After all – that’s exactly what had happened historically. Thing is, being rational is easy when it’s just theory. Try being back in 2011, trying to convince your more cautious partner going long in property is the right thing to do.

And so we turn to 2017. Any sense of deja vu? We’re hearing the same voices: ‘Affordability is out of control… prices can’t go up again… there will be a huge correction…’ And here we are again with credit availability tightened, in the form of a Reserve Bank  40% deposit requirement and banks introducing stricter lending criteria.

However, we haven’t stopped analysing the data. We keep asking ourselves – what has fundamentally changed? Has demand shrunk? Well, yes it has in one sense – the river of finance approved investors – but demand has also grown, in the dam of wannabe investors that can’t get finance. So in the wider sense, demand has not disappeared at all, it’s just held back by the credit dam. So what about supply? Are we at risk of being the Ireland of the Antipodes (as some have suggested) with so much excess stock we can’t even rent it? Hardly.

Ironically, I think the Reserve Bank may have created a fruitless game of ‘Whack-a-Mole’. It goes like this: they whack investors to take out demand and stop rapid price increases. Yep – that worked. Only problem is, investors make up about 40% of the market, so then you have a lot less buyers. At the same time the population continues growing, and we need more houses. Builders can’t build if they can’t sell their properties. And many are struggling – we know because we talk to lots of them, and many say their open homes are empty, their show rooms are quiet. We’re also seeing developers who have had funding pulled when NZ banks repatriated money to nervous parent banks in Australia. So hence we get Whack-a-Mole: up pops the mole of worsening supply and the 50,000 Auckland house shortage just grows.

What does all that mean? In my opinion, something will have to give. Perhaps the first thing is that rents will start to grow at a faster rate as supply fails to keep up with housing demand. Then with ever increasing percentages of people renting, there is a bigger voice. As it becomes unaffordable to rent tenants become stressed, then they start to make noise. It gets in the press, it starts to become thrashed on talkback radio. Politicians get challenged on their answers. Then they get voted out because renters want the other party who have promised to fix it. The new party valiantly gallops in to open up supply. How? Well, first there needs to be more finance… Can’t build without that. And off we go again. Don’t believe me? Just look at Queenstown – there is a housing crisis and renter woes are regularly in the headline news. How long before politicians get dragged in?

What would I do in this market? Easy. I’m a long term investor – minimum ten years – so I don’t buy with the intention of selling. I encourage my clients to do the same. In 10 years’ time, given where demand and supply is now, I can’t possibly see how prices won’t be significantly higher than today in key areas. So I’m buying. Feel free to contact me to discuss my latest purchase.