For several years now the housing market has defied predictions of a downturn. Several periods of moderating sales and price growth have been followed by waves of renewed strength, thereby creating an aura of invincibility.
Real estate agents have a vested interest in nurturing that impression. It is wrong, though, to conclude that, because the adjustment has not happened so far, it will not occur at all. Even though the timing may be uncertain, the reality is that a downturn is inevitable.
The housing boom has relied to a great extent on households' increased appetite for debt and it is the fast-growing cost of debt servicing that will ultimately force the long- awaited correction in housing demand.
The rise in household debt has exceeded income growth in every year since the early 1990s. The ratio of debt to disposable income stood at around 60 per cent in 1990 and reached 110 per cent in late 2001.
Since then that upward trend has accelerated as strong economic growth and falling unemployment have increased household optimism about future earnings. Mortgage rates that were low by historical standards and high house price inflation reinforced the increased willingness to borrow.
The debt to income ratio now stands at more than 160 per cent. Not only is that level the highest among developed economies, New Zealand borrowers are facing significantly higher interest rates than elsewhere. As a result, a comparatively large portion of aggregate household income is required for debt servicing.
The ratio of debt servicing to disposable income, which averaged around 8.5 per cent during the 1990s, has increased to 13.5 per cent since then. In the United States, Canada and Britain that figure is only about 8 to 9 per cent, while it is 11.5 per cent in Australia. A 13.5 per cent income share may not appear very high, but it has to be remembered that this is an average across all households. A large share of households has no mortgage at all. Taking that and rental income on investment properties into account, the average debt servicing ratio for households with mortgages is probably close to 25 per cent.
More important than averages, however, is the distribution of debt, with an increasing number of highly geared borrowers now struggling to make ends meet.
Households added nearly $19 billion to their liabilities during the past year, an increase of 13.7 per cent. If that pace were maintained, the already high cost of debt servicing would continue to rise at twice the rate of income growth. That trend is clearly unsustainable.
Bringing the rise in debt servicing cost into line with income growth would require the additional annual borrowing to fall from $19 billion to around $10 billion, a considerable adjustment that would impose a major constraint on growth in household demand.
THE OUTLOOK for consumer spending in both the Treasury and Reserve Bank economic forecasts is based on the scenario of a slowing debt uptake. The Treasury expects consumption growth to ease to 1.6 per cent per annum over the next few years, while the Reserve Bank is more pessimistic in projecting it to trend down to zero over the same period.
Similar dips in consumer spending growth in 1998 and 2000 led to brief periods of falling house prices. Taking history as a guide, a more protracted slowdown, as is forecast for the next few years, is likely to lead to a more substantial correction. Moreover, having supported the housing market on the way up, the increased share of investment properties may be a factor that reinforces the slowdown.
In many cases those investments are not profitable without ongoing capital gains. The prospect of a multi-year period of falling or stagnant prices may cause investors to put those properties back on the market sooner than originally envisaged.
Even though residential property may be a safe and high-yielding asset over the long term, it is not a good idea to enter the market ahead of a multi-year downward correction.
While it remains uncertain when the tipping point will be reached, the debt fundamentals suggest that the housing boom is living on borrowed time.
# Ulf Schoefisch is an independent economic consultant.
