Much bigger drop than predicted for house prices

In the bank’s November Economic Overview, the economists say the weakening in the housing market has been widespread, but it has been particularly stark in larger centres. Notably, prices in Auckland have fallen 16%, while prices in Wellington are down a whopping 18%.

With interest rates increasing, Westpac is forecasting house prices nationwide will fall by a further 10% over 2023 and 2024 combined. Coming on the back of the falls already seen, that will leave prices down 20% from their peak in 2021  - the bank’s previous forecast was a 15% fall.

Because the downturn in house prices comes at the same time as other prices in the economy are rising, - including building costs and wages - that means “real” house prices are set to fall by 30% from their 2021 peak, says the bank.

“The combined impact of higher interest rates, large increases in the cost of living and a weaker housing market points to a significant slowdown in household spending over the coming years, says Michael Gordon, Westpac’s acting chief economist. “Many households will be forced to wind back their spending due to the mounting pressure on their finances. And many others will do so out of an abundance of caution.”

Big changes are also on the cards for the building and construction sector as financial conditions are becoming increasingly unfavourable. In addition to higher financing costs, material prices have skyrocketed, rising by more than 10% over the past year alone. The sector is also struggling to source the skilled labour it needs, which has seen labour costs climbing rapidly.

“Many prospective buyers are nervous about buying new builds, and developers are becoming more hesitant to bring new projects to market.” A number of small to mid-size construction firms are already reporting a drop-off in forward orders, and some planned projects are being shelved.

Westpac is forecasting a 12% decline in home building over the next few years. However, this is a drop from historically elevated levels of activity.

And rather than a sudden drop, the downturn is likely to be gradual, with more then 50,000 new dwellings consented over the past year.

In fighting inflation, one of the RBNZ’s major complications is the prevalence of mortgage rate fixing. About 90% of New Zealand mortgages are on fixed rates, and many of those are still locked in at the low interest rates on offer in the early stages of the pandemic. For example, a borrower who fixed their mortgage at 2.7% in 2020 will now face refixing at a rate of 6% plus.

Large numbers of households are yet to feel the impact of rate hikes, which has allowed them to maintain their spending patterns.

Gordon says the “effective” average mortgage rate borrowers are paying is still only about 3.3%. As a result, the share of household incomes being spent on debt servicing is sitting close to multi-decade lows.

That picture will change dramatically over the coming months, with more than half of all mortgages coming up for repricing over the next 12 months, he says. “In many cases borrowers will face refixing at rates that are three percentage points higher than those they are on. As that occurs, we’re certain to see a slowing in domestic demand.

“The resulting increase in debt servicing costs will take a large bite out of many households’ disposable incomes. And combined with the ongoing increases in living costs (especially for necessities like food, housing and transport), that signals a significant squeeze on households’ spending power.

Gordon says the impact of those rate rises will feel different for households across the country. “For those households who took out a mortgage several years ago, the fall in interest rates in recent years has translated into a sizeable financial windfall, meaning that they could increase their spending while also saving more. That increase in savings is now providing a buffer from the other factors that are squeezing their purchasing power. In addition, while these borrowers are looking at potentially large increases in their interest payments, that is a rise from historically low levels – interest rates are ‘only’ going back to the sort of levels these borrowers faced during the past decade.”

In contrast,  says Gordon for those households who first took out a mortgage over the past one to two years, the interest rate rise now in train signals a much larger squeeze on their finances. These borrowers will not have had the same chance to rebuild their savings since purchasing a home. Consequently, the rise in borrowing costs is likely to impose a much larger drag on their spending. At the same time, many of these borrowers will have seen the value of their housing assets falling since taking out a loan.”