Lessons From The GFC
A decade on, from the global financial crisis, what have property investors learned? By Daniel Dunkley
1 September 2018
On September 15, 2008, Wall Street bankers hurriedly packed their belongings in cardboard boxes and fled the offices of investment bank Lehman Brothers. The American banking titan had just filed for Chapter 11 bankruptcy, becoming the biggest lender to go under in US history.
The collapse of Lehman Brothers, caused by its exposure to risky subprime mortgage securities, triggered the onset of the global financial crisis, setting in motion the worst financial downturn since the Great Depression.
No national economy was immune from the Global Financial Crisis (GFC). Huge government bailouts rescued lenders in America, Europe, and Asia, while others were acquired by rivals during a frenetic period of merger activity. Consumer credit for home loans, car finance, and personal spending dried up overnight as banks sought to avoid becoming the next Lehman.
The global property market, propped up for so long by loose underwriting standards and low-quality borrowers, collapsed as the subprime market buckled. Customers who had gorged on 100% or even 125% mortgages before the crisis were left hopelessly underwater. In America, tales of keys left in letterboxes, and rows of abandoned homes, were not uncommon.
Over 14,400 kilometres away from Wall Street, the GFC also took a tight grip on New Zealand’s property market. The GFC tipped New Zealand over the edge after a year of economic decline. From a peak in mid-2007, the New Zealand economy had already begun to stutter. GDP fell by 1% in the first quarter of 2008 as the country slipped into recession.
How hard did the GFC hit New Zealand’s property market? While New Zealand did not have a crisis on the scale of America or Britain, data shows average house prices plummeted between December 2007 and March 2009, falling by 9.7% according to CoreLogic. House price-to-earnings ratios fell to 5.2, down from 5.8 in 2007.
Why Did NZ Escape?
In real terms, the downturn was less severe than New Zealand’s 1974-1979 slump, when house prices halved. The New Zealand economy largely held together during the GFC, due to tighter lending controls and stronger capital adequacy regimes at the country’s major lenders. Economists say New Zealand’s ability to significantly slash interest rates saved the domestic property market.
Craig Ebert, an economist at BNZ, believes New Zealand “sailed through” the crisis. He adds: “Unemployment rose by 2 or 3%, rather than the doubledigit rates seen in other countries.”
Ebert says three main factors kept the Kiwi economy and housing market stable: a more robust banking system, sustained employment, and Reserve Bank rate cuts: “In New Zealand, we had a central bank that was leaning against a lot of pressure from the previous cycle. One manifestation of this was that interest rates got to strong levels, with rates of 7%, 8% and 9%,” Ebert says.
Kelvin Davidson, a senior research analyst at CoreLogic, describes New Zealand’s GFC as a “short episode” compared to the turmoil seen in America or Britain. “The banking sector in New Zealand stayed healthy and they didn’t have to come down hard on borrowers. Pre-crisis standards were higher, and there was more resilience.”
Is Today's Market Sustainable?
Following the GFC, the New Zealand property market enjoyed a slow and steady recovery. Low interest rates have remained in place since the crisis, due to less-than-stellar GDP growth. Strong population growth and a lack of housing stock has also driven the market in recent years.
‘It is not about reading the market. It is about setting yourself up so it doesn’t matter’ GRAEME FOWLER
Economists are unsure whether we have hit the top of the market. Price-toincome ratios are higher than they were before the crisis.
Dominick Stephens, Chief Economist at Westpac, does not believe current prices are sustainable. Stephens says Auckland was “more vulnerable” than the rest of the country: “My modelling suggests New Zealand houses have once again fully priced in the reduction in mortgage rates. While I’m not forecasting a large mortgage rate rise in the next few years, if that happens, the housing market could be in a lot of trouble.”
Stephens adds: “A red flag would be what happened pre-GFC. A period of low interest rates drove the value of houses, underlying to rental streams, higher, and drove asset prices higher in search for yield. People made a mistake and acted as though those rates would last forever. When rates rose prices were no longer sustainable. That could absolutely happen again.”
BNZ’s Ebert agrees: “History would tell us all the metrics we tend to look at are exceptionally stretched, certainly in Auckland. Is this an adjustment to a low interest rate environment? People need to ask whether rates will stay low, or whether this is the new normal.”
While interest rates may increase, Ebert and CoreLogic’s Davidson say house prices would be supported by population growth and a national shortage of housing stock.
A decade on from the GFC, what have property investors learned? And how can they insulate themselves from the next downturn?
For some investors, focusing on individual investments, rather than the cycle, is key. Experienced investor Graeme Fowler says he does not let the macroeconomic picture cloud his judgement. Fowler, who owns residential property from Hawke’s Bay to Hamilton, says he focuses on individual investments. He chooses long-term holds with a yield of at least 8%, in areas with a population of more than 100,000. He adds: “It is not about reading the market. It is about setting yourself up so it doesn’t matter.”
According to Fowler, many investors were over-aggressive with financing before the GFC, leaving them exposed once the banks tightened up. He says investors should use “common sense, rather than things they can’t control”. He argues loan-to-value ratio (LVR) restrictions are “a good thing” that have encouraged investors to “buy well”.
Andrew Bruce, an Auckland property investor and President of the Auckland Property Investors’ Association, described the GFC as “a struggle”. He says the key lesson learned was that “cash flow is king”.
Bruce says investors reliant on flexible credit facilities were caught short in the last crisis: “If you are just buying for capital gains, and there is a squeeze on cash flow, and you can’t pay your interest bill, things can get pretty ugly pretty quickly.”
Since the GFC, the Reserve Bank has introduced a raft of measures to curb reckless lending.
Westpac’s Stephens believes LVR restrictions have “broadly done the job they were meant to do”. He adds: “We saw what might happen here, and learned from it. We can see the number of high LVR loans is a lot lower, and that is the measure of success for these things.”
CoreLogic’s Davidson says curbs on interest-only lending would also help to reduce risk. “Putting a speed limit on interest-only lending has also helped. They are pre-empting any flashing red lights, and there is proactive stuff going on this time.”
"It is quite different to 2007,” says Stephens. “Interest rates are low, and banks are not lending 95% or 100% LVR. They are loath to lend on interestonly terms. Banks are better funded, so the situation is not anything like 2007 just yet.”
While tight lending controls have reduced the chances of a future New Zealand property crisis, some investors are hoping another downturn will eventually arrive and disrupt the market.
“Another GFC would be a good thing,” Graeme Fowler says. “Because all the investors with risky strategies that don’t know what they’re doing will probably have to sell.”
When the next downturn hits, investors will hope to use all of their experience from the GFC. If they can, the next crisis could present plenty of opportunities.
While New Zealand did not suffer a high-profile banking collapse like Britain’s Northern Rock or Wall Street’s Lehman Brothers, a host of non-bank lenders and finance companies retrenched from the market in the aftermath of the GFC.
More than two dozen mortgage finance companies collapsed, including South Canterbury Finance, once New Zealand’s largest independent finance company. South Canterbury’s collapse led to a $1.6 billion bailout by the New Zealand Government. Others, including Dorchester Pacific, ran into severe financial difficulty and came close to ruin.
Another high-profile departure from the New Zealand market was non-bank lender Bluestone Mortgages, part of the Bluestone Group. The finance company left New Zealand in 2008 at the height of the financial crisis but continued to manage a small loan book.
Yet in recent years, non-bank lenders and finance companies have made a comeback, amid tightening credit conditions at the major banks.
Late last year, Bluestone announced its return to New Zealand. Other non-bank lenders, including Australian company RESIMAC Home Loans, set up in New Zealand after the economic recovery.
Non-bank lending has increased over the past year. Non-bank lenders and finance companies enjoyed a 12.19% increase in total assets last year, with assets of $10.96 billion.