Why Do House Prices Rise?
None of us can control the market, but we can monitor and predict parts of it, writes Andrew Nicol.
1 March 2020
Despite the median sale price in New Zealand increasing by 3.7 times over the last 20 years, making property owners an estimated average $459,500, some investors are still cynical of market-made capital gains.
“You can’t control the market, so ignore market-made capital gains,” the narrative goes. It’s true, money can be made through instant equity and cash flow, but the majority of wealth created in leveraged property is made from long term price movements caused by the market.
Still, they are right (in part). None of us can control the market, but we can monitor and predict parts of it. So what makes house prices go up?
The usual answer is supply and demand. Housing supply is relatively easy to track, given that we can track the number of new dwelling consents.
But, housing demand is trickier. So, what influences demand in the housing market? And what should investors look for? Three areas impact housing demand (in order from the hardest to monitor, to the easiest to track): the financial environment; the New Zealand-wide economic climate; and changes in the local area.
The Financial Environment
All of the following increase housing demand:
• Falling interest rates make lending cheaper, increasing borrowers’ appetites for taking on more debt;
• Changes in bank lending policies make borrowing more manageable. For instance, if the test interest rate decreased, it would allow more borrowers to pass the bank servicing tests. This would enable more people to access lending and enter the housing market.
• Reserve Bank changes to its macroprudential policies, for example, decreasing the loan-to-value ratio so that borrowers can buy a property with lower deposits. These factors are tough to predict, and we have the smallest ability to forecast changes in these factors. We should, therefore, spend more time looking at the other factors that influence demand.
New Zealand-Wide Economic Climate
Next, we have the broader economy. These factors increase housing demand:
• Rising average incomes give borrowers the confidence to borrow, as well as more money to service mortgages. This allows them to take out more lending, which they can use to bid up house prices.
• Falling unemployment enables more people to enter the housing market. Even if these jobs are taken up by renters, higher rents encourage other renters to transition into homeownership.
You have more ability to predict these macro-economic changes than changes in the financial environment. The average weekly professional wage steadily increased by 28.9% for men and 35.3% for women over the last 10 years. This equates to 2.6 - 3.1% compounding annual growth. As wages increase, workers can borrow more, which helps to keep house prices buoyant.
Change In The Local Area
By far, you can most closely track movements in local areas. All of these factors will increase housing demand:
• More households forming, who then look to buy properties. This is influenced both by population growth and the number of people per household. If populationm increases or the number of people per household decrease, housing demand will increase
• The area you invest in becomes more attractive, whether through gentrification or by businesses moving into the area.
• Incomes increasing in that area at an faster rate than the rest of the country. This will drive housing demand and signify higher house prices in that area. While you can’t control these factors, you can monitor and predict them, which allows you to make an informed decision about where you invest. It’s hard to predict changes in the lending environment. But, local and NZwide economic factors are relatively easy. Stats NZ and Figure NZ show forecasted population growth for each region; income growth is relatively stable; and we broadcast this data almost every week on our Property Academy Podcast.