Interest rates to burst house price bubble

This is an about-turn from the bank that, as recently as two months ago, said house prices were not in a bubble.

As at the end of 2006, the investor value of housing was $327,000. The median selling price was $328,000, so Westpac chief economist Brendan O’Donovan concluded that houses were fairly valued at the time.

But mortgage rates have experienced an extremely sharp increase, following rate-hikes from the Reserve Bank and interest rate increases on wholesale markets.

O’Donovan’s current valuation on the median house is $278,000. “That assumes a five-year mortgage rate of 8.5%, a 2% increase in rents over the six months to June, and a long run average capital gain of 6% per annum,” he says. Meanwhile the latest REINZ data shows that the median house was selling for $343,500 in March.

Houses are now selling for much more than they are worth to property investors, says O’Donovan, who predicts there will soon be a notable absence of investors from the market, and house sales will slow. In addition, high prices and high mortgage rates will be tilting ordinary people’s rent-or-buy decisions in favour of renting and away from buying.

While he says rents could rise more quickly, they will still not be nearly enough to cover the cost of higher mortgage payments for landlords. A 6% increase on average yearly rental income is $645, whereas the hike in mortgage rates will cost a fully leveraged landlord $2400 per annum (on the median property).

“If interest rates remain at their current levels for a long time, or go higher, houses could fetch less than they are selling for now, especially at the lower end of the market,” says O’Donovan.

And he doesn’t expect conditions to improve for buyers for a long time. “It is only over the longer term that a slow and steady increase in rents, combined with a return to lower interest rates, will eventually lift investor values. But times have changed and the easy gains are taken.”

For tenants, rents are expected to rise. But renting will still be much cheaper than paying a mortgage. “High mortgage rates will make renting more attractive and buying more daunting. The trend towards renting for longer is likely to continue.”