Market faces sharp correction risk

First NZ Capital has just released a New Zealand House Prices Strategy Update which estimates that house prices are over-valued by 30% to 40%.

The report acknowledges there are fundamental economic factors – including Auckland’s supply shortage and low interest rates - which have underpinned recent house price growth.

However, its analysis suggests the rapid recent growth in prices, especially in Auckland, has left them at a level where there is increased risk of a sharp correction.

In the report, First NZ Capital director of economics and strategy Chris Green used five house price valuation metrics to estimate that the average and median house price overvaluation is in the region of 30% to 40%.

He states that the elevated starting point for house prices, along with the data suggesting substantial overvaluation, meant his housing market risk assessment was skewed towards the downside.

The report also looked at past property cycles and compared the ratio of downturns to upturns, as well as their duration and size, to get a sense of the magnitude of any potential downturn in the market.

When it comes to the current upturn, the report found the rise in real house prices to date of 38.9% is around both the average (41.3%) and median (37.9%) increases recorded over the previous six cycles.

Based on ratios derived from the past six cycles, the report suggests that major house price upturns tend to be followed by downturns which have, historically, retraced around 30-50% of the rise.

It states that using these ratios as a basic guide, and assuming the 39% increase in house prices until the September 2015 quarter is a peak in the current cycle, a potential decline with the average and median estimates of around 12-19% is possible.

In the report, Green also posited three potential house price scenarios.

They are high, medium and low price scenarios and all three anticipate a market correction and decline in prices to greater or lesser degree.

Using the medium price scenario, the report estimates a house price decline of 11% from peak the peak of the cycle to the trough.

However, NZ Property Institute chief executive Ashley Church doesn’t believe a sharp market correction, particularly in Auckland, is likely.

He said that, historically, the Auckland market flattens rather than corrects - as was the case following the global financial crisis in 2007-08.

“So price growth is likely to simply ease off and flatten for a few years and then it will lift again when the next boom starts.”

While the factors that drive and end property booms and downturns are always different, Church said.

“In my view, it would take a massive downturn in the world economy for Auckland’s housing market to suffer a sharp correction.”

Church also pointed to a recent article by BNZ chief economist Tony Alexander which suggested it would take an apocalyptic situation for the Auckland housing market to correct in a way that would threaten New Zealand’s economy.