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New Zealanders have one very large egg in their wealth basket

Investors with all their eggs in the housing basket is not a good option as house prices are unsustainable, says Reserve Bank governor Adrian Orr.

Tuesday, November 02nd 2021

Orr told the Property Council’s retail conference, investors need to be asking themselves the right questions to manage the risks.

The speech comes one day before the Reserve Bank is to give its six monthly Financial Stability Report (FSR), which will again elaborate on why the bank views the level of house prices in New Zealand as unsustainable and why this poses financial stability risks.

Orr began his speech by referring to the FSR and says: “Spoiler alert - today I will provide the gist of our analysis.”

However, he says the RBNZ says using interest rates to target house prices is not in its mandate - nor does it make sense.

“Monetary policy is best used to manage overall consumer price inflation stability i.e, an aggregate consumption price index, rather than being used to target a specific asset price."

"Likewise, trying to target both consumer prices and house prices with monetary policy will quickly lead to confusion and suboptimal outcomes,” Orr said.

In launching a plea for diversity of investments, he says the aggregate value of land and housing in New Zealand, including rental properties, is current around $1.5 trillion. This equates to over half of all household wealth. New Zealanders have one very large egg in their wealth basket.

However, investing in housing is driven by more than just the desire to live in a particular place. Housing is a valid asset class to invest in as part of a wealth portfolio, Orr said.

“Deciding to invest in property beyond your own family home is more of a financial, rather than social, decision. This is why investing in housing as a commodity needs to be stacked up against all other asset classes, and considered as part of an overall portfolio.”

He says when investing in an asset, or building an investment portfolio, having a view on an investment horizon, and the ability to identify and manage the risks that come with each investment, is necessary.

“Investors need to be asking themselves the right questions to manage the risks.”

Stacking investments

Orr said identifying and managing these risks can be life-changing.

“How often have we heard about people needing to sell an asset – especially a house - when they least wanted to? Or, when investors have had to be directly involved in managing their property when they were either unable to, or highly inconvenienced. Or, when they were unable to access a better investment opportunity due to the inability of being able to sell their investment property?

“Stacking your investment basket with only one asset (or asset type) accentuates these risks.

“For example, while all houses are not the same (i.e., there is some financial diversification within housing investment), there are some strong common factors that will drive your returns and lead to concentrated risks. These common factors include, for example, the state of the local economy (especially if your employment is also local), the level of interest rates, local climate conditions and insurability, and a wide variety of central and local government policies related to building standards and tax.

“Simply ‘doubling down’ on the same set of risks (i.e., similar assets) is not diversification.”

Orr says diversification is one of the few ‘free lunches’ in finance. Diversification in asset holdings can bring the same expected financial return for less risk, or a higher expected return for the same risk. In general, the broader the variety of eggs in an investment basket, the better.

Diversity Aversion

Diversification in household wealth has been supported over recent years by the introduction of KiwiSaver, now worth about $87 billion.

However, New Zealand’s household balance sheet still remains highly concentrated in housing.

The recent extraordinary rise in KiwiSaver balances has been outstripped by recent house price increases.

“The benefits of diversification are not being fully overlooked by New Zealanders. But the weight of money “is still favoured toward housing – helping drive house prices unsustainably higher,” Orr said.

“The drive for better investment diversity still needs a significant nudge – both in terms of investment options (more offerings from our capital markets), investor awareness, and at times regulatory imposts where market failure exists.”

Orr says property will always be an important asset class in a well-diversified investment portfolio.

However, there are strong grounds to believe that in New Zealand many of the associated risks have been inadequately priced, identified, and managed.

“As such, New Zealand households continue to hold uncompensated risk and are overly exposed to mortgage debt.

“This investment preference has worked well over time for many. However, this is not the case all of the time, for all people, and compared to all of the benefits that a more diversified portfolio will provide for the same or less risk.”

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