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Articles by Matthew Gilligan

Matthew Gilligan

Auckland smashed by LVR rules


It's interesting to receive feedback from the real estate agents and property industry people that we spend time with in the Auckland market. There is a lot of talk about Auckland heading towards a huge correction in property values.

One of the things I wrote about in my book Property 101 was an entire chapter on property inflation and asset bubbles (Chapter 4). Distinguishing an asset bubble from a housing cycle that is moving into the downturn phase is really a question of scale. Anecdotally, an asset bubble is a market that corrects by 20% or more following a period of sustained high growth. 


In the context of the current environment, Auckland is up 71% from its low point during the middle of the GFC in 2009, with 25% of that occurring in 2015. A question I often get asked is, 'Is the Auckland market a bubble, and therefore are we in for a massive crash?' 

Feedback from real estate agents at the moment is that auction clearance rates in Auckland are very low, with 30% or less of properties selling at auction. But this statistic is misleading, as property is still selling after auction. Remember also that real estate agents speak collectively for the whole market but really only represent one tiny bit of it, being their local environment. And they are thinking about their commission cheques that have suddenly disappeared, not necessarily understanding the wider market and what's going on in the bigger picture. This does not make them strategic observers, but they are very loud. 

Nonetheless, there is no question that the Auckland market is off the boil and we are seeing assets being sold at significant discounts on what they were selling for earlier in the year. Is it a bubble? I think the answer to this is in looking at the positives and negatives and weighing them up. 

On the positive side, net migration is at +62,000 into the country with up to 2/3 of this sticking to the Auckland catchment, generating demand for housing. Supply is at an all-time low. The Auckland employment market is at full employment – everybody has a job and they are well paid. Interest rates are low and there is nothing to say they are going to go up. On top of net migration, which is predominantly driven by expats returning to New Zealand (the grass is greener here at the moment), we have the Auckland population growing by natural increase (i.e. net births and deaths or organic growth) which represents 2/3 of our long-term demand for housing. Strong supply-demand fundamentals indeed, underpinned by high average incomes and a vibrant employment environment. 

Against this we have some short-term challenges. Foreign investors have been scared out of the market with new compliance rules requiring them to provide their foreign contact details and tax file numbers. New LVR rules require investors to have deposits of 30%. As I said in Chapter 4 of my book, from my research of overseas asset bubbles it appears that the biggest driver of property crashes is a reduction of liquidity or an act of god. In the current environment we have a reduction of liquidity for property investors, but not for home buyers.  

All in all there is a distinct chill on the Auckland property scene right now and there seem to be knee-jerk reactions from some investors to get out before ship sinks. I think this is short-sighted. 

Auckland has great fundamentals. In the last downturn the market bottomed out at a 4% year-on-year reduction in value in 2009, in what was the biggest global recession and banking crisis to hit the world since the 1920s. Interest rates were higher and property values were peaking at the end of 2007 when that started. Auckland was very resilient during the last down cycle. 

In my opinion, if Auckland is about to crash it will be a short-term blip, manufactured by Treasury reducing the availability of finance to property investors with the introduction of 30% deposits. I can't see this causing a long-term trend with net migration as strong as it is. 

Remember this is an Auckland thing. The rest of the country's property market is going gangbusters at time of writing (December 2015) because of Auckland's lack of affordability (having boomed before the rest of the country). Ripple effect is pushing money out of Auckland into the regions at this time, especially with the 80% LVR ratio maintained by Treasury outside of Auckland. (When you listen to Auckland real estate agents, bear in mind they are just focusing on their niche of the Auckland market; the rest of the country is doing very well and is about to get its turn at growth from the ripple effect.)

In 2013 when the 80% LVR rule was introduced, there was a 12-month flattening of house prices and many investors dumped property thinking the sky was falling in. It wouldn't surprise me if we see the same pattern again in the next 12 months. 

I think the first quarter of 2016 will be much flatter for Auckland, and I see good buying opportunities for those in the know in the Auckland market over the next 90–180 days. Contrarian investors who invest counter cyclically by taking a long-term view of what asset values are doing, rather than making short-term knee-jerk reactions, often make a lot more money over time. A contrarian investor's view of the Auckland market would be that a market with such good fundamentals being artificially manipulated by Treasury via the money supply is a market with opportunities for astute investors. But not all properties in Auckland. Some houses look well overpriced to me, so be careful. 

In my view of Auckland, there are still lots of properties out there that are currently zoned single house, but you will be able build two or three more houses on the site next year when the Auckland Unitary Plan becomes operative. You can literally buy houses with free sections in the back yard because the vendor doesn't understand the rezone potential of the land and neither does the real estate agent. I bought two houses in the last six weeks and they were both fantastic buys. 

I see as much opportunity in a downturn as I see risk because I am a long-term investor and I have a great trust of the Auckland supply-demand fundamentals. Ask yourself, 'Will the Auckland housing stock be more valuable or less valuable in 10 years?' I think the answer to this question makes any short-term downturn more palatable and easier to relate to in the context of long-term investing. 

What happens when markets get ahead of themselves?
If markets go too high, they don't tend to crash as long as people have full employment and good incomes, coupled with a functioning banking system. Plainly speaking, most people don't have to take the loss if they are not forced sellers and if they have the income and capacity to service debt. This is likely the case if Auckland's employment environment and low interest rates prevail. What tends to happen when markets turn after big growth in short periods of time, is longer periods of flat growth, rather than a big crash. Like Sydney post the 1990 boom, which had a very long flat period because the market got ahead of itself. This could easily happen to Auckland – a longer flatter period, giving the market time for income ratios to catch up with the new asset values and a long-term equilibrium price to catch up to the inflated price. This is all part of the property cycle. 

In summary, don't panic. If we are going into a downturn, I see it as short-term and a good thing because markets that go up 25% in a year are too hot. If that happened two years in a row we would more than likely see a substantial correction, and that would be much worse. So look at a cooling off of the market as a constructive thing for a long-term investor because it leaves space for growth in future years. 

Merry Christmas. 


Matthew Gilligan
Director
© Gilligan Rowe & Associates LP

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