Interest rates

House prices and GDP set to suffer from rising interest rates

Harry Smith is a portfolio manager in international equities at Fisher Funds.

OPINION: I started to wonder if New Zealanders hadn’t taken the old adage ‘safe as a house’ a little too literally, believing that property prices will not fall and fall. .

Over the past few years, many of us have seemed to be betting that when it comes to real estate prices, the only way is up.

The reality is that real estate, like all asset classes, can and does fall. And there are some similarities between our current housing market and that of the United States in 2007, which fell 27% from peak to peak.

Before the global financial crisis of 2007, 50% of home loans in the United States were adjustable rate mortgages. These mortgages had a low interest rate for the first two years, but were reset to a significantly higher rate when the Federal Reserve raised interest rates.

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Rising mortgage rates affected half of all US households, reducing discretionary income and impacting consumer spending, which accounts for 70% of their gross domestic product (GDP).

Here in New Zealand, our Reserve Bank has been raising interest rates rapidly in an effort to control inflation, and as we have seen in the United States, this has the potential to impact homeowners who are used to much lower interest rates.

<a class=Interest rates are rising around the world as central banks pull their monetary levers in an attempt to stave off inflation.” style=”width:100%;display:inline-block”/>

Seth Wenig/AP

Interest rates are rising around the world as central banks pull their monetary levers in an attempt to stave off inflation.

With nearly 60% of mortgage debt maturing within a year, the New Zealand housing market is highly interest rate sensitive, perhaps to a greater degree than that of the United States in 2007 .

According to current estimates, the official exchange rate should reach 4.25% by the end of the year. Historically, the one-year mortgage rate has been around 2% higher. This means that a household that bought a $1 million home in 2021 with a 20% deposit and a 2.3% mortgage rate will see their annual cost of servicing the mortgage increase from $37,000 to $59. $000, an increase of 60%.

Consider this increase against the 2021 average annual equivalent household disposable income of $50,164 and our lack of savings; our bottom-of-the-envelope calculations suggest that the rising cost of servicing mortgages could wipe out more than 1.5% of New Zealand’s GDP.

Current estimates from economists expect house prices to fall between 15% and 20%. These estimates may turn out to be too optimistic.

House prices are falling, interest rates are rising, and homeowners will have less to spend on other things, which could hit our GDP hard.

KATHRYN GEORGE / Stuff

House prices are falling, interest rates are rising, and homeowners will have less to spend on other things, which could hit our GDP hard.

If a new homeowner wanted to maintain a mortgage service of $37,000 per year in 2021 with higher interest rates, that would imply house prices would have to drop 35%. After rising 48% in the two years to December 2021, a 35% decline would bring prices back to September 2020.

Now, it’s true that many New Zealand households have little or no debt. We also benefit from having banks with good underwriting standards – no Ninja loans (no income, no job, no assets) that US financial institutions gave out before the financial crisis.

While much of this news may be unsettling and even frightening to some, it should be remembered that this is just one scenario based on higher interest rates. Even if property prices fall, they will recover over time, and with this recovery there could be further positive results.

First, like Americans, we could learn to lengthen the maturity of our debt, or at least split it into different tranches to reduce our exposure to incredibly hard-to-predict macroeconomic trends.

The 2007 experience radically changed the way US households structured their debt. Today, 90-95% of mortgagees borrow for 30 years with a fixed mortgage rate for that entire period. So when the Federal Reserve raises interest rates by 0.75%, as it did recently, it will have virtually no effect on consumer consumption, as increases in the official exchange rate of New Zealand are likely to have them.

Second, we could take the opportunity to reduce the emphasis on real estate in our investment portfolios and instead shift to a more balanced portfolio of cash, bonds, real estate and equities.

Harry Smith is a portfolio manager in international equities at Fisher Funds.

Provided

Harry Smith is a portfolio manager in international equities at Fisher Funds.

Real estate prices are falling due to higher interest rates, which presents opportunities in term deposits and bonds as an alternative investment. Foreign equity markets have already fallen 20-30%, presenting attractive entry points.

Finally, and arguably most importantly, lower valuations should allow those who have saved a lot for a deposit to finally buy their first home and that would be welcome news.