COVID-19 triggered a global economic recession in 2020, and central banks across the globe reacted by slashing interest rates – a standard practice to prop up liquidity and stimulate the economy.
More than a year later, regulators are still holding off on hiking the rates back up due to the continued effects of the pandemic. But New Zealand is about to buck that trend in 2021 and become the first advanced economy to raise interest rates. The move was widely expected in August but has since been postponed due to the country’s first COVID outbreak in six months. This outbreak is only a temporary setback – the smart money remains firmly on the RBNZ to hike the rates later in 2021, and it would be hard to deny that the New Zealand property market has played a major role in that.
Here, we look at how rising interest rates will impact the real estate market and residential development finance in 2021.
The New Zealand housing market is facing an affordability crisis in 2021. This did not happen overnight – it was years in the making. In the decade after the last global recession in 2008-09, the New Zealand economy had bounced back strongly.
Rising income levels, strong immigration, overseas investment, and lower interest rates have combined to drive demand in housing to historic highs. Even when the economic recovery started losing steam by 2018-19, the lowering of interest rates and traditionally low supply of properties ensured the boom in the New Zealand property continued.
When COVID struck in 2020, the Reserve Bank of New Zealand (RBNZ) responded by slashing the interest rate (OCR) by 0.75%. That move brought the OCR to 0.25%, the lowest recorded in recent memory. Even as the wider economy stalled under the strain of COVID, property prices showed no sign of slowing down.
The RBNZ has tried to use other measures like higher Loan-to-Value Ratio (LVR) restrictions to rein in the housing prices, with limited success. In Q1-Q2 2021, it had soared to a 31% increase. A hike in interest rates now seems to be the only readily available tool for address the current housing crisis, noting the RBNZ has called the current rates “unsustainable.”
There are numerous factors at play in a dynamic free market, and a rise in interest rates rise can play out in many ways. But in a “healthy” market, the impact of a hike on the real estate business is quite well established.
Interest rates determine the cost of debt. They force banks and other lenders to charge a higher interest rate on top of the principal amount in loans, including home loans. Simply put, when the interest rate is low, it is good news for property buyers – credit is cheaper and mortgage rates are decreased. A hike in the rates has the opposite effect – as mortgage rates increase, houses become less affordable, and the cost of servicing debt rises. Even an increase of 1% interest rate can have a significant impact on mortgage costs. You can expect monthly payments to increase by an average of 10-15%.
For example, Auckland’s median house price is $1,175,000. Assuming an 80% LVR (or 20% deposit), the average Aucklander will have a loan of $940,000.
If Jim has a $940,000 mortgage on a 30-year term with a 3% fixed interest rate, he will pay $3,963 in interest each month. Increase the interest rate to 4% and that payment increases by 13% to $4,488.
Rising interest rates do not just affect buyers, those looking to sell property also face challenges when mortgage rates increase. Selling a house at a higher price becomes harder, as there are fewer buyers who can afford it at the prevailing mortgage rates. For investors, not all will be affected the same; in the face of higher debt servicing costs, highly leveraged investors will likely need to sell properties to reduce the debt exposure. Others, who are well capitalised, may benefit from an increased demand for rentals properties (and subsequent increase in rents) as demand for new homes falls.
When interest rates are increased, real estate prices do usually decline (noting that these price adjustments can take some time to be realised by the market). New Zealand banks and lenders have already started adjusting mortgage rates in anticipation of expected interest rate hikes later this year.
In the current context of the New Zealand property markets, an interest rate hike is likely to be a welcome move. While lower rates are ideal for the growth of the market, in excess, it can lead to overheating. Keep in mind that interest rate rises generally occur in response to strong economic activity. The labor market is strong with low unemployment and a recent revival of wage growth. In this context, an interest hike is not likely to have any serious adverse effects on New Zealand property prices and should be well accommodated by the market.
Furthermore, New Zealand has experienced one of the lowest cumulative restrictions in the OECD, even accounting for the recent outbreak. This has insulated our economy from severe shocks, with the country faring better than many of its peers, with positive growth – in contrast, across the Tasman, Australia does not expect growth to resume until 2024.
This is not to say that the industry does not have its headwinds. Higher rates, tighter credit conditions, changes to tax policy, and increased supply will all have their part to play over the next 12 months. At ASAP, we remain optimistic and continue to seek new funding opportunities for 2021 and beyond.
We are a market-leading property finance company in New Zealand, offering bespoke residential and commercial property finance nation-wide. Talk to one of our expert team members today for expert advice on the NZ property market.