Stuff: Sorry, homeowners — prices must fall

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Would you be willing to see your house value fall by 40 per cent if it helped restore affordability within a generation? That’s the question now facing homeowners. I hope their answer is yes.

As a congenital optimist, I react to something like a housing crisis by asking: how quickly could we solve it? So I ran the numbers, and discovered – surprise, surprise – that there is no easy solution.

Currently, the typical (median) house costs $820,000 (although I typed that sentence yesterday, so it may be higher now). The typical household income – if you assume one and a half earners in their 30s, as is standard – is $97,000.

That gives a typical house price-to-income ratio of 8.5. (Other calculations put it even higher.) It’s generally accepted that in an “affordable” housing market, one where prices are within reach of ordinary people, that ratio is 3:1.

If house prices plateau, and incomes grow at 2.5 per cent a year after inflation, as they have done in the last decade, want to guess how long it takes to get back to affordability? 42 years. We have to wait until 2063, a whole two generations away. (My calculations can be found at here.)

If you’re an aspirant homeowner, that seems … suboptimal. Income growth alone won’t do the job.

What would? We could assume incomes will grow more quickly than 2.5 per cent a year, but that seems risky, given the turbulent times ahead.

We could hope that house prices rise more slowly than inflation, as they have in 19 of the past 50 years, according to Selena and Shamubeel Eaqub’s Generation Rent. But we still wouldn’t return to affordability until 2051, an unacceptably long way off.

What if prices fell – say, 1 per cent a year? If inflation was 2 per cent a year, that would work out to a 3 per cent annual fall after inflation (relative to the increase in the price of everything else, in other words). And on that basis, we could restore the 3:1 ratio by 2040, one generation away.

Morally, I think that’s still too far off; but, pragmatically, it might be the best we can do. Bear in mind that the last time we had a 3:1 ratio was the 1990s: this is a crisis decades in the making. Bear in mind, too, that New Zealand house prices “have never really fallen sharply or for a sustained period”, the Eaqubs write.

Even getting homeowners to accept a 3 per cent a year decline, adding up to a 40 per cent real-terms fall over two decades, could be extraordinarily difficult.

In theory, of course, such a fall needn’t be catastrophic. People’s ability to repay their mortgage depends on their income, not the notional value of their house. Prices have risen 40 per cent in the last couple of years, so only the most recent buyers would lose out anyway.

A slow decline might give people time to adjust to the fact that their retirement-fund property would reap less than expected; ideally, they would make other savings plans. Those having to sell might be at least partially compensated by buying their next house more cheaply.

All that makes sense, in theory. In practice, people hate the idea of their house losing value. Even a gradual decline could provoke panic. It could also damage the economy: much consumer spending depends on sentiment, and owners feel more buoyant when their house value is too. (Hence politicians’ desire to keep prices up.)

That said, if the trade-off is that the next generation can actually afford a house, enough people might accept the idea to make it politically viable. And though it might take 20 years to reach 3:1, every year of gradual price decline would bring affordability closer. What’s more, a ratio higher than 3:1 might be manageable – for those with a deposit – if interest rates remain low.

More radical change, though, seems off the table. I understand why some commentators want the market to crash. But if prices suddenly fell 30 per cent, say, I think there’d be an outcry, and the government that allowed it would be rapidly replaced by one committed to reversing it.

Even a slow decline is hard to conceive. Most politicians have so far shown no interest whatsoever in reducing house prices. The prime minister’s position is that people expect single-digit annual increases, which would presumably mean homes remain unaffordable forever.

Politicians’ control over the housing market is partial, in any case, and engineering a perfectly gradual decline is probably beyond them. Still, we have to hope for something of this nature.

House-price growth is already slowing. And last year, for the first time in ages, more houses were consented than was needed to meet demand. If we keep that going, alongside other measures, a gradual decline might be achievable. It’s the least we owe to those looking to own the roof over their heads.