Housing: Lessons from history

Observation 1: New Zealand’s house price index has trended upward over its 40-year history. Since 1984, inflation adjusted house prices have grown an average 3.4% a year, exceeding output growth per person of 1.6%.

Observation 2: House prices are procyclical. Periods of house price deflation coincide with troughs in the economic cycle. House price peaks, by comparison, do not necessarily coincide with peaks in the economic cycle, although prices do rise when the rate of activity is increasing.

Observation 3: The duration of real house price rises and falls differ widely over time (see Table 1): no two economic cycles are alike.

Observation 4: House prices tend to rise further than they fall: the average cumulative gain during each period of house price growth is more than 28%, while falls are just 15%. The most severe decline in house prices occurred in the mid-1970s. Real house prices have fallen on three other occasions, although these were smaller in terms of duration and severity.

Observation 5: There have been two major housing cycles in New Zealand since banking liberalisation in the late-1980s. New Zealand is currently experiencing its second housing market cycle, which began in September 2001. To date, annual house price growth in this cycle peaked at 23% in December 2003, its fastest rate in thirty years. Real house prices are currently 49% higher than three years ago.

Observation 6: A large part of the rise in house prices can be explained by falling interest rates and the strength in household incomes.

Observation 7: This cycle differs to the 1970s. Banking liberalisation allows households to borrow more. Unemployment is near all-time lows. Inflation is low and less variable than thirty years ago (less mixed signals). Real interest rates in the 1970s were negative – spurning debt accumulation. Ultimately, when interest rates rose, the housing market capitulated. Real rates are unlikely to rise as far today as they did in the late 1970s. Declining real house prices are more prevalent in a low inflation environment but not to the tune of 40-odd percent falls.

Observation 8: But prices are still likely to be weighed down as we go into the downturn in the business cycle. Easing economic growth is likely to see softness in the housing market into 2006. Easing employment growth and the effects of restrictive monetary policy will act as an anchor on house price growth. In real terms, house prices have the potential to fall. This, in turn, has implications for financial markets.

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