Low interest rates are creating broader instability

The housing market is becoming untenable for reasons not currently emphasised.

The demand is underpinned not only by market forces driven from home owners or those looking to purchase a beneficial investment. It is also bolstered by investors fleeing ultra-low bank term deposit rates and the futility of upcoming savings vehicles offered by banks.

Interest rates, when very low, have a substantial and direct impact on the intensity of housing demand. The New Zealand housing market has proven to be directly stimulated by low interest rates.

Even when liquidity controls are placed on lending, the low interest rates remain potent for those who already have capital. There has been an over emphasis on the effects of interest rates on borrowers rather than on investors with unallocated monetary resources.

These investors are buying rental properties to avoid declining rates of return from alternative bank investments.

"THESE INVESTORS ARE BUYING RENTAL PROPERTIES TO AVOID DECLINING RATES OF RETURN FROM BANK INVESTMENTS."

The money flow is now out from banks and securities and into housing, most of which is residential, driven by private investors.

This is validated by a number of statistics including the jumps seen in recent rental rates, where investors are trying to match yields between the excessive prices paid to their returns. Rent rates all over New Zealand are soaring, especially on the end cycle of existing tenancies.

Many private investors are indeed fuelling the housing market, particularly in regions such as Auckland and Wellington, with money they have intentionally chosen to place in housing rather than securities or banks.

This is a substantively dangerous ideology, as it is neither based on sound investment principals nor a rational response to the current market conditions, which demand diversification.

For instance, the current NZX dividend paying stocks remain solid long term performers in both yield and capital growth. Moreover, the last few weeks have seen a bearish response from the markets offering a number of well-priced opportunities.

The peculiar and increasing flight from banks and securities is also directly impacting the overall liquidity levels in New Zealand, especially among private investors who are locking substantive portions of their portfolios into housing.

The housing market will eventually see declines when this capital in-flow and liquidity decline.

The assumption investors appear to be making is that the ultra-low interest rate yields are no match for invested value in the rocketing housing market. To some extent over the last few years this holds true.

Moreover, they are assuming housing will continue to see similar ongoing increases, thereby offsetting the risks assumed for overpaying on non-liquid assets.

With these ultra-low interest rates, there is a very real possibility that this flight from investment in banks and even securities will expand.

Each signal from the Reserve Bank for potential further interest rate cuts is perpetuating the assumption among many investors that the better offering is in the booming housing market.

"EACH SIGNAL FROM THE RESERVE BANK … IS PERPETUATING THE ASSUMPTION THAT THE BETTER OFFERING IS IN THE BOOMING HOUSING MARKET."

What New Zealand needs, perhaps as much as other offered solutions, is a broadening of the Reserve Bank’s mandate, and an immediate review whether interest rates must continue to decline.

When investors no longer see this volatility and low yields associated with banks, their tendency will be to retain existing portfolios instead of seeking alternative options.

It should be noted that there is a growing disparity between the amount of loans supplied by banks at these low interest rates for growth, such as development of housing in Auckland, and the total funds the banks hold.

The pressure to manage these market dynamics by increasing tax and legislative burdens specifically on investors will exacerbate the situation by forcing new investments to move to off-shore higher yield alternatives.

Hence, when interest rates are artificially low, they have a substantial and direct impact on the overall stability of the New Zealand economy.

To believe that it is possible for New Zealand to retain ultra-low interest rates while also managing this particular and peculiar housing boom is not validated by any precedent.

Only once interest rates stabilise can there be a reduction in real estate demand, especially if this is a component of other mitigating factors including immigration and taxation.

If, on the other hand, interest rates continue to be driven downward, the demand for housing as a safe asset will further intensify.

This has the potential to drive the market to a point in which it is no longer tenable and therefore substantial, volatile corrections may occur.

Other Scoop articles by Mark Rais:
• Clash of Super Powers in an Age of Global Conflict
• Op Article: Oil Rules the World
• Op Article: War for the Hearts & Minds of Our Children

Mark Rais is a writer for the technology and science industry. He serves as a senior editor for an on-line magazine and has written numerous articles on the influence of technology and society.

© Scoop Media