How much will house prices fall?

At the start of the pandemic everyone expected house prices to fall substantially and no-one that I can recall gave a view that after falling, prices would rapidly climb. This should serve as a warning to anyone casting around currently for predictions of how prices will change over the next 1-3 years. Accuracy in forecasting house prices cannot be achieved.

Nonetheless, I do have a view on the extent to which house prices will retreat from unsustainably high levels in response to factors like higher interest rates, increasing new build supply, migration losses, and reduced credit access. Declines up to 10% look like they can be reasonably expected in most locations, including Auckland.

As to whether this makes much difference for the average purchaser is another story given that the vast majority of us have a long time-frame in mind when we make a purchase.

Back in the first lockdown average house prices fell by 3% during April and May of 2020 then climbed almost 46% to sit 41% above their March 2020 level in November last year.

Since November average prices have fallen by 2.6% and they now sit where they were in October. If prices fall 10% from their November peak, they will be back to levels of June last year and if they fall 20%, they will be back to where they were in December 2020.

For Auckland overall, prices so far have retreated by 5% exactly from their November peak. However, it pays to note that prices leapt 3.1% in November and 4.2% in October, so currently we are simply back to where average prices were sitting in early October. A 10% decline would take prices back to July and a 20% decline (unlikely) to January last year.

Let’s assume a 20% decline scenario nationwide. How many people might be in negative equity? Let’s assume that every borrower with less than a 20% deposit had in fact only a 10% deposit. That means we can add the exposure of all those who bought with a low deposit since June last year, plus those buying up until maybe the middle of this year.

The June-December 2021 sum of low deposit lending commitments is $5.3bn. Let’s add another $2bn and say total negative equity exposure come a 20% price decline trough will be a rough $7bn or so. Out of total lending in a typical year recently of $99bn that is 7%.

So, a maximum of about 7% of those who have bought a house with a mortgage would be at risk of negative equity. This equates to about 2% of mortgage debt.

Very few people will be at risk of being in a negative equity position in the extreme scenario where house prices fall by 20%.

Given my best guess that the price decline is considerably less than that from peak to trough the proportion will be a lot less than 2%.

On top of that we need to allow for a lot of low deposit lending involving deposits between 10% and 20%. Very little lending occurs with deposits less than 10% of the property’s valuation.

Then we water this down further by noting banks are unlikely to be much concerned about anyone in a negative equity situation because of the strong jobs market meaning they will be able to continue to service the debt. Plus, banks do not have any automatic rules saying they will sell someone’s house from under them if the market price falls below the bank’s initial loan amount.

Then we water things down further by noting that most people will have reduced their principal debt since taking out their mortgage. Therefore, the fall in price to reach negative equity is bigger than one would naturally think.

One can quibble about the numbers. But what it comes down to from my point of view as a forecaster and commentator who focusses on the underlying forces at work rather than the specific, usually undefinable numbers is this.

In the absence of a labour market shock there will be very, very few mortgagee sales. Media will switch away from highlighting annual price gains now to monthly falls. But the price collapse and woe feelings are unlikely to blowout.

However – keep an eye on the new build sector. If I were contracting for a new build I would prepared to wait in a queue until a reputable long-lasting developer was able to accept me as a customer given the challenges which lie ahead for project completion.