Rental property investors and the real estate industry should prepare for some turbulence later this year because the Reserve Bank is gearing up to tighten lending rules for landlords, possibly as early as November.
The Reserve Bank finds itself between a rock and a house. It needs to cut interest rates to try to boost Consumer Price Index inflation from 0.4% currently to closer to the 2.0% mid-point of its 1-3% target range. But it knows that further falls in mortgage rates would just pour more fuel on the fire burning under Auckland house prices and now spreading to the rest of the country.
The Reserve Bank finds itself between a rock and a house. It needs to cut interest rates to try to boost Consumer Price Index inflation from 0.4% currently to closer to the 2.0% mid-point of its 1-3% target range. But it knows that further falls in mortgage rates would just pour more fuel on the fire burning under Auckland house prices and now spreading to the rest of the country.
The pressure on Reserve Bank Governor Graeme Wheeler is intense because inflation has been below his mid-point target for four years and below the bottom of his target range for two years. To make matters worse, the New Zealand dollar has remained stubbornly higher than Wheeler expected because New Zealand’s Official Cash Rate (OCR) at 2.25% is far higher than US interest rates at 0.5% and European and Japanese interest rates that are under 0%.
The high New Zealand dollar is driving even more deflationary pressures through the economy. The Reserve Bank even posed one scenario in its June Monetary Policy Statement where the currency stayed around its early June levels, rather than falling 4% as the Reserve Bank forecast. It said this scenario would force it to cut the OCR to 0.75%, which would in turn force mortgage rates closer to 3% from just over 4% currently.
The New Zealand dollar has actually increased even more since the Reserve Bank’s warning about it being too high. By mid June the currency was 4% higher than the Reserve Bank’s ‘worse case’ scenario for a high dollar.
So the Reserve Bank needs to find a way to be able to cut the OCR without pouring more fuel on the housing fire and to avoid further inflating property prices in Auckland, which it considers a threat to financial stability if prices were to fall sharply. It has been here at least twice before and it has chosen to limit Loan to Value Ratios for mortgage borrowing each time – once in November 2013 with a blunt LVR and secondly last November with limits targeting Auckland investors. It is about to do it for a third time.
Wheeler made clear on June 9 in a news conference and later to Parliamentarians in a select committee appearance that the Reserve Bank was working on another round of LVR controls that was likely to target rental property investors again.
He was particularly focused in his comments on the increased share of purchases going to rental property investors and the rise in lending to landlords, particularly those based in Auckland. The Reserve Bank pointed to sharp rises in the share of purchases going to landlords in recent months and quickening of annual credit growth this year to over 8%. This is more than double income growth and the fastest seen since mid 2008.
“We're doing quite a lot of analysis at the moment around loan to value ratios and whether they should be modified in some way, and perhaps connected in to investor properties," Wheeler said, without giving details.
He did however admit the bank was looking at the prospects of the reducing the current 70% limit for Auckland investors to 60%, and/or extending the limit on Auckland investors to the rest of the country.
But an even heavier gun could be wheeled out next year. Wheeler said the Reserve Bank was looking at whether to limit debt to income multiples. The Reserve Bank has been collecting data from banks over the last year on debt to income multiples for investors and owner-occupiers. It reported in May that more than 60% of landlords are borrowing more than six times income, while just over 30% of owner-occupiers were over that threshold.
The Reserve Bank has not indicated where it could set the threshold, but similar controls in Britain and Ireland are set at 4.5 times income and 3.5 times income. A limit set at anything under seven times income in New Zealand would have a substantial impact on investor buying, given well over 40% of homes are now sold to investors, up from closer to 30% a decade ago. CoreLogic estimated 46% of Auckland home sales in May were to investors.
The Reserve Bank is taking its time looking at this particular limit because it needs to work out how to define and prove income for rental property investors, in particular whether the owners’ income or the property’s rental income should be considered.
The Government has said it is open to the Reserve Bank moves to introduce further controls because it is also keen to limit house price inflation and take pressure off the Auckland market, where housing supplies are well short of demand.
The bottom line:
By Bernard Hickey
The high New Zealand dollar is driving even more deflationary pressures through the economy. The Reserve Bank even posed one scenario in its June Monetary Policy Statement where the currency stayed around its early June levels, rather than falling 4% as the Reserve Bank forecast. It said this scenario would force it to cut the OCR to 0.75%, which would in turn force mortgage rates closer to 3% from just over 4% currently.
The New Zealand dollar has actually increased even more since the Reserve Bank’s warning about it being too high. By mid June the currency was 4% higher than the Reserve Bank’s ‘worse case’ scenario for a high dollar.
So the Reserve Bank needs to find a way to be able to cut the OCR without pouring more fuel on the housing fire and to avoid further inflating property prices in Auckland, which it considers a threat to financial stability if prices were to fall sharply. It has been here at least twice before and it has chosen to limit Loan to Value Ratios for mortgage borrowing each time – once in November 2013 with a blunt LVR and secondly last November with limits targeting Auckland investors. It is about to do it for a third time.
Wheeler made clear on June 9 in a news conference and later to Parliamentarians in a select committee appearance that the Reserve Bank was working on another round of LVR controls that was likely to target rental property investors again.
He was particularly focused in his comments on the increased share of purchases going to rental property investors and the rise in lending to landlords, particularly those based in Auckland. The Reserve Bank pointed to sharp rises in the share of purchases going to landlords in recent months and quickening of annual credit growth this year to over 8%. This is more than double income growth and the fastest seen since mid 2008.
“We're doing quite a lot of analysis at the moment around loan to value ratios and whether they should be modified in some way, and perhaps connected in to investor properties," Wheeler said, without giving details.
He did however admit the bank was looking at the prospects of the reducing the current 70% limit for Auckland investors to 60%, and/or extending the limit on Auckland investors to the rest of the country.
But an even heavier gun could be wheeled out next year. Wheeler said the Reserve Bank was looking at whether to limit debt to income multiples. The Reserve Bank has been collecting data from banks over the last year on debt to income multiples for investors and owner-occupiers. It reported in May that more than 60% of landlords are borrowing more than six times income, while just over 30% of owner-occupiers were over that threshold.
The Reserve Bank has not indicated where it could set the threshold, but similar controls in Britain and Ireland are set at 4.5 times income and 3.5 times income. A limit set at anything under seven times income in New Zealand would have a substantial impact on investor buying, given well over 40% of homes are now sold to investors, up from closer to 30% a decade ago. CoreLogic estimated 46% of Auckland home sales in May were to investors.
The Reserve Bank is taking its time looking at this particular limit because it needs to work out how to define and prove income for rental property investors, in particular whether the owners’ income or the property’s rental income should be considered.
The Government has said it is open to the Reserve Bank moves to introduce further controls because it is also keen to limit house price inflation and take pressure off the Auckland market, where housing supplies are well short of demand.
The bottom line:
- House prices rose over 10% nationally in May from a year ago, while inflation in Wellington, Hamilton and Tauranga is over 15%. Queenstown inflation hit 40% in May.
- The Reserve Bank is expected to cut the OCR again to 2.0% in August, and could cut it to 1.5% by the end of the year if the currency remains stubbornly high.
- The Reserve Bank is working on a third round of LVR controls targeting rental property investors. It could bring them in by November this year. It may introduce a debt to income multiple limit for investors next year.
- The Reserve Bank is likely to exempt owner-occupiers and loans to finance new builds. The Government is open to such limits on rental property investors borrowing to buy existing homes.
By Bernard Hickey
