Investment Insight | All your eggs in one asset basket
House prices to fall 10%! This was one of many headlines that came out of the Government's housing policy announcement this week. The policy aims to reduce speculation in the residential property market and help first home buyers.
The package of measures will likely impact house prices at the margin. But given the staged implementation, it will take some time to play out.
Escaping the headlines, the meteoric rise of housing is predominantly due to one factor; interest rates. John Key, in his role as ANZ chairman, recently commented that “low interest rates are really what's fuelling this, probably more than anything else."
Interest rate risk
It is interest rates that will dictate where property prices go from here. If interest rates remain low, the demand for property will remain and prices will remain high. However, as interest rates increase, financing becomes more difficult and debt servicing expensive. Demand will drop. Supply of investment properties will increase. Prices will fall.
All this is obvious so far. The problem, however, with residential property is there no way to manage this interest rate risk other than to sell. Any significant increase in interest rates could therefore cause a wave of selling. House prices may fall further than expected.
TINA – Actually, there is.
Interest rate risk is also present in listed assets such as bonds and shares. But this can be managed through 'hedging'. Clients can even benefit from interest rate rises.
Using our intelligent investment approach, we positioned clients' income portfolios to reflect the current investment environment. This includes increasing the levels of cash held in the Income Category and using derivatives to position for interest rates moving higher.
Our actions mean NZ Funds KiwiSaver Income Category is up 8.93% (before tax and fees) year-to-date to 28 February 2021 versus the global and New Zealand corporate bond index which are both down -2.23% and -2.16%. You can read more in 05 March 2021 | Bonds are a bubble waiting to pop.
Global phenomenon
The surge in property prices is not confined to New Zealand. At various times over the past decade, China has sought to rein in the animal spirits of its housing market. To little avail – prices have more than doubled in that time. Policymakers in several European countries have also become worried about growing excess housing.
Housing markets in Australia and the United States are also booming. House prices in the United States rose 10.3% in 2020. In Australia they rose by a smaller 3.6% but have already risen 4.0% in 2021 and are forecast to increase by 15% for the full year.
While each market has its own nuances and domestic influences, the core factors driving house prices remain the same as here in New Zealand – namely a shortage of houses, strong demand and most importantly, low interest rates.
Australia
In Australia, demand had been suppressed by tough lending criteria set by the regulator which had limited the availability of mortgage finance. These restrictions were lifted at the onset of COVID-19. The Australian government also encouraged housing activity by introducing a homebuilder subsidy scheme and tax relief in some states.
The Australian market may be even more susceptible to interest rate risk as it tends to be a predominantly floating rate mortgage market. This means that any action by the Reserve Bank of Australia will act as a rapid handbrake on prices.
United States
A decade ago, the Global Financial Crisis brought the world to the brink of economic implosion. The cause of that crash? The collapse of America's US$1.5 trillion sub-prime mortgage-backed security market. That began a fire sale of assets that threatened to engulf the world economy.
The building of houses in the United States essentially stopped. Over the following ten years, the rate of house building was heavily suppressed due to the difficulty of obtaining finance. This has resulted in a shortage of houses, much like New Zealand.
Meanwhile, demand for houses in the United States is steadily rising. Not only is there a secular shift in the wake of COVID-19 towards owning a suburban single family home vs an inner city apartment, but there is the larger demographic force that is the millennial generation. This is the largest cohort in the United States population, and they are now hitting the age of peak household formation (typically associated with marriage and children).
The relationship between housing and interest rates in the Untied States is more complex. The staple source of financing is the 30-year fixed mortgage. This means that existing homeowners are not impacted by rising rates once they have a mortgage, unlike in New Zealand where fixed terms beyond five years are rare.
Where to from here?
There is no 'right' way to generate returns. Housing has been a lucrative investment for those who have been invested over the last 10 years. However, as the investment regime changes and the risk of rising interest rates becomes more likely, housing as an investment might face headwinds. When those headwinds appear, there is no way to hedge against them.
As well as getting the asset allocation right for clients using NZ Funds' sophisticated asset allocation tool, we are also positioning clients' portfolios for the changing investment regime. This includes rising interest rates.
At NZ Funds you will see Portfolios with securities and asset allocations that are different from the traditional approach, and you will see the allocations change as we actively position client portfolios for the road ahead.
The package of measures will likely impact house prices at the margin. But given the staged implementation, it will take some time to play out.
Escaping the headlines, the meteoric rise of housing is predominantly due to one factor; interest rates. John Key, in his role as ANZ chairman, recently commented that “low interest rates are really what's fuelling this, probably more than anything else."
Interest rate risk
It is interest rates that will dictate where property prices go from here. If interest rates remain low, the demand for property will remain and prices will remain high. However, as interest rates increase, financing becomes more difficult and debt servicing expensive. Demand will drop. Supply of investment properties will increase. Prices will fall.
All this is obvious so far. The problem, however, with residential property is there no way to manage this interest rate risk other than to sell. Any significant increase in interest rates could therefore cause a wave of selling. House prices may fall further than expected.
TINA – Actually, there is.
Interest rate risk is also present in listed assets such as bonds and shares. But this can be managed through 'hedging'. Clients can even benefit from interest rate rises.
Using our intelligent investment approach, we positioned clients' income portfolios to reflect the current investment environment. This includes increasing the levels of cash held in the Income Category and using derivatives to position for interest rates moving higher.
Our actions mean NZ Funds KiwiSaver Income Category is up 8.93% (before tax and fees) year-to-date to 28 February 2021 versus the global and New Zealand corporate bond index which are both down -2.23% and -2.16%. You can read more in 05 March 2021 | Bonds are a bubble waiting to pop.
Global phenomenon
The surge in property prices is not confined to New Zealand. At various times over the past decade, China has sought to rein in the animal spirits of its housing market. To little avail – prices have more than doubled in that time. Policymakers in several European countries have also become worried about growing excess housing.
Housing markets in Australia and the United States are also booming. House prices in the United States rose 10.3% in 2020. In Australia they rose by a smaller 3.6% but have already risen 4.0% in 2021 and are forecast to increase by 15% for the full year.
While each market has its own nuances and domestic influences, the core factors driving house prices remain the same as here in New Zealand – namely a shortage of houses, strong demand and most importantly, low interest rates.
Australia
In Australia, demand had been suppressed by tough lending criteria set by the regulator which had limited the availability of mortgage finance. These restrictions were lifted at the onset of COVID-19. The Australian government also encouraged housing activity by introducing a homebuilder subsidy scheme and tax relief in some states.
The Australian market may be even more susceptible to interest rate risk as it tends to be a predominantly floating rate mortgage market. This means that any action by the Reserve Bank of Australia will act as a rapid handbrake on prices.
United States
A decade ago, the Global Financial Crisis brought the world to the brink of economic implosion. The cause of that crash? The collapse of America's US$1.5 trillion sub-prime mortgage-backed security market. That began a fire sale of assets that threatened to engulf the world economy.
The building of houses in the United States essentially stopped. Over the following ten years, the rate of house building was heavily suppressed due to the difficulty of obtaining finance. This has resulted in a shortage of houses, much like New Zealand.
Meanwhile, demand for houses in the United States is steadily rising. Not only is there a secular shift in the wake of COVID-19 towards owning a suburban single family home vs an inner city apartment, but there is the larger demographic force that is the millennial generation. This is the largest cohort in the United States population, and they are now hitting the age of peak household formation (typically associated with marriage and children).
The relationship between housing and interest rates in the Untied States is more complex. The staple source of financing is the 30-year fixed mortgage. This means that existing homeowners are not impacted by rising rates once they have a mortgage, unlike in New Zealand where fixed terms beyond five years are rare.
Where to from here?
There is no 'right' way to generate returns. Housing has been a lucrative investment for those who have been invested over the last 10 years. However, as the investment regime changes and the risk of rising interest rates becomes more likely, housing as an investment might face headwinds. When those headwinds appear, there is no way to hedge against them.
As well as getting the asset allocation right for clients using NZ Funds' sophisticated asset allocation tool, we are also positioning clients' portfolios for the changing investment regime. This includes rising interest rates.
At NZ Funds you will see Portfolios with securities and asset allocations that are different from the traditional approach, and you will see the allocations change as we actively position client portfolios for the road ahead.
Source: Bloomberg, Core Logic.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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James Grigor is Chief Investment Officer for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. James' comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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