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Edward Miller

Shock and Orr: Rate hikes kill off housing affordability and development

Hundreds of construction companies were put into liquidation last year, and industry experts are voicing their concerns. Photo: Getty Images

With the cost-of-living and housing crises, the need for Government intervention in the housing market is becoming more urgent. What that intervention will be may determine the colour of our next Government

Opinion: The official cash rate is the primary lever in our housing-centric economy, and with skyrocketing interest rates dragging prices downwards, there’s growing evidence of a slowdown in the residential construction industry.

It seems impossible to balance the low rates required to propel housing development, and the inflationary pressures those rates seem to incur. Is there a way out of this conundrum?

House prices fell 13.3 percent in the year to January 2023, including a 21.7 percent decline in Auckland and 16.4 percent in Wellington. Would-be buyers struggling to save hefty deposits may be happy, but real housing affordability has been more than offset by the most hawkish rates rise in NZ history. As well as hammering affordability, rate rises also threaten a post-GFC-scale slump in the rate of residential construction.

READ MORE:Skyline chair bucks market downturn with hefty house saleHome-building firm goes bust owing $16 m as industry pain worsensWest Auckland woman's big loss in housing market downturnMeremere v Normandale – suburbs turning house price tables’s home loan affordability report – which tracks lower quartile selling prices, average two-year fixed rates and the combined median after-tax pay for couples aged 25-29 – suggests that housing today is at its most unaffordable since series began in 2004.

Average mortgage payments have crept up from 32.8 percent of combined after-tax income in December 2021, to 37.6 percent in December 2022. The Northland, Auckland and Bay of Plenty regions have already bypassed the 40 percent unaffordable threshold.

The country’s mortgage interest bill paid to banks has just hit its highest level in history, but things will continue to get worse before they get better. In the next 12 months, $120 billion in owner-occupier lending and $48 billion in residential property investor lending – together roughly half of current mortgage lending – will come up for refinancing at higher rates.

Adrian Orr, Governor of the Reserve Bank, has increased the official cash rate by four percentage points in a single year. Photo: Getty Images

This is having an impact on the construction sector, with growing evidence of a slowdown. Hundreds of construction companies were put into liquidation last year, and industry experts are voicing their concerns.

In December 2022 Simplicity Living’s Shane Brealey told Newshub he thought interest rate hikes were pushing housing development “off a cliff”, which could result in the loss of 45,000 jobs.

A February 2023 Westpac research note suggested that increases in operating and borrowing costs would lead to a housing slowdown in the second half of 2023, and in the same month industry leaders told the NZ Herald they were facing a 20-50 percent reduction of residential building work for 2023.

Learning from past crises

Despite the embarrassment of Kiwibuild, the Ardern Government enjoyed a record high rate of housing construction, supported by a long run of low interest rates.

Since the 2008 global financial crisis, economic growth has become increasingly dependent on low interest rates; in New Zealand, that story is all about housing.

The Reserve Bank dropped the OCR 575 basis points in less than a year. It hit 1.75 percent in late 2016, 1 percent in mid-2019, and then in March 2020 as the pandemic began, the OCR dropped to a record low of 0.25 percent.

Official Cash Rate and housing consents. Source: RBNZ, Infoshare BLD106AA

The above graph shows the effect interest rates had on the rate of house building consents – a good proxy for housing development. During the Clark years, a 2 percent rise in the OCR is accompanied by a sharp contraction in consents, dropping by roughly a third.

When the OCR reached 8.25 percent under the Governorship of Alan Bollard, housing consents dropped to fewer than 4,000 per quarter. On the other hand, low (and lower) interest rates under both Key and Ardern helped reverse, push, and then supercharge the rate of housing development, which tripled from 2011 to 2021.

House Price Index and housing consents. Source: Corelogic, Infoshare BLD106AA

The global financial crisis hammered house prices and in turn housing development. From 2007 to 2011, real house prices fell 15 percent, with housing consents falling by 56 percent. Low interest rates were a solution to the credit shock unleashed during the global financial crisis, bringing a long boom from 2014 until 2019, when real house prices increased by more than a half.

Ultra-low rates and the $50 billion Large Scale Asset Purchase programme flooded the market with capital, with already-overvalued house prices growing more than 40 percent in under two years. The net value of our housing stock swelled by more than $535 billion over this period, more than three times the total value of the NZX Stock Exchange.

Conversely, today we are witnessing ‘Shock and Orr’, with the Reserve Bank cranking the OCR up four percentage points in a single year. December 2022 data shows the seasonally adjusted number of new consents is already down 7.2 percent while prices continue to fall.

A halving of new construction activity would see housing development fall back to where it was in 2014. We already know mortgage-holders are staring down the barrel of significant pain, but falling prices threaten to pull many young families into negative equity territory, as well as the threat of mortgagee sales.

All of this should loom large for the Monetary Policy Committee, which is currently mulling the scale of the next OCR hike, due on February 22.

In a recent public consultation, the Reserve Bank has drawn a line in the sand, stating that including house prices within its remit is a bit much and it would like to stick to just setting interest rates that balance inflation with unemployment. For those in the construction industry, those lines are becoming increasingly blurry.  

Construction workers to pay pound of flesh?

The brutal exercise of cutting consumption by increasing interest rates is particularly fast and effective in Aotearoa because of our high level of household debt and the fact most of our mortgages are fixed for such short terms. And, while mortgage-holders will feel be feeling the pinch in the coming years, they are hardly the worst affected group by OCR hikes.

In its November 2022 monetary policy statement, the Reserve Bank suggested employment would need to rise to 5.7 percent over the next two year to bring down inflation, meaning another 74,000 unemployed workers (and at least as many underemployed).

With residential construction contracting, there is reason to believe construction workers may make up a reasonable proportion of the newly unemployed.

READ MORE: Banks not sharing the pain with mortgage holidays  * How to stop your mortgage 'holiday' costing thousands

The size of the construction workforce rises and falls in line with the completion of new residential dwellings. In 2011 when consenting activity had fallen to a historic low, the construction workforce fell to just seven percent of the total labour force.

Between then and now, the construction workforce has grown two-and-a-half times as fast as the rest of the workforce, meaning a full 11 percent of the workforce are now construction workers.

Over the past three years alone, employment in the construction sector has increased by 21 percent (52,000 workers), roughly four times the general rate of the expansion across the labour force. Women now account for 14,500 of those new roles, a 43 percent increase in female employment in the construction industry.

It is time for Treasury to explore the implications of designing a similar set of mortgage products for first-home buyers and other low-income households that can lock in long-term mortgage rates and make investment capital available to mitigate the boom-and-bust cycle

Construction employment is particularly prone to the boom-and-bust cycle. Construction unions across the world bemoan the seeming-endemic insecurity of construction workers, whose tenure often lasts project-to-project, short-term contract to short-term contract, and even day-to-day.

This is particularly the case in the New Zealand residential construction industry, where a substantial proportion of historical construction activity has been standalone homes, although multi-unit dwellings have become more popular.  

Indeed, despite making up only 11 percent of the general workforce, construction workers account for a whopping 18 percent of independent contractors (‘self-employed, no employees’ in the data). Classifying workers as independent contractors pushes costs – both regulatory and financial – onto the worker, while also making them easier to terminate.

While these practices might not stand up in Court, low union density means the practice has persisted throughout the residential construction industry.

This means that when business packs up, much of the workforce can be sent packing with limited costs to the employer. Some unemployed construction workers from the residential sector might be absorbed into other parts of the construction industry doing infrastructure or commercial works, while others might jump the ditch to Australia. We are already starting to see this, as mid-size construction company liquidations make waves.

Some of this may be offset by the impact of flooding and Cyclone Gabrielle, but until the Reserve Bank takes its foot off the brake and the rate of housing development restarts, tens of thousands of construction workers may be heading for the dole queue.

The role of housing within today’s inflation

Given the inflation policy response – OCR hikes – is killing off residential construction, it seems ironic that housing plays such a major role in our inflation story.

Alongside supply chain disruptions and the surging cost of fuel, food and fertiliser in the wake of the Russian invasion of Ukraine, the cost of housing looms large in the inflation data.

Ultra-low interest rates supercharged house prices, making returns in residential construction much more handsome. That in turn put demand on our building materials supply chains and the cost of construction labour; these factors play an outsized role in how we measure and respond to inflation.

CPI, tradable and non-tradable
components (%)

Statistics NZ divides up inflation between tradable (imported) and non-tradable (domestic) components. As the NZ economy has globalised, tradable components have become more significant. Tradable goods tend to be disinflationary (for example because they rely on relatively cheaper labour or resources), dragging the general rate of inflation downwards.

This flipped with the end of Covid-related social and economic policies across the world. Throughout 2021, post-pandemic supply chain pressure raised the cost of import goods above the rate of general inflation, supercharged by surging fuel, food and fertiliser costs as Russia invaded Ukraine in February 2022.

Of course, raising rates in New Zealand won’t stop Russia from invading Ukraine, or global fuel, fertiliser and food giants from hiking margins. Nonetheless, the global cost-push narrative is a compelling one, and has in effect been publicly adopted by the Labour Government to explain cost of living pressures on working families. In both 2021 and 2022, tradable inflation has accounted for at least 40 percent of inflationary pressure.

In New Zealand, however, our inflation story wouldn’t be complete without exploring the role of housing. In the year to December 2021, “housing and household utilities” made up 58 percent of non-tradable (domestic inflation), or 35 percent of total inflation. The year to December 2022 was much the same, accounting for 53 percent of non-tradable inflation (31 percent of total inflation). In both years, the rising cost of building a house made up about 60 percent of this pressure, while the rising cost of rents accounted for another 20 percent.

We’ve already recounted this part of the story, with ultra-low pandemic interest rates pushing up house prices, encouraging commercial housing developers to expand orders, pushing consenting activity to new heights.

This demand also puts pressure on costs throughout the supply chain. The cost of residential building construction services has increased 8.2 percent in the past 12 months (the sharpest increase since data collection began in 2009), and 14.2 percent since the beginning of pandemic.

The past 12 months have also seen the largest price increases on record for building materials, about 30 percent for gypsum and limestone, wood and timber, and panels, boards and veneers. At 7.5 percent, construction worker wage growth also reached a new record in 2022.

Residential building construction goods and services have broken records this year. Source: Infoshare PPI029AA and QEM002AA

The bit we don’t really have good data on is what happened to profit margins over this period, and whether firms were able to hide rising margins behind rising prices. Treasury tax revenue data suggests that economy-wide profits rose 60 percent in the past two financial years to a whopping $70 billion (roughly 20 percent of GDP), fuelled by low interest rates.

Other data shows a $24.5b increase in surplus before income tax in the 2021 financial year alone, with two-thirds of that increase going to financial and insurance services ($10.6b), rental, hiring and real estate services ($3.7b) and construction ($1.7b).

Years of complaints over the lack of competition in the NZ building materials sector have led the Commerce Commission to undertake a market study into residential building supplies. Unlike the similar report for the grocery market, no detailed analysis of margins and profitability was undertaken.

That same year, as the cost of building a house propelled inflation, construction giant Fletcher Building reported a 42 percent bump in net profit, to $432m.

A test for market fundamentalism

Our building materials supply chains clearly aren’t equipped to deal with this degree of demand. However, it seems patently unfair that such enormous impacts flow from unusually busy housing markets doing what they’re supposed to do, in this case actually building houses.

Monetary tightening hammers the living standards of mortgage-holders, renters (whose landlords often pass on costs) and precarious workers. We’re reaching the hard edge of a very long boom cycle, but a collapse in residential construction activity could have a catastrophic impact on affordability.

Workers hard up in building and construction trades have often felt the pull from Australia, and no doubt many of those made unemployed by the housing downturn are attracted by the fistfuls of cash waved by big employers in that country’s construction and resources sectors.

There, construction worker wages and conditions have long been protected by the militant CFMEU (Construction, Forestry, Mining, Maritime and Energy Union), whose enormous pensions fund invests billions into the pipeline of future construction, and provides work, housing and infrastructure for their members. Our market lacks these stabilisation measures, submitting working class communities directly to the boom-and-bust cycle.

When markets collapse, the state is supposed to show leadership and intervene to protect the national interest. Last year, the state showed leadership with the establishment of a plasterboard taskforce that has quickly and efficiently addressed supply chain issues in that market.

However, the housing market is the biggest game in town, and certainly too big to fail. What kind of interventions will be required to stabilise and ensure housing development will continue and both house prices and borrowing costs come down?

After World War II, the State Advances Corporation began providing 3 percent loans for ex-servicemen (substantially lower than available in the private market), later expanded to all low-income households.

It is time for Treasury to explore the implications of designing a similar set of mortgage products for first-home buyers and other low-income households that can lock in long-term mortgage rates and make investment capital available to mitigate the boom-and-bust cycle.

The state can also play a major role in supporting the building materials and construction industries. While steps to improve competition in the building materials supply chains would no doubt be welcome, the state should consider exploring taking equity shares in existing firms to expand production.

Returns from those shareholdings could be used to purchase materials when prices are low and establishing national stockpiles to prevent housing demand causing prices to rise, hedging against domestic inflationary pressures.

The New Zealand Government similarly has an established history in the building industry. In October 2021, First Union published a report co-authored by Max Harris and Jacqueline Paul that calls for the establishment of a Ministry of Green Works, a state-level builder of housing and infrastructure that brings economies of scale, policy coordination and removes profit margins from the building industry.

The liquidation of building firms across the company would enable a fledgling ministry to purchase significant plant as well as absorbing its workforce.

At the same time the recent repurposing of Ōtākaro, the former Christchurch rebuild agency, into a national state-owned infrastructure delivery company, shows there is a real interest from this Government in entering the construction market.

In the short-term, all eyes will be on the Reserve Bank’s next OCR-setting exercise, with the consensus among economists seeming to predict a more moderate 50 basis point hike. This is already too much to sustain current rates of housing development, with the remaining question being how severe and how long the slowdown will be.

The scale of that slowdown will start to become clearer by the time our political parties confirm their election policy offerings.

It is clear that between the cost-of-living crisis and the housing crisis, the need for Government intervention in the housing market is becoming more urgent. What that intervention will look like may indeed determine the colour of our next Government, and certainly whether the calculus for first-home and low-income buyers ever gets any easier.  

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