The letter to the Reserve Bank and what it means

In November 2020 Hon Grant Robertson wrote a letter to the Reserve Bank of New Zealand essentially requesting that they control house prices. Unfortunately the Reserve Banks mandate is to control inflation not house prices. I thought it prudent to address how this relates to property from an investor’s perspective.

The Reserve Banks mandate is to keep inflation between 1 and 3% (Currently 1.4%), (which is why we always include at least a 2% rate of inflation in our plans and investment models). The way the reserve bank does this is by controlling the finance available through the official cash rate which is currently only 0.25%. This is the amount of money banks need to pay when they get their own loans. A bank will normally add 2% as their margin and pass this onto the consumer. What the low cash rate means is people can easily get mortgages lower than 2.29%.

Low interest rates are meant to stimulate business growth, there is growing evidence to suggest that it has a smaller influence the lower the OCR is to 0. Most businesses are controlled by their ability to get finance, not the rate they can get it, so dropping it too much seems to stimulate property more than anything else as it reduces mortgage repayments. The diminishing returns of lowering the OCR to combat inflation decline has become a growing concern to economists.

The Reserve Bank reduced the OCR during the pandemic to stimulate the economy. Economists were predicting a 20% fall in house prices, however, as time went on it became clear that we were still experiencing a housing boom despite the pandemic, New Zealand was faring very well. The housing market has continued to be stimulated by falling interest rates and “predictions” that they're here to last. Jacinda Ardern addressed the media and said that house prices were predicted to continue to see strong growth for the next five years, which is like pouring gasoline onto a fire.

Now the Government needs to control the out of pace housing market. They have a few tools at their disposal including; changing the OCR (unlikely), tightening lending restrictions (very likely on investment properties, in fact BNZ have already voluntarily started implementing this strategy), changes to the Brightline test, locking in investment property losses, debt to income ratios, land tax, capital gains tax, and many more.

It seems Kiwis are used to a 12% return on property whereas historic figures are only around 5% net of inflation. My concern is that it may become harder to invest into property and its outlook is uncertain. If the government managed to increase the OCR then it could crumple our housing growth for a very long time.

Investing in property is not without risk, I consider direct & leveraged property investment to be a category 6 risk strategy (diversified investments sit at 5). Therefore business and property are very similarly placed in terms of risk. Overwhelmingly Kiwis don’t see the risk in property fluctuations and are not prepared for a downturn in property.

You might read this and think “ahh isn’t it in my financial plan to invest into property?” and if it is we have probably talked about it in considerable depth. The point of this article is to make you aware of the potential changes and risks. If property is your primary investment approach, now might be the time to purchase another property as it could be harder soon.

If you are planning on a significant portion of your portfolio to be dependent on property you may want to try and add some diversification. Knowing your risk tolerance is key and applying it to your investment approach will keep you on track to achieving your goals.

I know of a couple that have sold their personal residence because they think the market is in a bubble, they may be right, but what would they do if they’re wrong. You should know by now that I’m not a fan of timing the market, I believe in sticking to your strategy. Instead of thinking; ‘what will things do tomorrow’, think ‘let’s not worry about tomorrow as we know it won't affect our plan’. Look towards your goals and your review process to ensure you’re on track to reach your goals.