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28-08-2012

Are NZ property prices really too high?

The Economist magazine recently stated that New Zealand house prices were 66% over valued based on a comparison to New Zealand rental prices. The NZ Property Investors’ Federation believes that the magazine’s study uses the wrong figures for rental price and expected rental return. The Federation also believes that the magazine has not examined whether rental prices are in fact too low when using them to reach a conclusion on property prices.

NZPIF President, Andrew King, said that “The conclusion that the magazine came to is wrong. It is not that house prices are too high, it is more that rental prices in New Zealand are too low.”

The magazine used median house and rental prices plus an assumed rental return to come to its conclusion. According to the NZ Real Estate Institute, New Zealand’s median house price for July 2012 was $361,000. According to the Government Bond Centre, the New Zealand median rental price was $340 per week.

Using these figures, if New Zealand house prices are 66% over valued compared to rental prices then the magazine is saying that NZ house prices should be $217,500, not the actual figure of $361,000. At a rental price of $340pw and an average value of $217,500, the magazine have assumed in their calculations that rental property should be making an 8.1% gross return.

However the NZPIF say that the rental figure of $340pw that the magazine uses is not correct and neither is the 8.1% expected return. King says “They are using the median rental price figure to estimate the relative value of the whole NZ property market. But rental properties only make up around a third of all properties in NZ and they are not representative of the entire property market. In general, NZ tenants prefer a lower quality rental property in order to save money on rent. Because of this, the average value of rental property in New Zealand is lower than the average price of all properties”.

King believes that when using rental prices to make assumptions about the value of all NZ properties, The Economist should have used the upper quartile rental price statistic of $420pw, as this more closely represents the value of the average New Zealand property.

In addition to using the wrong statistical figure, the NZPIF also believe that the Economist have assumed that rental prices in New Zealand are at the level they should be. However the Federation believe that rental prices in NZ are actually too low.

This conclusion was reached after the Federation analysed the cost difference of renting and owning the average New Zealand house. Their study shows that it currently costs $4,284 more to own the average New Zealand house than it does to rent it. This doesn’t take into account the $72,000 deposit required to buy the house or that mortgage interest rate costs are at their lowest point for many years, making home ownership that much more accessible.

“At this point in the economic cycle the cost of renting the average New Zealand home should be about the same as owning it” says King. “If this assumption is correct, then rental prices should be some $80pw higher than they actually are. So if you are going to use rental prices as a means of judging housing affordability, then a realistic rental price needs to be used.
Looking at the expected rate of return of 8.1% that the magazine used in its assumptions, the NZPIF believe that the magazine has failed to take into account how the New Zealand rental market differs from other countries.

“Many other countries have a capital gains tax on housing which means that rental property investors in those countries require a higher return to make the investment work” says King. “Other countries also have stamp duty or some other form of tax on property, which we don’t have in New Zealand. Rather than make the rental return from property in New Zealand more profitable, the absence of these extra taxes mean New Zealand investors don’t require such a high return. Because of this, The Economist should have used an appropriate rental return figure for the different countries it analysed. In New Zealand’s case a return of around 7% would be more realistic.”

The NZPIF have produced a table comparing The Economist magazines calculations to their own calculations.

The NZPIF calculation estimates the expected value of New Zealand property compared to rental prices at $366,000 rather than The Economists expected value of $217,500.

With the actual median value of New Zealand property for July being $361,000, the NZPIF believe that New Zealand property prices are in fact 1.4% below their expected value when compared to where rental prices in New Zealand should be.

“At the end of the day, NZ house prices are not too high compared to rental prices as The Economist has suggested, it is NZ rental prices that are too low” says King. “When a realistic rental price and expected return are used, Property prices appear to be about where they should be. The conclusion should be that rents need to rise rather than property is over valued.”

Estimated NZ Property Value

 

Factor Economist Magazine NZPIF
Weekly Rental Price $340 $500
Expected return 8.1% 7.1%
Equation $340 x 52 at 8.1% $500 x 52 at 7.1%
Estimated NZ Property Value $217,500 $366,000

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