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October 01, 2020
People

Low interest rates and their contribution to inequality

Historically low interest rates brought on to combat the impact of COVID-19 have the potential to increase wealth inequality

In March, the Reserve Bank dropped the Official Cash Rate (OCR) from one percent to a record low 0.25 percent. Interest rate cuts at all major lenders have followed. The intention is to maintain confidence in markets. However, this has the potential to have a long term impact on home ownership and wealth inequality.

Property prices remained strong coming out of the national lockdown. According to realestate.co.nz the national average asking price increased by 12.9 percent from July 2019 to $756,250 in July 2020. However the total number of homes available for sale in July was down 11 percent on the same month in 2019. The strong performance of house prices is likely to slow as the full impact of COVID-19 is felt. This will be highlighted as the wage subsidy and mortgage deferral schemes end. Many expect that house prices could fall for the next six months with predictions of a price drop of anywhere from three to ten percent1.

Source: Reserve Bank of New Zealand

While lower interest rates may make mortgage repayments on residential property more affordable, it does not mean that New Zealanders will be able to take advantage of the low rates to get onto the home-ownership ladder. A critical obstacle to getting onto this ladder for many New Zealanders is the relatively large (as a proportion of income) deposit required. This requirement has not been lessened by lower interest rates.

Although the Reserve Bank has slashed the OCR to encourage spending, banks have tightened their lending criteria. With unemployment almost certain to increase there will be redundancies of people across the entire income spectrum. Tough economic conditions will impact business performance. This will flow through to employees with many likely to experience lower incomes. The expected increase in unemployment and uncertainty brought about by COVID-19 has caused banks to reduce their risk appetite. In some parts of the country the location of the applicant has even become a factor in whether banks are willing to lend.

These impacts will likely make the ability to accumulate the deposit required to get onto the home-ownership ladder even more difficult for many.

With interest rates at an all-time low and banks reducing risk, it creates a situation where the housing market again benefits the wealthy at the expense of the less well off as explained later. This continues a long term trend of housing consolidating amongst less and less of the population. In 1991, almost three-quarters of households lived in a home that they owned. By 1996, this figure had decreased to 70.7 percent, was 64.8 percent in 2013 and 64.5 percent at Census 2018.

A consequence of low interest rates is that saving becomes unattractive and borrowing becomes more popular. This borrowing needs to find a home, and given the success property investors have had, property appears to be a safe place to look. Even with falling prices expected in there short term the long term trend has been for increasing house prices.

Source: Real Estate Institute of New Zealand

The attractiveness of residential property as an investment during the financial downturn is supported by the views of the public. New Zealanders remain optimistic about prices in the housing market, according to a recent Trade Me Property survey. As reported by stuff.co.nz in July almost two-thirds of survey respondents expected property prices to increase or remain the same in the last quarter of 2020. However, about one-third of Kiwis expected to see house prices fall once the wage subsidies end.

The long term security offered by housing is attractive to investors at a time of uncertainty. To put the recent security of housing as an investment into perspective the median house price in April 2020, through the majority of alert level four, increased from $640,000 in February to $680,000. Although the median price fell to $620,000 in May 2020 this was still 2 percent greater than the median price this time last year, October 2019.

Land isn’t going anywhere (unless the property is on the coast), meaning capital gains in the long term. Those with money, a down payment and good credit make for attractive customers to lenders. This benefits the well-off who have the ability to save for deposits. Some investors will also have considerable equity in existing property or investments that they can offer as security which is not possible for first time buyers. Backed by greater financial security these investors have the potential to pay higher prices than everyday households who stretch themselves looking to get into their first home.

Astute investors can leverage off their other assets to obtain interest-only mortgages, use the rents to remain cash flow positive and wait while capital gains accrue to them. Property investing is likely to remain attractive, even though recent law changes have strengthened tenants’ rights and protections.

In the long term this is likely to result in increasing inequality. Those already wealthy increase their housing assets and further improve their wealth situation (while also not paying tax on any gains). This occurs at the expense of those who are unable to access the housing ladder and the opportunities that go with a secure housing situation. Indeed, they are also likely to be already the most vulnerable to the negative impacts of COVID-19 at the start of the outbreak of the pandemic.

A further danger lies is if current home owners are unable to make repayments due to difficulties brought about by COVID-19 and are forced to sell their house. With investors looking for opportunities this will further move housing assets to the wealthy. The tenant who would otherwise have owned the home but for the impact of COVID-19 now pays rent to the investor rather than repaying their own mortgage. Further increasing the level of wealth inequality.

If you are facing the challenges inequality presents we want to speak to you.

BERL is beginning an investigation into the impacts, effects, causes, and possible solutions to address intergenerational inequality for the benefit of the next generation. We intend to run these as a series of interviews, articles, podcasts and possibly videos to explore intergenerational inequality. Rather than coming up with the solution based on theory, data, and international examples we want to develop a truly New Zealand response. The views of a diverse group of interviewees and contributors including those who are working on the front line, academic experts, advocates, and policy advisors is important. If you believe you could add value to this work and are interested in being involved please contact  nick.robertson@berl.co.nz for more information.