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Residential property: a lesson from China

Dynamics of residential property in China are very different to ours, but their market may have useful lessons.

john HeadshotsTRY sq John Berry 3 minute read

 Residential property has been a standout performer for investors over 2021, rising nearly 30 per cent. That’s stellar, particularly compared to another popular investment option, the New Zealand share market, which has fallen slightly this year.

Many view the rise and rise of residential property as a sign that it will keep going up forever. But despite the amazing run, it will reach a plateau or turning point.

Interest on a house purchase needs to be funded from personal earnings or, if you’re an investor, by property rental. As house price rises outstrip wage and rental growth, would-be homeowners need new ways to access extra funding.

There have been a few levers for buyers to pull over recent decades, allowing prices to be bid ever higher. For a start the 20-year trend for lower interest rates helped borrowers service increasingly larger debts. Couples could decide both should work to increase household income. Maybe they could scrape together a bigger deposit by borrowing from parents or delaying their purchase.

With our house price affordability among the worst in the developed world, these levers won’t support outsized house price rises forever. When interest rates were falling people could borrow more, now rising interest rates mean less capacity to borrow.

Dynamics of residential property in China are very different to ours, but their market may have useful lessons.

In China, property has dominated as a place to store household wealth, to the exclusion of most other investment options. Only 7per cent of people in China own domestic listed company shares which is extremely low, compared to the US where over half the population own shares.

Chinese policy setters want to encourage a shift from property to shares, funding local business growth and jobs.

In New Zealand we’ve tinkered with rules around interest deductibility to slow property investment. Meanwhile, China restricted how much developers can borrow against their cash flow and assets, slowing development work. Their population is hardly growing so they don’t need to keep building ever-increasing amounts of residential property.

Evergrande, a massive Chinese property developer, was the first high profile casualty of these restrictions, struggling under US$300 billion of debt. Evergrande’s debt is 18 times larger than the market capitalisation of New Zealand’s 10 biggest listed property investment and retirement home companies.

Astonishing in a New Zealand context, but not overwhelming for the world’s second largest economy.

After six years of new-house prices rising every month in China, prices fell by a small amount over both September and October. Even a small fall is a dent in confidence.

No matter how long property has risen for, and no matter how much investors want prices to keep rising, they can’t outstrip wage growth forever. Interest rates, tighter lending policies and the exhaustion of buyers’ levers to borrow more will bite, eventually.

Here in New Zealand our Treasury expects house prices to rise by 10 per cent over 2022, meanwhile the Reserve Bank and our main banks see it differently. For example, ASB and BNZ predict falls of 4 per cent and 6 per cent respectively over 2022 while ANZ expect a 4 per cent drop by mid-2022.

After six years of new house prices increasing every month in China and now a dip, there may be a lesson for us. We all know the standard warning ‘past returns do not indicate future results’ applies to shares and cryptocurrencies.

Maybe now, after years of irrelevance, the warning about past returns applies to property again as well.

-John Berry is co-founder and Chief Executive of ethical fund manager and KiwiSaver provider Pathfinder Asset Management, the first B Corp certified fund manager in New Zealand which is part of Alvarium Wealth

(This article was originally published by Stuff  December 23, 2021)

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