WEB: 79/09

key factors driving prices higher:• Strong population growth combined with lack of buildingactivity has created a shortage of new houses.• Low mortgage rates.Both of these drivers are necessarily temporary. This bulletindetails our thoughts on the current market. The conclusions are:• Conditions will favour rising prices for some time yet. Weexpect the annual rate of house price inflation to go double-digit by the middle of 2010.• In 2010 we expect interest rates to rise, net migration toslow, and a strong increase in house building. This will negatethe market’s short-term strength and cause a downturn,possibly involving another brief period of house price decline,or a longer period of house price stagnation.• We have the downturn tentatively pencilled in for late-2010,but the timing is extremely difficult to pick, and dependsmostly on when the Reserve Bank acts to raise the OCR.

The shortage of new houses

In 2008 New Zealand net migration (arrivals less departures)was 3,800. For 2009 net migration is likely to be around 22,000.Although population growth has accelerated from 0.9% to 1.3%,the residential construction industry has been relatively inactive.House building is running at only 14,000 per year, whereas25,000 houses per year are needed to accommodate this rate

Housing encore

Update on the New Zealand housing market

12 November 2009

New Zealand housing is displaying all the symptoms of a bullmarket. House sales have risen sharply, and now stand aroundtheir long-run average. The time taken to sell has shortened. Thenumber of houses listed on the market has fallen. All indicatorsare typical of a market upturn, and point to a significant priceincrease.According to the REINZ Monthly House Price Index, house pricesare now 8% higher than they were in January 2009, althoughthey remain 4% lower than the November 2007 peak. Priceshave risen 4.2% over the past three months. It is fair to say houseprices are booming again.The market revival is being led by the major urban centres,especially Auckland. According to Quotable Value, annual pricegains in Auckland Wellington and Christchurch have all exceededthe national average gain. The major urban centres also ledhouse prices down in 2008, so it is not surprising that they areleading the recovery.So what is causing all the excitement? Improved economicconfidence is no-doubt playing a role. In addition, there are two

• House price inflation is heading double-digit in thenear-term, but we foresee a downturn in late-2010.• House building activity is expected to pick upstrongly.

For all clients: Westpac Institutional Bank is a division of Westpac Banking Corporation ABN 33 007 457 141, incorporated in Australia (“Westpac”). The information contained in this report: does not constitute an offer,or a solicitation of an offer, to subscribe for or purchase any securities or other financial instrument;· does not constitute an offer, inducement or solicitation to enter a legally binding contract; and is not to be construedas an indication or prediction of future results. The information is general and preliminary information only and while Westpac has made every effort to ensure that information is free from error, Westpac does notwarrant the accuracy, adequacy or completeness of the Information. The Information may contain material provided directly by third parties and while such material is published with necessary permission, Westpacaccepts no responsibility for the accuracy or completeness of any such material. In preparing the Information, Westpac has not taken into consideration the financial situation, investment objectives or particular needsof any particular investor and recommends that investors seek independent advice before acting on the Information. Certain types of transactions, including those involving futures, options and high yield securities giverise to substantial risk and are not suitable for all investors. Except where contrary to law, Westpac intends by this notice to exclude liability for the information. The information is subject to change without notice.Westpac expressly prohibits you from passing on this document to any third party. Westpac Banking Corporation is regulated for the conduct of investment business in the United Kingdom by the Financial ServicesAuthority. © 2001For Australian clients: WARNING – This document is provided to you solely for your own use and in your capacity as a wholesale client of Westpac.

For further information, questions or comments contact Brendan O’Donovan, telephone (04) 470 8250, email bodonovan@westpac.co.nz

Figure 1: NZ house sales and available listings

02,0004,0006,0008,00010,00012,0001998199920002001200220032004200520062007200820093 mth average, s.a.02,0004,0006,0008,00010,00012,0003 mth average, s.a.NZ house salesAvailable listings, Auckland

Source: REINZ, Barfoot & Thompson

Figure 2: Westpac house price forecast

-10-50510152025301993199619992002200520082011ann % chg-10-5051015202530ann % chg

Source: QVNZ, Westpac

Westpac forecasts

Update on the New Zealand housing market– 12 November 20092

WEB: 79/09

The new environment we envisage, where developers’ marginsare higher but finance is more difficult to obtain, suggeststhe structure of the residential construction industry couldchange. Large, well-capitalised corporations that can draw oninternational balance sheets will be the most able to seize thisprofit opportunity. Small-scale builders that are mostly cash-flow positive might go from building two houses per year tobuilding three. But mid-size developers who are highly leveragedmay suffocate from lack of finance.A second possibility is that the cost/difficulty of obtainingfinance could ease. In this case the price of bare land would riseagain, construction activity would blossom, and the developers’margin would shrink. We view a complete return to the looselending conditions of 2004 – 2007 as exceedingly unlikely. Butsome easing in credit constraints is sure to follow economicrecovery, as has always happened in the past.

Interest rates

The second driver of the bull-market in housing is low interestrates. In our last housing update (4 June 2009) we correctlypredicted that low interest rates would drive a house pricerecovery. But we incorrectly surmised that rising long-termrates would soon squash the market. Long-term interest rateshave gone up, but house prices have just kept on rising, with themarket reacting more to low short-term rates. That is worrying.Because if low short-term rates are driving prices up, then theinevitable increase in short-term interest rates will eventuallydrive house prices down again.of population growth. This has left New Zealand with an acuteshortage of houses. New Zealanders are actually ‘crowding’more people into each house, for only the third time since 1960.History shows that when crowding occurs, higher house pricesand strong growth in residential building activity are sure tofollow.Rising house prices should be providing an incentive for developersto build more houses and alleviate the obvious shortage. So alland sundry, Westpac Economics included, are anticipating avery rapid increase in residential construction activity. But evenour forecast 50% increase in residential construction activityover two years would leave construction activity at a low level,and would not be enough to completely alleviate the housingshortage.The reason we are not picking an earlier or sharper increasein construction is that finance for NZ property developmentis extremely difficult and/or expensive to secure. Most of thefinance companies that provided high-risk mezzanine financeat low cost during the last building boom have disappeared.Banks are wary of high-risk lending and are charging muchwider spreads because they are themselves facing a highercost of funds. It is worthwhile explaining just how we expectthe construction industry to overcome its finance problems todeliver the houses New Zealand needs.The relative expense/difficulty of financing propertydevelopment has seen the price of bare land fall by far more thanthe price of houses. The ratio of house prices to section prices haswidened sharply in the past year, the first significant rise since1990.

So the reward for putting a house onto bare land – thedevelopers’ margin – has increased substantially. Our contentionis that eventually, the developer’s margin will get large enoughto enable developers to overcome the high cost of finance. Thereis a price for everything, and if the price paid to developers riseshigh enough, they will find a way to develop!

Figure 4: Section prices and house prices

0501001502002502000200120022003200420052006200720082009050100150200250House pricesSection pricesIndex Jan 2000 = 100

Source: REINZ

Index Jan 2000 = 100

Figure 3: People per house

2.402.452.502.552.602.652.702.7519901992199419961998200020022004200620082.402.452.502.552.602.652.702.75

Source: Statistics NZ, Westpac

Figure 5: Ratio of house prices to section prices

1.71.81.92.02.12.22.32.42.52.620002001200220032004200520062007200820091.71.81.92.02.12.22.32.42.52.6

Source: REINZ, Westpac

The ratio trends down because sections are getting smaller while houses aregetting bigger. This makes the widening of the ratio all the more remarkable.