Mark Lister, 2 February 2016

Auckland housing, and many other parts of the country to a lesser degree, is grossly overvalued, it’s as simple as that.

One of the most foolish comments I hear is the one about house prices not being too high, but wages in New Zealand being too low. We’d all like average incomes to be higher, but this is quite a ridiculous explanation for why housing is unaffordable.

It’s like saying that in 1999 share prices for internet companies weren’t too high, but their profits were too low. No kidding, but their profits were real, driven by economic fundamentals and genuine demand for their products.

Their share prices, driven by perceptions and expectations, were what was out of whack and what needed to change for balance to be restored. House prices are be driven by wages and incomes (among other things), not the other way round.

QV says the average rental yield in Auckland is 3.0 per cent. If you assume a measly half-a-per-cent for expenses, the 2.5 per cent rental yield you are left with suggests a price-earnings (PE) ratio of 40.

If a fund manager was confronted with a company trading on a PE ratio of 40 and a dividend yield of 2.5 per cent, they would likely deduct one of two things.

One explanation could be that this company has exceptionally strong growth prospects, and the high valuation reflects a likely big ramp up in earnings in the years to come.

Fisher & Paykel Healthcare fits into this camp, as one of the most expensive companies on the local market. Its PE ratio of 35 is double the average, and its dividend yield of 2.7% about half the average.

This high valuation is acceptable because its growth prospects are very strong. Profits are up almost 80 per cent over the last three years, and earnings and dividends could rise another 80 per cent over the next three.

The second possibility is that the company has only modest growth prospects, and the market has got the valuation completely wrong, as was the case in 1999 with US technology companies.

I think I know where Auckland houses sit on this scale, and they’re no Fisher & Paykel Healthcare.

New Zealanders have this unwavering expectation that house prices only every go up, and that owning them is a guaranteed way to getting rich. Maybe it’s the herd mentality or the aversion to shares that’s been with us since 1987, but the obsession is taking us into dangerous territory.

“Not only are some very unappealing social outcomes looming, but the housing fixation is causing people to make some dangerous financial choices.”

In many ways, a major correction would be a good thing for us all in the longer-term. Not only would it bring prices back to reality but it would burn a few people, teaching some valuable lessons about risk, leverage and overconfidence.

Ironically, I worry these trends are actually working in reverse and that in the eyes of authorities and policy makers, the housing market is becoming too big to fail.