Market Outlook 2020: short term realism coupled with long term optimism

On Monday, Property Council hosted Head of Research at BNZ, Stephen Toplis, for an exclusive member-only webinar that provided his take on the market and where we are heading in 2020 and beyond.

“The good news is that the economy is definitely in the midst of a massive recovery…the bad news is that it is going to take a long time before we get back to the levels of activity that we saw pre-COVID-19 and there’s going to be some massive adjustment costs along the way”, says Toplis.

“The property sector is one of the sectors that is going to bear the brunt of this adjustment, as the economy not only changes in size but equally changes in shape.”

Toplis says it is this changing shape, coupled with changes in population growth, that he believes is going to have long lasting impacts on the broader property market.

“If you think about the last ten years, the overriding factor that has driven property of all descriptions has been the increasing number of people in the economy.”

Toplis says that since 2015, the population size has been growing by 1.5-2% per annum, driven predominantly by net migration. Overall, this equates to 80,000-100,000 extra people per annum. As a consequence of COVID-19, this population growth is likely to drop from around 2% per annum (as of the last actual reading in March 2020) down to around 0.5% per annum.

“That is going to have a major impact on the demand for buildings of all types”, says Toplis.

Residential housing supply may finally outstrip demand

Toplis says the residential housing market will be most significantly impacted, because that market was being driven “almost exclusively by the belief that there would be a shortage of houses almost forever as migration-driven population growth increased the demand for housing but supply was unable to keep up with it.”

When we were growing at around 2% population growth per year, we needed approximately 35,000 houses simply to cope with population growth. This didn’t take into consideration degradation of building stock, second homes, etc.

“Until recently, we weren’t building this many houses, which is why the market went from strength to strength.

“Pre-COVID we were predicting building 40,000 houses per annum for both this year and the following year, meaning that we would effectively meet demand based on population growth. If the migration levels fall to what is being predicted, New Zealand will only need to build around 11,000 houses per year to meet this demand."

Toplis says the BNZ has taken an optimistic view of the housing and construction market, predicting that the construction industry will build 20,000-25,000 houses in the coming year.

“That’s optimistic in the sense of the construction industry, but it’s actually not great from an investor perspective because it means we will be eroding the demand for housing very, very quickly”, says Toplis.

“Overall, whether you’re involved in the construction side or the investment side, in the housing market things are going to be a lot tougher”, he says

Increasing unemployment will hurt the property sector

Toplis says that it doesn’t matter which type of property you’re talking about, this change in population growth is going to have a major impact and the other vital statistic worth considering is the unemployment rate. “The unemployment rate in New Zealand is going to skyrocket” says Toplis.

“Pre-COVID, the unemployment rate sat at just below 4%. Right now we think it is round 6.5%, by the end of the September quarter we see this moving to 8.5% and at the end of the December quarter we see the unemployment rate at 10%.

“The third quarter of this year will be the real killer. At the moment we’ve got masses of disguised unemployment. It’s disguised because the Government’s wage subsidy scheme has kept people in work in businesses that simply will not survive."

“Since the wage subsidy has stopped (approximately two weeks ago), we’ve seen 75 businesses go into liquidation already, and that number is going to increase quite dramatically over the next quarter as that wage subsidy rolls off,” says Toplis.

He notes that the BNZ are predicting a drop in house prices similar to those seen during the GFC but says, “it’s quite hard to get upset when the average Auckland house purchaser has seen their house value double in recent years. To have it drop by 10% is not disastrous by any stretch of the imagination.”

Toplis says they see the commercial property market as being “highly stressed” due to three key drivers:

  1. Employment slumps
  2. Increased demand for businesses to work from home
  3. Confidence has been thumped

“Short-term, the number of people employed is expected to fall by 200,000. While not all of these will be employed in a commercial building, none the less it will be a big drop in the demand.”

“We don’t think the number of people employed in New Zealand will return to pre-COVID levels until September 2022,” says Toplis.

Commercial property confidence declines

“In the commercial property space, what we are seeing is that confidence has well and truly been shattered. We’re seeing expectations for own activity, expectations for employment and general confidence falling to levels that we’ve never seen before.

“That ultimately effects all investment decisions – not just property – people just don’t want to invest in this environment”, says Toplis.

“COVID-19 in many ways has not caused sudden changes in the economy, what it has done is accelerate trends that were already well and truly in place.” Toplis cites trends such as working from home, virtual conferencing and online shopping as examples.

Retail challenges ahead

“There’s quite a lot of optimism in retail at the moment because if you look at the electronic card transactions data over the last four weeks, total spending over the last month is 10% up on 2019 levels, which is a phenomenal performance.”

Toplis warns that this could be due to pent-up purchasing post-lockdown and an increase in the use of card payments over cash.

Again, the increase in unemployment and the huge number of people who have taken salary cuts in order to see their company through this period could have a detrimental effect on retail spending. Similarly, tourism has a significant impact on shop-front sales in New Zealand and the removal of tourists from the economy is having a major impact on retailers.

Lack of international tourism a blow for hotel sector

Referencing hotels and tourism, Toplis says, “it’s going to take years before tourism numbers rise back to pre-COVID levels. We forecast out to 2025 and we do not have tourism numbers as high as they were pre-COVID and realistically speaking tourism is going to be exceptionally weak until such time as we open up our borders.”

Toplis says we could open the borders with Australia (provided they are COVID-free), however community transmission rates there are increasing with talk of increased border controls between states in Australia. “The earliest we could expect to see anything happen with Australia is probably mid to late September 2020, but only if they manage to get COVID under control,” he says.

“There’s a lot of talk about the fact that New Zealander’s could provide the missing link for domestic tourism, but I think that’s overstated."

“If you look at the total quantity of money spent by New Zealanders offshore last year that comes to $6.5bn. You could argue that that $6.5bn will be spent in New Zealand, and indeed it might be, but bear in mind that tourists in New Zealand last year spent almost $17bn, so even if every cent that was spent offshore was now spent onshore, that’s not going to provide the boost that is required”, says Toplis.

Industrial property a safer haven

“Industrial space doesn’t tend to get hit as hard as other space in this sort of environment. We do believe that New Zealand manufacturing will hold up relatively well through this process. We do believe there will be some substitution from offshore manufacturing to New Zealand manufacturing, but currently indicators have manufacturing activity slumping greater than it did during the GFC, so near-term there will be issues in that sector as well.”

We will recover, but it will take time

“If you’re looking for sectors where property might do well, I think distribution sectors, warehousing, transport hubs all look good. The health sector is going to continue to expand and in the education sector – schools and the like – there will be substantial investment in this space.”

“Normally front of mind for the property sector is where interest rates are going. The answer to that is ‘nowhere’”, he says.

Toplis commented that the BNZ don’t believe the Reserve Bank have any intention of adjusting interest rates until March 2021, at which time they could very well go down, noting that they don’t see negative interest rates on the horizon as this would do little to stimulate the economy.

“It's really important to recognise is it's going to take years to get back to normal, this is not something that we're going to adjust to in the next five minutes. I’m actually a real optimist for New Zealand on a five/ten/fifteen year horizon. We will come out of this relatively well by global standards and we will become or remain a strongly favoured tourism destination (provided we keep on top of this I might add).

“I think we will also become a favoured migration area yet again. So I think that when we do come out the back end of this New Zealand will outperform much of the rest of the world but you're going to have to be patient to take advantage of that.

“We might get rid of COVID-19, but the rest of the world sure as hell isn't and New Zealand's export to GDP ratio is a third, so that's a big chunk of the economy that is going to remain constrained for the foreseeable future."

“We know that population growth will remain constrained until the borders open up, we know that the unemployment rate will stay lofty, we know international tourism will remain in disarray and we know that investment activity will not pick up until confidence returns.

“We think that it will be mid 2022, or more likely the second half of 2022 before we get levels of activity back to pre-COVID levels.

“Additionally, in terms of headwinds for the economy, bear in mind that the Government is building up a massive amount of debt. We’re going to go from 19% of GDP debt to 60% of GDP debt. That means that we're going to have to go through a period of fiscal austerity to try and reverse that debt build-up at some stage and that will be a headwind to future economic activity,  albeit not as great a headwind as it will be for many other countries whose debt loadings will be far greater than our own.

“I'm strongly of the view that we are currently on the right path. I'm really optimistic about New Zealand on a long term view, but we need a savage dose of realism in terms of where we go over the next 48 months, because this process is only just beginning.”

To view the full webinar, including live Q&A from our attendees, click here.

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