Changes in loan-to-value ratio (LVR) restrictions have had clear effects on housing market outcomes since they were added to the Reserve Bank’s toolbox in 2013. One of the most interesting results has been the apparent weakening of the relationship between house sales and prices, and dwelling consent numbers, with shifts in the housing market’s momentum being increasingly driven by LVR changes. Considering the current sharp slowdown in the housing market, we examine whether residential construction activity can be expected to follow suit in 2022/23, or if LVR exemptions provide a more solid foundation for construction.

At its most basic, our modelling of residential construction activity is premised on the two key drivers of population growth and interest rates. The logic is that slowing population growth or rising mortgage rates dampen buyer demand for housing, leading to weaker sales volumes and less upward pressure on prices. Developers see these signals of softer demand, and, with a bit of a lag, the rate of residential construction slows until demand conditions become more favourable again.

Although this relationship has not completely broken down, Chart 1 suggests that the correlation between house prices and consent numbers has become weaker throughout the last decade. We’ve considered whether this breakdown might be due to the Christchurch rebuild during the mid-2010s, or the trend away from standalone houses to multi-unit developments. Both have had some effect on the relationship, but we still get a sense that the swings in growth rates for residential consent numbers have been less pronounced in recent years than house prices would have previously suggested.

One of the key features of the LVR framework is the exemption of new builds from the lending restrictions. This exemption was introduced due to concerns about the undersupply of housing and the desire to ensure that the LVR restrictions did not have the perverse consequence of worsening housing supply issues over the medium term. The exemption has provided investors and first-home buyers with a potential pathway towards property ownership without needing to meet the usual deposit requirements, currently set at 20% for owner-occupiers and a hefty 40% for investors.

The incentive for investors to purchase brand new homes has been further increased since early 2021. New properties have retained both a five-year bright-line test and the ability to treat mortgage interest as a tax-deductible expense for their first 20 years of ownership.

A deep dive into the Reserve Bank’s mortgage lending data shows that investor demand has dropped substantially over the last year since LVR requirements were reinstated. New loan numbers for investors in the three months to February 2022 were down 50% from a year earlier.

We can’t compare exempt investor loan numbers with a year ago because the absence of any LVR restrictions in 2020/21 means that no loans fell into the “exempt” category. However, a comparison of the recent proportion of exempt investor lending against 2016/17 figures, when the same 40% LVR requirement was in place, is instructive. Since May 2021, the proportion of exempt investor lending has averaged 44% of total investor lending. This figure is in line with the 45% average recorded between October 2016 and December 2017. If we take exempt lending as a proxy for demand for newly built homes, investor demand seems to be holding up well.

The trend is similar, although less pronounced, for owner-occupier exemptions. Lending data shows a 31%pa drop in new loan numbers for owner-occupiers in the three months to February. However, the proportion of exempt lending since October, when the LVR requirements were most recently tightened for owner-occupiers, has averaged 11%, above the 9.5% average in 2016/17.

Notwithstanding the usual seasonal decline in loan numbers during January and February, both investor and owner-occupier demand for new dwellings appears to have held up relatively well over the last year, despite the changes in housing market conditions. Chart 2 and Chart 3 show our estimates of the numbers of new loans that are exempt from the LVR requirements.1

In total, we estimate that the number of exempt mortgage loans made over the last year is about 36,000, with about 22,200 made to owner-occupiers and the remainder to investors. Not all these loans will be for new builds – other exemptions include non-routine repair work (for example, for leaky buildings) and Welcome Home Loans for lower-income borrowers. The latter grouping is likely to represent a reasonable proportion of owner-occupier exemptions. Nevertheless, the house price caps for Welcome Home Loans have become increasingly restrictive over the last two years as property values have soared, leading to declines in the number of Welcome Home Grants across the country, which are likely to be reflected in falling loan numbers as well.

Although not all the 36,000 exempt loans over the last year will be for new builds, this estimate gives us some idea of how exempt lending compares with the build rate. New dwelling consent numbers from two years ago, as an indication of homes currently being completed, sat just below 38,000pa.

The outlook for residential construction has become shakier over the last six months as the housing market has turned. Experience from previous LVR adjustments over the last eight years suggests that the 2021 changes won’t necessarily lead to a downturn in residential consent numbers. The data on loan exemptions so far seem to back up this conclusion.

However, if we see exempt lending numbers fall away over coming months, it could indicate that the downturn in the market for existing housing is spilling over into demand for new builds more than we have seen from previous LVR changes. If a slowdown in exempt lending does occur, we suspect that the restrictions around credit, such as the LVR limitations or changes to the Credit Contracts and Consumer Finance Act, will prove not to be the dominant drivers. Instead, it is likely that the surge in mortgage rates and collapse in population growth over the last year would have reasserted themselves as the key determinants of housing market and residential construction outcomes.

1 The Reserve Bank publishes data on the number and value of new loans by borrower type, but only data on the value of new loans that are exempt from the LVR requirements. We have cross-tabulated these figures to estimate the number of exempt loans.