The other week, BNZ chief economist Tony Alexander put out a statement chastising young people for not saving harder to buy a home. As I pointed out, his argument was based on a pile of untrue assertions and misleading data. Others also expressed similar views.
In a further statement reported by Jenée Tibshraeny, he clarified that crazy house price increases have actually made it harder for young people to afford a home. It’s nice that he’s aware of that, but the rest of his article suggests that he thinks the hole he’s in will turn into a tunnel if he keeps digging.
Alexander’s core advice remains:
Young buyers these days need to make deep sacrifices in spending on other things if they want to purchase a house and if such sacrifices cannot be made home ownership could well remain out of reach…
If purchasing a house is your goal then there is no shortage of things which those who already have purchased sacrificed as they built up their savings, worked at reducing the principal to improve their position, and adjusted when their interest rates and/or expenses went up. Things people have cut out have included…
· Cafe visits
· Going to restaurants and bars
· The latest telephones, games consoles, cars
· International travel
· Weekend and evening leisure time because they took an extra part-time job.
· Hired help like dog washers, landscape designers, etc.
· Subscription tv, gaming, music
· Privacy – by taking in flatmates, student boarders, or renting out space on Airbnb.
And he continues to make blatantly false statements about the saving behaviour of Boomers (who spent their 20s taking on debt) and Millennials (who are saving lots in their 20s):
Baby boomers will understand this need to build savings over many years before seeking a mortgage. But the younger generation used to businesses chasing them continually for their dollar will take some time to cotton on to the implications and figure out how to get to the head of the queue.
As I said last week, house prices have risen significantly relative to the price of just about everything else. In that context, Alexander’s advice to save money by cutting back discretionary expenses, most of which are relatively cheap, is bad advice for the average young person. That might have worked in the past, when housing was cheap compared with overseas travel or consumer electronics, but it doesn’t work now.
Since Alexander hasn’t done the maths on this, I will. H
I’m going to start by making a few simplifying assumptions. First, I assume that people are saving money in bank accounts that offer returns that are roughly equal to inflation, and then I ignore inflation – all numbers are in real terms.
Second, I’m going to make some generous assumptions about future increases in the price of housing. Today, the price of a median Auckland home is just over $800,000, and the price of a lower-quartile home – ie a typical starter home – is around $680,000.
Those prices have risen at double-digit rates for the last five years. But I’m going to make a very optimistic assumption that we get real house price inflation down to a much lower level – say, a mere 3% per annum.
Third, I’m going to assume that first home buyers will still be required to come up with a 20% deposit due to loan-to-value restrictions. Lowering that ratio would probably cause house prices to rise faster anyway, offsetting the benefits for first home buyers.
Finally, I’m going to consider a hypothetical case of a very feckless Millennial who spends money on a whole bunch of unnecessary luxuries rather than prudently saving for a mortgage. Our made-up spendthrift is assumed to:
- Go on one overseas holiday a year at a cost of $4000
- Buy a coffee a day at $4 per coffee, or $1460 per year
- Go out for a $40 brunch every Sunday, which costs $1040 per annum
- Get acupuncture ($80) on a weekly basis, costing $4160 per year
- Subscribe to Sky TV at $600 per year
In addition to all of this self-indulgence, they also hire a cat whisperer to visit their pet while they’re at work and prevent it from developing emotional problems. Cat whispering costs $23 per visit, adding up to an astonishing $5750 per year (based on 250 working days a year).
These savings add up to $17,010 per annum, or around 30% of the average pre-tax income for an 25-29 year old Aucklander with a full-time job (a bit over $50,000). Surely someone saving that hard would be able to afford the deposit on a home in no time?
Well, no. Here’s a chart comparing their accumulated savings with the required deposit. While their savings would eventually exceed the required deposit, it would take:
- 11 years for them to afford a lower-quartile home
- 14 years for them to afford a median home.
In other words, someone who started saving in earnest at 23 wouldn’t be able to afford the deposit on a home until they were 34. Furthermore, if real house price inflation was even slightly higher – say 5% rather than 3% – it would take 23 years to afford the deposit on even a lower-quartile home.
This analysis demonstrates two important things.
First, following Alexander’s advice and saving until it hurts won’t help young people. The only way things will get significantly better is for house prices to fall to a more realistic level.
In Alexander’s world-view, the only two paths forward are for young people to give up everything fun and work three jobs to save for a deposit and pay the mortgage, or for them to give up on home ownership. But that’s a false choice that only applies if house prices stay at current levels. If prices were lower, bank economists wouldn’t be making silly comments about how to save for a deposit by firing your cat whisperer.
Second, this shows that any further increases in house prices are unsustainable for first home buyers. Even if real house prices only increase by 3% per annum, that means that the value of a median home will increase by $24,000 a year, or almost half of the average wage for employed people in their late 20s. The required deposit will in turn increase by $4800, meaning that the average employed Millennial would have to save almost 10% of their pre-tax income just to keep up with inflation in the average deposit.
This in turn means that we have to take a hard look at our baseline assumptions about capital gains on residential property. Although rising prices have been beneficial to some, it’s becoming increasingly apparent that they have a range of negative social and economic consequences. Put it another way: I wouldn’t necessarily buy on the promise of everlasting capital gains.