THE Impact of COVID-19

March 30, 2020

There are a lot of people who will be feeling financially vulnerable right now and with good reason.

Westpac chief economist, Dominick Stephens is forecasting 200,000 jobs will be lost in New Zealand as a result of the response to the coronavirus pandemic. No doubt job loss will be asymmetric with 165,000 people employed directly and indirectly in the international tourism sector most at risk, while a further 135,000 work within hospitality. Job loss on this scale is unprecedented in New Zealand. The last time there was widespread unemployment was during the Great Depression of the 1930s where real unemployment is estimated to have been as high as 30%.

Potential unemployment on this scale is a daunting prospect and there is little doubt that New Zealand will enter recession as a result of the COVID-19 pandemic. How we respond will define our economy for a generation. Recovery is also asymmetric and this means that while many sectors will struggle, others will do well. For example, Coles’ supermarkets and liquor stores across Australia have hired an additional 12,000 workers. Amazon is hiring an additional 30,000 staff and these major employers will pick up workers from the travel and hospitality sector. While we remain in lockdown it is impossible to determine the symmetry of recovery across different sectors however, it is reasonable to assume that our primary sector and the add value food industry will do well. All New Zealanders should hope for rain as much of the country has been in drought and for economic recovery to be meaningful we will need all the luck we can get.

While the economic impact will no doubt be painful, it is preferable to the terrible loss of life that would inevitably occur if the strict measures we’ve adopted weren’t in place. New research from the University of Auckland suggests up to 80,000 New Zealanders could die from COVID-19 with 89% of the population infected. While the government has told us that the initial lockdown period will be only for four weeks, my view is that this will need to be for six to eight weeks to halt the spread of COVID-19 along with far wider testing. At present we can test 2,500 people per day and this will need to be substantially increased for us to truly get ahead of this including the testing of people who are asymptomatic. For those interested, I have provided a link to the recent TED interview with Bill Gates where he discusses the importance of isolation and testing as the most effective ways of managing the coronavirus pandemic.

Taking our economic pain upfront is the best chance we have of returning to a new normal as quickly as possible. Despite our incredible response to the pandemic, the world will have irrevocably changed and it will be many months after we leave lockdown that we will even be able to contemplate reopening our borders to the rest of the world. No doubt questions will be asked of our government as to whether we could have acted sooner, however these will be debated for years and for now it is important that we focus on the situation as it is today rather than speculate about what more could have been done.

Unlike the Global Financial Crisis where there was a significant credit crunch, governments around the world have responded quickly to provide liquidity. The Reserve Bank of New Zealand (RBNZ) will buy up to NZ$30 billion ($17 billion) of government bonds in the secondary market over the next 12 months. This is the first time RBNZ has used Quantative Easing (QE) and this package will fund the massive fiscal spending required to counter the economic headwind which we will inevitably face. New Zealand is not alone in adopting these measures and central banks around the world will adopt QE to provide stimulus to the global economy.

The RBNZ has also reduced the OCR to 0.25% following a substantial 75bp cut on the 16th of March along with a directive to banks to pass this on to consumers. This will hit savers hard and there is little attraction in leaving your money in a savings account at present. While savers are negatively impacted, borrowers able to access credit are able to do so at an incredibly low cost. Historically this has positively impacted the property market and compressed yields and driven the price of property upwards.

While property markets have remained reasonably stable (for now) due to the illiquid nature of investment, capital markets have seen an incredible amount of volatility. This volatility has translated into significant losses for KiwiSaver schemes and it seems unfair that New Zealanders are unable to direct their pension into their preferred asset class and investment as you are able to do in many other countries around the world. KiwiSaver schemes are heavily weighted towards global and domestic equities and for many people this is not their investment of choice.

So with liquidity in the market and historically low-interest rates it would be reasonable to assume that we have the makings of a property boom ahead of us, however as I’ve pointed out earlier, recovery will be asymmetric. Property investors who have been following speculative microeconomic opportunities in regions outside of Auckland will feel the impact of this. Hospitality towns like Queenstown and Rotorua will take months and even years to recover and we can expect the property market to follow a similar trajectory. Regional growth has historically lagged Auckland and my view is that the regions will feel the brunt of any property market correction. Investors who have chased a provincial investment strategy and purchased poor quality, high yielding assets or who have bought property for Airbnb will be unlikely to see rental growth for some time.

At a macro level, our economy and in particular the Auckland property market has been driven by population growth over the past decade. While migration will slow for a period of time as the world endeavours to tackle COVID-19, internationally New Zealand is seen as a “safe haven” destination and will continue to attract migrants under the investor category 1 or 2 visa. While I expect this trend to continue, in the short term we can expect many of the one million New Zealand passport holders living overseas to return home. This will put tremendous strain on our current housing stock and we can expect that ex-pats and first home buyers will continue to be the clearinghouse for second-hand property over the next two years.

Lack of supply has been a critical issue for the Auckland property market and Colliers' latest research indicates than an additional 290,000 homes will be required over the next decade, the majority of which will be needed in Auckland. It would be reasonable to expect that a significant portion of the government's fiscal package will be targeted towards infrastructure investment as a mechanism to drive economic growth. Inevitably a large portion of this will be spent on pre-approved projects through Auckland’s southern corridor creating employment along with the requirement for new housing.

The most resilient asset throughout the COVID-19 pandemic has been affordable apartments and townhouses along with government housing. Stability of cash flow is far more important than yield alone and these assets have performed at a time when office, retail and industrial landlords have had little to no income. Property investors in the provinces and at the higher end of the market also face market risk whereas affordable accommodation is generally government-backed through WINZ underwriting the performance of more vulnerable tenants. While the story of undersupply in the New Zealand market has been well documented, the greatest need for accommodation is within the affordable, emergency, transitional and social housing sectors. For our housing market to be functional there needs to be supply at every rung of the property ladder and we remain committed to developing housing at the affordable and aspirational end of the market.

As we come out of lockdown, I expect to see both head-contractors and subcontractors struggle through the initial stages of recovery as their cash reserves will have been severely depleted. Within New Zealand there are few contracting businesses with a balance sheet of substance and this lack of financial resilience will mean that a number of businesses will fail in the short term. With a weaker dollar, the cost of construction products will increase and merchants will be looking to their supply chain to fund stock as they gear back up. While this will even out over the medium term, a lower dollar will see an escalation of building costs across New Zealand which will ultimately be passed on to the consumer.

A critical issue for our construction industry across infrastructure, housing, and commercial sectors is whether we are able to physically deliver on projects without a migrant workforce. A key opportunity for the government and the private sector will be to attract travel and hospitality workers to the construction industry. Unlike the secondhand property market, new housing provides huge economic stimulus and significantly adds to our GDP. I expect to see the government take a significant role within the Auckland property market through Kāinga Ora, MSD and ACC over the next few years.

Since 1981 Auckland has experienced real house price growth (adjusted for inflation) of 4.5% per annum whereas provincial New Zealand has experienced growth of 2.5% per annum (Reserve Bank bulletin – volume 79). Remember that this period of time encompasses major world events that include the recession of the early 80’s, the share market crash of the late 80’s, the fall of the Berlin Wall, the dot com crash, the Asian crisis, wars in the Middle East, the September 11 terrorists attacks, the global financial crisis of 2008 and now COVID-19. Despite these events, the Auckland property market has continued to be a predictable safe haven for investors and home buyers alike.

It is important to remember that when you buy a new property, the whole economy wins and on completion, you also provide vitally needed independent accommodation. As an investment, it spans market cycles and purchasing property at today’s prices for completion in 2022 or later still makes a great deal of sense and gives investors the opportunity to save to increase their deposit while benefiting from capital gain during the construction period. I’m backing Auckland and another property boom by 2022.

In this market, Du Val will be a buyer and we will be seeking to acquire land in strategic locations and to repurpose hospitality assets to increase our direct and managed portfolio of affordable apartments which continue to be New Zealand’s most financially resilient investment.

I will leave you with the words of Westpac’s chief economist, "It is important to remember, though, that this is a temporary disruption to economic activity, not a new long-run trajectory for the economy". "We anticipate a period of above-normal GDP growth after the worst of the virus-related disruptions have passed, as the economy returns to a normal level of economic activity, catch-up production to restore depleted inventories occurs, and even lower interest rates stimulate asset prices."

Stay safe, Kenyon Clarke