Do property taxes affect housing affordability?

A few weeks ago, I took a look at property taxation in the US, Canada, and New Zealand. I found that Auckland homes are taxed lightly by comparison – rates average 0.39% of house value. Property tax rates are twice as high in most of the other cities I looked at. In some cases – e.g. Houston, where property taxes average 2.31% of home value – they are much, much higher.

This should come as no surprise to anyone who’s read the literature. For example, Grimes and Coleman (2009) find that New Zealand under-taxes property:

McLeod et al (2001; p.26) showed that the proportion of taxation raised through property taxes was lower in New Zealand than in Australia or the United States. Taking into account all levels of government (federal, state and local), Grimes (2003) found New Zealand’s share of property taxes in government revenue was relatively low, at 5.7%, compared with a (20 country) OECD average of 8.3%. As a share of GDP, New Zealand’s property tax share was also relatively low at 1.8% compared with the average rate of 2.4%.

They go on to suggest that introducing even a relatively small land tax could result in fairly large changes to land prices. It’s intuitively sensible that higher property taxes would discourage people from bidding up prices – the more they pay for land, the more they pay in taxes!

Stu recently took a look at the same research, and some of the broader trends, and concluded that higher property taxes could take some heat off the housing market. But how much does property tax really matter for housing affordability?

To get a rough sense of the relationship, I’ve put together a chart showing the relationship between property tax rates (x axis) and Demographia’s “median multiple” measure of house prices relative to incomes (y axis). It includes data on all 59 US, Canadian, and New Zealand cities with a population over 1 million.

Notice the substantial negative correlation between property taxes and median multiples. There is a strong tendency for places with lower property taxes to have higher house prices, and vice versa. The least “affordable” places all have relatively low property taxes.

property taxes and median multiples chart 1

Overall, this chart suggests two things: First, New Zealand’s relatively low property taxes may contribute to our relatively high house prices. Notice how Auckland’s house prices seem to fit the overall trend in the data.

Second, as I’ve previously argued, Demographia’s analysis is largely meaningless as they have failed to account for the full range of explanatory variables, from interest rates to tax policies to economic fortunes.

Here’s another view on the same data. I’ve taken the natural logarithm of both variables to smooth out the relationship, and put a trend-line through the data points. This simple bit of analysis suggests that:

  • About 44% of the variations in median multiple can be “explained” by differences in property tax rates. For a bivariate regression, this is quite high.
  • The slope of the regression line suggests that, within this sample of cities, a 10% increase in the property tax rate is associated with a 4.6% reduction in the median multiple. Again, that’s a quite strong relationship.

property taxes and median multiples chart 2

I don’t think we can draw any firm policy conclusions from this data, but it certainly suggests that our low property taxes are worth investigating as a cause of our high house prices. In the words of xkcd, “Correlation doesn’t imply causation, but it does waggle its eyebrows suggestively and gesture furtively while mouthing ‘look over there’.”

Correlation doesn't imply causation, but it does waggle its eyebrows suggestively and gesture furtively while mouthing 'look over there'.

Finally, it’s worth taking a closer look at the four US cities with the highest median multiples – the top data points on the left hand side of the first chart. They are all large cities in California – San Francisco, Los Angeles, San Jose (i.e. Silicon Valley), and Sacramento (the state capitol). They provide a great illustration of why failing to account for multiple, correlated explanatory variables can undermine an analysis of house prices.

But first, a California-themed music break:

In California, state-level legislation establishes a common planning framework. There are local variations, but if one city is constrained by regulations – as San Francisco and Silicon Valley are – the rest are likely to have similar problems. To give an example, the California Environmental Quality Act, which is the state’s equivalent of the Resource Management Act, has traditionally required all new developments to assess their impact on traffic congestion and mitigate it. As a 2011 Citylab article explains, this requirement has prevented the development of space-efficient forms of housing and transport:

There’s also a great irony underlying the use of LOS [traffic Level of Service] as part of CEQA’s environmental impact checklist. It seems self-evident that bike projects are favorable to the environment, but the use of LOS to evaluate them can sometimes imply quite the opposite. The person who filed the 2005 lawsuit against the San Francisco master bike plan, for instance, suggested that because bike lanes raise LOS they also raise congestion and car idling, and thereby cause pollution.

That’s not the only contradictory aspect of LOS. Case in point: a developer whose building fails an LOS threshold can mitigate the environmental impact by widening the street, which of course would attract more cars and pollution. So instead of encouraging dense development and lower vehicle mileage — the hallmarks of a transit-first city — San Francisco’s use of LOS as part of CEQA actually discourages livable design. In a three-part series on LOS at Streetsblog, one transportation consultant called LOS the “single greatest promoter of sprawl and the single greatest obstacle to transit oriented development” in California.

However, CEQA and its absurd requirements for traffic assessments (etc) aren’t the only thing going on in California. State-level laws have also constrained local governments’ ability to raise property taxes. Proposition 13, a citizen-initiated referendum passed in 1978, caps property tax rates at 1% and fixes them to the value of the house at the time it was purchased, plus a 2% annual increment for inflation.

This has had a number of perverse effects, including stripping away funding from California’s formerly excellent primary and secondary education and setting it on a path of decline. (Prop 13 is basically exhibit A in the case against binding referenda.) It has also distorted the housing market. Because home-owners know their property taxes won’t increase if the value of their house increases, they may be more willing to speculate on capital gains.

A 1982 paper by economist Kenneth Rosen offers empirical support for this hypothesis – he found that reductions in property tax rates were almost immediately followed by proportional increases in house prices.

Consequently, it would be foolish to analyse the Californian housing market without attempting to control for both taxation and planning policy. If you only looked at one policy, your conclusions would be biased by mis-attributing the effects of the other policy. (That’s precisely what Demographia seems to have done, by the way.)

What’s true for California is also true for New Zealand. I find it hard to take seriously the claims of people who attribute housing affordability solely to regulatory policy and fail to consider the potential impact of our low property taxes.

What do you make of the data on property taxes and house prices?

In defense of population growth

Growth: what is it good for?

Accommodating a growing population can certainly be challenging. It means having to find more money to invest in transport and water infrastructure to enable new residents to live and travel in the city. As Auckland Council’s recent consultation on the Long Term Plan shows, asking people to pay more is never a very popular proposition – even if they like how the money’s being spent.

And, as Stu pointed out in his post on Auckland house prices this Monday, population growth can also put pressure on housing markets. Multiple research papers from the Reserve Bank have shown that increases in net migration tend to be followed by increases in house prices – shown in this chart. Obviously, homeowners do quite well out of this, but others face added costs:

RBNZ net migration and house prices chart

In short, it’s not surprising that some people feel trepidatious about population growth and migration. And it’s not surprising that those anxieties are especially present in Auckland, which is projected to continue growing rapidly over the next three decades.

While unease about population growth is understandable, I’d argue that it’s misplaced. In my view, the benefits of urban population growth in New Zealand far outweigh the costs. While large urban areas can become dysfunctional – think of Beijing’s astonishing smog problems or the high cost of infrastructure in sprawling American cities – New Zealand’s cities are nowhere near large enough for the diseconomies of scale to triumph over the economies of scale.

This is easy to see if we look at the periods when Auckland hasn’t been attracting migrants. Here’s a chart from a presentation on Auckland’s demographics by Auckland Council social researcher Alison Reid. It displays the composition of Auckland’s population growth since 1922. In recent decades, natural population increase – i.e. people having babies – has been the biggest source of growth. Net migration is important, but it can be quite volatile – surging up and then crashing back.

Auckland components of population growth 1922-2012

What stood out to me from this chart was that the years with little or no net migration to Auckland have not been good times for the city. Net migration slowed to a trickle during the Great Depression, and turned negative during the constrained years during and after World War Two. More recently, quite a few people fled Auckland during the economically calamitous Muldoon years. Net migration remained low during the painful adjustments imposed by the following two governments.

I wasn’t living in Auckland during the 1990s – my parents had joined the queues leaving via Auckland airport – but friends who were say that the city was turning into a ghost-town. History shows that shutting off the migration tap has never led to a better, more vibrant city or more opportunity for residents. It’s simply been a sign of failure.

My hypothesis is that New Zealand has a strong feedback loop between net migration and economic growth. When growth prospects get worse – as they did in the 1970 and 1980s – it dissuades people from coming here and encourages Kiwis to leave for greener pastures. This in turn worsens growth prospects by sucking consumer demand out of the economy and reducing perceived household wealth (i.e. lowering house prices).

By contrast, good growth prospects tend to attract migrants to New Zealand’s cities and encourage potential emigrants to stay. This in turn leads to a virtuous cycle between higher growth and increased migration.

We can’t fully control this process, as it depends in part on what’s happening in Australia and the rest of the world (not to mention macroeconomic variables that we don’t fully understand). But we can make sure that our cities are in a good position to take advantage of population growth.

The first, and most important thing we can do is to build better cities that are able to attract and efficiently accommodate more people. In Auckland, for example, we’ve got some challenges, including transport investment that’s been heavily skewed towards cars (and only cars) and rising house prices. But the flip-side of those is that we’ve got great opportunities to:

  • Improve transport choice by investing in Auckland’s “missing modes” – a frequent bus network throughout the city, rapid transit infrastructure, and safe walking and cycling infrastructure
  • Improve housing choice by providing opportunities for people to develop higher-density residential typologies in market-attractive areas
  • Invest in great public spaces, such as Auckland’s waterfront and increasing numbers of shared spaces.

Second, as we attract more people to our cities, we need to accommodate them in an efficient and environmentally responsible way. This means enabling people to live in areas that are accessible to jobs, shops, and other amenities. As I found when I looked at carbon emissions from commutes in New Zealand cities, people in inner-city areas are considerably more environmentally friendly than their co-workers from the urban fringe.

Annual CO2 emissions per commuter DRAFT v1

Moreover, the data shows that increasing density can be a positive-sum game for existing communities as well as for the environment. At the city level, we can’t observe any relationship between rising population densities and congestion – fears of traffic-choked streets just don’t seem to have materialised in practice. (So much for diseconomies of scale!)

On the other side of the ledger, suburbs with higher population densities have better consumption choices. Many of the services that people rely upon – from vege shops to Japanese restaurants to public transport to roads – exhibit strong economies of scale, which means that they get better when there are more people around.

Which suggests that there is also a third important thing that we need to do, which is to tell good stories about the opportunities that urban growth will offer us. New Zealand’s used to thinking of itself as a rural economy with some cities sprinkled around as afterthoughts. That’s a dated and inaccurate self-image when over half the economy is located in our three largest cities.

So, what’s your perspective on urban growth?

Getting the maths wrong on the cost of housing

The New Zealand Herald’s cover story last Friday was quite sensational: “Homeowners in Auckland’s fringe saving up to $50,000 a year“. But while the eye-grabbing headline was worthy of clickbait merchants like Buzzfeed, the underlying analysis was not so good.

Here’s the key point of the article:

Bayleys calculated the first-year mortgage repayment costs for different suburbs based on median house prices from the Real Estate Institute of New Zealand (REINZ) and the ANZ variable rate of 6.74 per cent.

It found the annual cost of servicing a mortgage for a median priced Orakei or Remuera home ($1.35 million) was $84,060 in the first year.

In Pukekohe, where the median price of a home is $500,000, the annual mortgage repayment in the first year would be $31,128.

Even factoring in the $4032 annual cost of commuting from Pukekohe to the CBD by train on the At Hop card system – as well as the $768 public transport cost from Orakei to the city – living in the southern suburb was about $50,000 cheaper.

This is not entirely wrong. Housing costs do tend to decline as you get further out from the centre, while average transport costs tend to increase. That’s exactly what I found in a research paper I wrote on the topic last year. But it’s not entirely correct, either. Bayleys and the Herald have made two elementary errors in their analysis.

First, they’ve chosen a misleading measure of housing costs. House prices aren’t a realistic measure of the true cost of living at a point in time, as they are influenced by a range of short-term and long-term factors. In particular, when you buy a home, you are actually buying three very different things:

In other words, looking only at house prices is like arbitrarily including the cost of Kiwisaver into your housing costs.

My intuition is that rental costs are a better indicator of housing costs. They’re certainly less volatile, as I found in a recent paper that I co-authored on the relationship between rents and prices in Auckland. One of the key findings in that paper was that rents were quite low relative to prices in inner-city and coastal suburbs. As the following maps shows, median rents are only around 1/3 to 1/2 of median mortgage repayments in Remuera:

Nunns, Hitchins and Owen indicative rental yields 2013

It’s not as though data on rents isn’t available. The Ministry of Business, Innovation and Employment publishes quarterly data on average rents for new tenancies, broken down by suburb, dwelling type, and number of bedrooms. So let’s take a look at that data instead. According to MBIE’s data, the average weekly rent for a three-bedroom house was:

  • $754 in Remuera (or $39,000 per annum)
  • $406 in Pukekohe (or $21,000 per annum)

However, there were a number of cheaper options available in Remuera, and the inner suburbs in general. Going down to two bedrooms would reduce your rent by $9,000 per annum – a viable and attractive option for many households – and looking for flats or apartments would save even more money.

But basically, looking at the rental data shows that most of the cost of buying in Remuera is not related to housing costs per se – you’re actually buying the expectation of capital gains. The rent data shows that it’s still possible to save money on housing costs by living further out, but the magnitude of savings is far lower.

Which brings me to a second major flaw in the Herald’s analysis: They have only accounted for the monetary costs of commuting further into the city centre and completely excluded the value of people’s time. A quick look at AT’s journey planner shows that the train trip from Pukekohe to Britomart takes about 70 minutes, while a public transport trip from Remuera to Britomart takes 20-30 minutes depending upon whether you’re closer to the train station or a bus route.

In other words, the Herald has assumed that people don’t mind spending an extra 80-100 minutes commuting every day. They haven’t even tried to account for the cost of wasted time. Most researchers and transport economists disagree with this approach. Here, for example, is a discussion of the subject from Charles Montgomery’s great book The Happy City:

[University of Zurich economists] Stutzer and Frey found that a person with a one-hour commute has to earn 40 percent more money to be satisfied with life as someone who walks to the office. On the other hand, for a single person, exchanging a long commute for a short walk to work has the same effect on happiness as finding a new love…

Daniel Gilbert, Harvard psychologist and author of Stumbling on Happiness, explained the commuting paradox to me this way:

“Most good things and bad things become less good and bad over time as we adapt to them. However, it is much easier to adapt to things that stay constant than things that change. So we adapt quickly to the joy of a larger house because the house is exactly the same size every time we come in the front door. But we find it difficult to adapt to commuting by car, because every day is a slightly new form of misery, with different people honking at us, different intersections jammed with accidents, different problems with weather, and so on.”

In short, the Herald’s analysis has:

  • Overstated the real magnitude of financial savings from living in Pukekohe vs Remuera by a factor of three – a comparison of rental data suggest that the financial savings are actually $16,000 per annum or less
  • Ignored the non-monetary costs of commuting extremely long distances, which makes people miserable. All else being equal, people should be willing to pay more to live in the areas which have the best job accessibility.

Bertaud urban structure graph

My advice, if you are choosing where to live in Auckland, is to disregard the advice of real estate spruikers such as Bayleys and the Herald, and take a more objective and comprehensive look at the topic using the affordability.org.nz app developed by my co-worker Alex Raichev. The app provides information on a much broader range of factors, including the rents, the monetary and time cost of commuting, and the costs of car ownership. Here’s a sample:

affordability-org-nz screenshot

And, as always, my advice to the Herald is to check the facts more comprehensively before committing this sort of thing to print.

Demographia and omitted variable bias

My last two posts about Demographia’s analysis of house prices prompted quite a bit of discussion. I thought that it may be worth expanding on my points and clarifying why they mean that we should take Demographia’s conclusions with a large grain of salt.

Economists (and statisticians) have a term for what Demographia has done: “omitted variable bias”. This can occur when there are multiple variables that have a causal impact on an outcome. If we attempt to understand that outcome without considering all explanatory variables, we run the risk of biasing our conclusions.

Economists are trained to identify and address issues arising from omitted variable bias. Here, for example, is a comment on the topic from a widely used undergraduate econometrics textbook:

Now suppose that, rather than including an irrelevant variable, we omit a variable that actually belongs in the true (or population) model. This is often called the problem of excluding a relevant variable or underspecifying the model. We claimed in Chapter 2 and earlier in this chapter that this problem generally causes the OLS [ordinary least squares regression] estimators to be biased.

Now, I realise that’s a bit obscure, so let me be more specific. Here’s a list of (some) factors that can influence house prices, with a view on their expected impact:

Variable Expected impact
Expectations for future population and economic growth Future expectations tend to be capitalised into house prices – i.e. prices will tend to be higher in areas with better growth prospects
Consumer and natural amenities People are willing to pay more to live in nicer places
Interest rates (and availability of finance) Lower interest rates enable people to afford a larger mortgage on a given level of income
Construction sector productivity Lower productivity will increase the cost of supplying new dwellings
Tax policies, including capital gains taxes and mortgage interest deductions Taxation of capital gains will reduce willingness to invest in housing for capital gains
Tax subsidies for mortgage-holders will tend to push prices up
Other housing market policies, such as rent subsidies or public housing provision Rent subsidies tend to be captured by landlords and thus will tend to push up prices
Ongoing construction of state housing will add supply to the low end of the market and thus constrain price increases
Urban planning policies Policies that constrain the development of new housing in desirable areas, or make it more costly or uncertain to develop, will reduce supply and push up prices

Demographia only addresses one of those seven variables. Because they fail to account for the other six potentially explanatory variables, their estimates of the welfare impact of urban planning policies are not likely to be reliable. Without controlling for other potential explanations for high housing prices, it’s impossible to say whether their conclusions about any individual city are correct or not.

Consequently, my recommendation to people seeking to understand the impact of urban planning policies on housing costs is simple: Ignore Demographia and go read the relevant economics literature instead. For those who are interested in doing so, here are a few papers that I have learned a lot from. They apply a range of modelling approaches, but what they have in common is that they undertake a detailed analysis of rules, rather than making sweeping and unsupported generalisations:

  • Glaeser, Gyourko and Saks (2005) studied the impact of building height limits in Manhattan by looking at the gap between observed sale prices and the marginal cost to add another floor to high-rise buildings. They find that constraining the supply of high-rise apartments imposed a significant “regulatory tax” on residents.
  • Grimes and Liang (2007) took at look at land prices around Auckland’s Metropolitan Urban Limit, finding evidence of a “boundary discontinuity”. They interpreted this as evidence that the the MUL is overly restrictive.
  • Kulish et al (2011) developed a hypothetical model of the impact of several factors on housing and transport costs. They modelled density restrictions as well as increased transport costs and lower building productivity, finding that building height limits raise housing costs and increase sprawl. I have previously discussed their findings.
  • MRCagney (2013) examined the impact of minimum parking requirements in Auckland, finding that they impose a loss on developers and businesses by forcing them to over-supply parking. They also cause worse congestion, meaning that not even drivers benefit. Luke C briefly discussed this study in a post on the Unitary Plan parking rules.

My favourite economics paper on planning regulations is Cheshire and Sheppard’s 2002 study on the impact of greenbelt rules in Reading, UK. The authors observed that greenbelts have both positive and negative effects. On one hand, they limit the supply of land for new housing, which drives up costs. On the other hand, they give residents access to public open spaces, which people like. Rather than ignoring this trade-off, they used house price data to model it.

Overall, Cheshire and Sheppard did find that allowing development in Reading’s greenbelt would make people better off. However, they also found that a failure to consider the amenities produced by planning rules would have resulted in too high an estimate of the gains in wellbeing. In other words: right direction, wrong magnitude.

In light of the evidence, my view is that failing to account for urban amenities and other explanatory variables in an analysis of the impact of supply restrictions can result in two errors:

  • First, it can make us over-optimistic about the degree to which loosening rules will affect housing prices. That’s not to say that less restrictive planning regulations couldn’t make us better off – just that we should not expect house prices to fall by 60-75% as Demographia implies when it says that Auckland should have a median multiple of 3.
  • Second, it can lead to perverse outcomes, by encouraging us to eliminate rules that are serving a useful purpose. Often (although not always) planning rules are managing the external social or environmental costs associated with some developments. A proper cost-benefit analysis – which Demographia has not done – will consider both the pluses and minuses of rules.

In short, housing markets are complex, and any analysis needs to consider that fact. To reiterate my point from last week: Demographia takes an inappropriate, overly simplistic view of house prices. This may be good for grabbing headlines, but it’s not good economics.

Alternative explanations for Auckland house prices

Last week I took a look at the economics underlying Demographia’s “International Housing Affordability Survey” and found them severely lacking. As it turns out, Demographia’s data isn’t much good as a measure of the costs of poor planning rules – but it does seem to provide some information about people’s “revealed preference” for urban amenity.

To recap: urban economics suggests that differences in the level of the median house price to median household income ratio between cities can be interpreted as differences in livability. All else equal, people should be willing to pay more to live in cities that offer better quality of life.

But how should we interpret changes to the median multiple from year to year? If a city’s median multiple rises from 5 to 5.5, does that mean that the city suddenly got 10% more livable? Or did something else happen?

Demographia is very certain that higher median multiples are the product of one thing, and one thing only: limits on sprawl into greenfield areas. Here’s Don Brash, former Governor of the Reserve Bank of New Zealand and former head of several right-wing political parties, laying out that view in Demographia’s 2008 report:

Once again, the Demographia survey leads inevitably to one clear conclusion: the affordability of housing is overwhelmingly a function of just one thing, the extent to which governments place artificial restrictions on the supply of residential land.

With that in mind, Demographia’s data seems to indicate that housing in Los Angeles and Las Vegas (as well as many other US cities) suddenly became a lot more affordable in the late 2000s. It’s obvious that they must have removed their Metropolitan Urban Limits – how else to explain such a big drop? Oh, wait…

Demographia Los Angeles Las Vegas median multiple

(It’s slightly disturbing that our Reserve Bank used to be run by a man who doesn’t believe that interest rates and credit conditions can affect house prices. But I digress.)

Here’s a graph of changes in Demographia’s median multiple estimate for Auckland since 2004. We haven’t seen the same drastic swings as in the US, where the housing bubble and bust was pronounced, but house prices have risen relative to incomes. (Although, as Stu found in his analysis of different measures of housing costs, this hasn’t flowed through to rents or mortgage payments, due in part to changes in interest rates.)

Demographia Auckland median multiple

This change has been especially pronounced in the last few years. Since 2012, Auckland’s median multiple has risen roughly 22%. Does this mean that we’ve become 22% more “livable” during that time?

With all due respect to the good work done by Auckland Council and Auckland Transport since their inception, probably not. So we need to look for alternative explanations, of which there are several. I’ll focus on three in particular.

The first potential explanation is that there has been a market failure. Residential construction slumped massively during the Global Financial Crisis, with the most significant reductions occurring in the supply of apartments and attached dwellings. Here’s a graph that John Polkinghorne put together illustrating that trend:

NZ building consents

Incomes and employment have mostly come back from the recession, but construction has been a bit slow to respond. I suspect this reflects technical constraints within the development sector, as it takes a while to organise finance, find sites, and hire the cranes, bulldozers, and blokes/blokesses in hardhats. Until they get into gear, there may be a bit of an undersupply – but one that will tend to sort itself out.

The second potential explanation is that the introduction of Auckland’s Unitary Plan has caused people to expect housing supply to be more constrained in the future. While the Unitary Plan envisages the gradual expansion of the city’s Metropolitan Urban Limit to meet new demand for greenfield suburbs, it maintains extensive controls on the supply of new dwellings in accessible, high amenity areas. Moreover, the plan actually got significantly more restrictive following the consultation process.

Transportblog has highlighted this issue a number of times before. To recap, here’s a map (from Koordinates) that shows where the Unitary Plan got more restrictive as a result of consultation. The areas in red have been down-zoned to restrict development, while areas in green have been up-zoned. The large orange areas show future greenfield land. As you can see, there are not a lot of opportunities to develop new dwellings in the isthmus and lower North Shore, while West Auckland has been happy to facilitate growth:


Unitary Plan changes from draft to proposed version on Koordinates

Timing is important here. Demographia’s figures suggest that there was a jump in house prices relative to incomes between the end of 2012 and the end of 2013. This coincides with the notification of the Unitary Plan in September 2013, which, as described above, will ease greenfield land supply while limiting development opportunities in the inner suburbs.

However, there is also a third potential explanation: that our rising house prices reflect increasing awareness of Auckland’s great quality of life. For most of the last decade, our city has been near the top in Mercer’s Quality of Living Survey. It’s been ranked third for five years running.

So maybe the story is that potential migrants and investors have observed that, by international standards, Auckland offers high quality of life at an affordable price. And they are in the process of arbitraging that away.

I’ve illustrated that process in the following graph, which shows the relationship between Demographia’s median multiple (X axis) and Mercer’s Quality of Living Survey (Y axis). The trend-line is estimated based on 2012 data. I’ve also plotted Auckland’s median multiple and Mercer index in 2015.

The red dot that represents Auckland is moving towards the trend-line, suggest that its prices are catching up with its livability.

Demographia Auckland median multiple change 2012-2015

Previous studies have found that growth in New Zealand house prices is strongly correlated with net migration – i.e. migrants tend to bid up house prices. Net migration to New Zealand did, in fact, start picking up in 2013 – around the time that Demographia’s estimate of the price to income ratio began to rise. Perhaps this is evidence for the “amenity arbitrage” hypothesis?

NZ net migration Feb 2005-2015

So, which explanation is true? Honestly, it’s impossible to say without a lot more detailed analysis. My point in writing this is not to argue that there is a single explanation for changes in Auckland’s house prices, but to point out that there are many possible explanations. Housing markets are affected by a number of factors, and it’s inappropriate to focus on one without controlling for the rest.

This is, essentially, why Demographia’s analysis fails. Rather than articulating a model that encompasses all of the potential explanatory factors, they have settled on a single number and insisted that it must be interpreted in a single way. It’s hard to see the value in that approach. And it’s definitely not good economics.

Sunday reading 11 January 2015

Every week we read more than we can write about on the blog. To avoid letting good commentary and research fall by the wayside, we’re going to publish weekly excerpts from what we’ve been reading.

McKenzie Funk, “The Wreck of the Kulluk“, New York Times:

The Arctic was a long-term investment — Shell would not start production on such a big project in such a distant place until at least a decade after it found oil — but the future is always getting closer, and by 2010 the company was anxious. It took out ads in newspapers, hoping to pressure the Obama administration into opening the Arctic. One pictured a little girl reading in bed, a figurine of a polar bear next to the lamp on her nightstand. “What sort of world will this little girl grow up in?” it asked. If “we’re going to keep the lights on for her, we will need to look at every possible energy source. . . . Let’s go.”

Even with permission, getting to the oil would not be easy. The Alaskan Arctic has no deepwater port. The closest is in the Aleutian Islands at Dutch Harbor, a thousand miles to the south through the Bering Strait. In the Inupiat whaling villages dotting the Chukchi coast, only a handful of airstrips are long enough for anything other than a prop plane. There are few roads; human residents get around in summer by boat, foot or all-terrain vehicle. Shell was trying the logistical equivalent of a mission to the moon.

The Economist, “Nimble Opposition: A new study confirms suspicions about what drives planning decisions“:

Local opposition to new housing developments is common across Britain. It has long been argued that such opposition—NIMBYism to its critics—is linked to home ownership. Homeowners, unlike distant landlords, vote in local elections and receive planning consultations in their postboxes. They lose out from development in multiple ways. Loss of green space reduces their quality of life and increased supply of housing suppresses prices. Landlords managing diversified portfolios are less exposed to the value of one property. The idea that planning decisions are driven by the desire of homeowners to maximise house prices is known as the “home-voter hypothesis”.

On October 24th the Institute for Government, a think-tank, released a study supporting this theory with data. It looked at English local planning authorities (LAs) between 2001 and 2011 and found that for every additional ten percentage points in the proportion of homes that are owner-occupied, 1.2 percentage points were knocked off growth in the housing stock. Average growth was 8.8%, so the effect was marked. The authors are cautious about making a causal claim, but the correlation was observed after controlling for the number of planning applications and the amount of available land. A rough calculation suggests that, without the NIMBY effect, one million more homes would have been built during the period.

Brad Plumer, “Driving in the US has been declining for years. Will cheap gas change that?“, Vox:

The key concept here is price elasticity — how much the demand for gasoline changes in response to changes in price. The EIA estimates that, in the very short run, Americans’ demand for gasoline is fairly inelastic. The price of gas would have to fall 25 to 50 percent for US driving to rise by just 1 percent. (That is, the elasticity is -0.02 to -0.04.) …

Driving is on the downswing for a few reasons: 1) The US population is getting older, and retirees tend to drive less. 2) More and more young people are moving to cities, where there are better transit options. 3) It’s become much harder for teenagers to acquire drivers’ licenses. 4) Young people may be driving less for cultural reasons (possibly they prefer to hang out with their friends on Facebook than piling into a car and driving around aimlessly).

That may explain why American driving habits today seem to be less responsive to changes in gas prices than they were in the 1990s. Back then, the EIA estimates, it only took a 12 percent drop in gas prices to boost driving by 1 percent (elasticity was -0.08). Nowadays it takes a 25 to 50 percent drop.

Emily Badger, “Why no one likes indoor malls any more“, Wonkblog:

The mall that’s dying is, in fact, a specific kind of mall: It’s enclosed, with an anonymous, windowless exterior, wrapped in yards of parking, located off a highway interchange. It’s the kind of place where you easily lose track of time and all connection to the outside world, where you could once go to experience air conditioning if you didn’t have it at home…

The death of old-fashioned indoor malls is also the rebirth of shopping hubs that feel more like Main Street.

The importance of expensive apartments

Apartment development in Auckland often seems to be caught in a Catch-22. When we build cheap apartments, they’re criticised as a blight on the city – “shoeboxes” that nobody would ever want to live in. (Never mind that many people do live in them, and value the fact that they are an affordable way to live near jobs and universities in the city centre.) When we build high-quality but pricey apartments, some people claim that they prove that apartments aren’t a solution to Auckland’s high housing costs. (Never mind the fact that they allow more people to live in desirable areas.)

great north road apartment plan

Proposed apartments on Great North Rd – too flash to help affordability?

Over in the San Francisco Bay Area, they’re having a similar debate over how to plan for growth. The Bay Area has more severe affordability issues than we do, as the tech boom is placing pressure on both housing and office space. In San Francisco, new condos for wealthy geeks are frequently criticised as out-of-keeping with the city’s unruly liberal character.

Moreover, fragmented local government means that there is no coherence in regional planning – every city is effectively assuming that their neighbour will accommodate the growth that they won’t. This is the result:

Asking Prices Relative to Units Built

SPUR house prices vs new builds chart

Even though Manhattan and LA have more expensive neighborhoods, San Francisco is far and away the most expensive metro in the nation. This is due to the small number of units built each year relative to demand.

In Berkeley, a university town in the East Bay, residents just voted down a (binding) referendum that would have prohibited the construction of new dwellings in the downtown area. Local writer Zach Franklin reviews the state of the debate on the measure. His point about expensive apartments is particularly important:

Some “progressives” don’t believe in supply and demand. I’ve heard this at parties and online – people who say “the new condos are just for rich people”, or think that pro-development policies are a front for greedy real estate interests. Then there are the folks who have pet theories about how housing economics really work, which can feel eerily like talking with climate deniers. It’s actually pretty simple Econ 101 stuff – the rich folks will be at the front of the line no matter what, and if you don’t build the condos they’ll just take over middle-class housing. Build more housing and at least the line gets longer.

This is absolutely essential to understand. Economists have all sorts of arcane ways of describing this phenomenon, but the principle is simple: If you try to push down growth here, it will pop up there instead.

Preventing people from building new homes in a neighbourhood won’t simply make them go away – they will stick around and compete with each other to bid up the prices. (Some will lose out, of course – they’ll have to go to somewhere else that’s less convenient.) Here’s how this works in practice:

  • We regulate to make it difficult to build new homes in inner-city areas which offer the best access to labour markets
  • Upper-income people bid up prices for old villas and flats in Ponsonby, Mount Eden, and Newmarket
  • Middle-income and lower-income people can’t afford to pay these prices, so they move a bit further out, and bid up prices in Avondale, Three Kings, and Onehunga
  • The people who could formerly afford to live in those areas go even further west or south, driving up prices in Te Atatu and Otahuhu
  • The people at the bottom of the income ladder are thoroughly rogered – they’ve got a choice between paying heaps to live in overcrowded, unhealthy houses or moving so far out that they can’t access jobs or education.

The end outcome is residential segregation and unaffordable housing. A casual look at Census data on household incomes suggests that this might be happening in Auckland. The map below shows the share of households in individual Auckland suburbs that had low incomes in 2001 and 2013. (I used a higher threshold for “low income” in 2013 to account for the fact that average household incomes increased over this period. This is a pretty cursory analysis – I’d welcome ideas on better ways to present or analyse the data!) Areas coloured in darker blue had more low-income households, while areas coloured in yellow had relatively few.

As you can see, the Auckland isthmus and many coastal suburbs have become yellower over this time – which suggests that low-income families are being priced out of these areas. Many other areas – especially in west Auckland and Manukau – have gone from blue to green. Meanwhile, some pockets of blue in south Auckland have become darker, which suggests that low-income households may be crowding into those areas.

Notably, the city centre, where loads of apartments (both expensive and cheap) have been built, has a greater share of low-income households now than it did in 2001.

Auckland low income households 2001-2013

This is not a good outcome for Aucklanders, especially those on low incomes. By comparison, building lots of apartments, even expensive apartments, in desirable areas means that some of the well-heeled people who want to live in that area will not bid up prices on the run-down houses down the street as a second-best option. As a result, the affordable houses in the area can remain affordable.

Supply and demand – how does it work?

Housing Accord first year results

The results for the first full year of the Housing Accord between the government and Auckland Council have just been released.

It’s a politically charged topic – witness the government talking it up (“First year Auckland Housing Accord target exceeded“), and Phil Twyford from Labour rather unfairly talking it down (“Fourth housing report confirms failure“).

The Housing Accord is ultimately about increasing the number of new homes being built in Auckland. It’s open to debate how much success it’s had in its first year, but it’s also laid the groundwork for future growth.

The story so far – by the numbers

Overall, “11,060 new sections and dwellings have been achieved in the first year – more than 20 per cent above the target of 9000″. That’s perhaps a little exaggerated, as we’re actually talking about consents or approvals for those new sections and dwellings – they haven’t necessarily been built. And, as I’ve pointed out previously, the target is actually lower than the 9,975 sections and dwellings achieved in the year before the Accord came into effect.

Still, 11,060 sections and dwellings is a lift. It’s not enough of a lift (the targets for year 2 and 3 are 13,000 and 17,000 respectively, so lifting by 4,000 a year), and there’s probably some double counting compared to the previous year,* but it’s a start.

A lot of the attention has focused on Special Housing Areas, but these haven’t really translated into consents yet. That will take a bit longer, partly because it hasn’t been long since most of them were approved, and partly because they often have to go through an extra stage – getting rezoned via a plan change, before they can be subdivided. I imagine they’ll make a much bigger difference to the numbers in year two.

Behind the rhetoric, what we’re actually left with is an increase in planned construction activity (subdivision consents to create new sections, and building consents to create new homes), much of which is simply due to a recovering construction sector. And we’re still not building enough homes, especially with migration running at record levels.

I’ve shown the number of annualised building consents in Auckland below – note the very low figures in 2009-2011, and the upturn which has been underway since then.

Auckland consents

The story so far – making the process easier

That’s not to say the Accord has been a failure. The remarks I’ve heard from people across the property industry have been quite positive. I went to the Property Council’s Residential Development Summit last month, and the Accord was given a thumbs up by a range of people. Developers are keen on the “one stop shop” where stakeholders such as Auckland Transport, NZTA, Watercare and the council consents team are all available to talk through the issues, and the consent process has been streamlined. Perhaps these are things that the council should have gotten going itself anyway, but maybe it needed a nudge from the government.

Planning applications are made under the Proposed Unitary Plan rules, and that was only possible with a law change from government. We’ve been a bit annoyed about the relative lack of “intensification” Special Housing Areas, compared to the “greenfields” ones. However, the council did say in its Auckland Plan that it wanted to have a ready supply of land for housing, and the SHAs are needed to create that supply. Besides, the Unitary Plan rules often aren’t much better than the existing rules when you’re trying to create apartments than terraces – which we’ve also criticised – so many developers wouldn’t bother.

The next step

It’s going to be tricky to ramp up construction fast enough to meet the Accord’s year 2 and 3 goals, and to actually convert the consents into built homes. An article last month suggested that building consents are unlikely to come close to the targets, based on forecasting work done for the MBIE, and that the targets might be revised downwards.

* More on the double counting, since I haven’t seen this discussed elsewhere. Within the year, the report doesn’t double count, so a piece of land gets counted when it is given subdivision consent but isn’t counted again when it’s given building consent. However, some of the building consents granted in this last year will have been given subdivision consent the year before the accord, so it’s not possible to compare the 9,975 to the 11,060.

The MBIE will address this for years 2 and 3, i.e. they won’t double count between the years of the accord.

Looking at just building consents, though, it is possible to compare the numbers over time. Those consents have risen 30% in the last year, which is pretty substantial – from 5,648 to 7,366.

 

Aussie apartment boom: the cities

As explained in my last post, Australia is currently in the middle of a major apartment boom. Of course, the picture changes depending on which city you look at. The following graph shows the share of attached dwellings for the “large Australian cities” – the ones which are bigger than Auckland, at 1.9 to 4.7 million people:

Big city dwelling approvals

Sydney has been building mainly attached dwellings for the last 12 years – 60% to 70% of all dwelling approvals. There’s a lot less of this activity in Perth, where the share of attached dwellings is around 25%, without much change in the trend in the last twelve years. However, Melbourne and Brisbane have seen a real lift over that time, from around 30% of approvals in 2002 to 55% now.

Here’s the share of attached dwellings for what I’ve called the “small Australian cities” – state capitals which are smaller than Auckland, at 132,000 to 1.3 million people (and note Australia has many other cities in this size range which I haven’t looked at):

Small city dwelling approvals

These percentages fluctuate quite widely, but note the high share of attached dwellings in Canberra (the size of Christchurch or Wellington) and Darwin (the size of Tauranga).

The figures above are for “Greater Capital City Statistical Areas”, which are defined very broadly, and include a large amount of rural land and smaller settlements as well as the main urban area. This tends to bring down the share of attached dwellings, since you’re more likely to get apartments in central Sydney than Campbelltown. In terms of land area, the GCCSAs range from 170,000 to 326,000 hectares for the “small cities” and 642,000 to 1.6 million hectares for the “large cities”.

It’s a little tricky to compare these areas to any New Zealand measurement – they’re probably in between the typical size of a territorial authority and a region – but the Auckland Region, stretching from Wellsford to Pukekohe, is 1.6 million hectares. The graph below compares the attached dwellings share for the Auckland region (in dark blue) to those for the large Australian cities:

Big cities plus Auckland

So, we’re building a smaller share of attached dwellings than Brisbane, Melbourne or Sydney (which, to be fair, are all larger cities than Auckland), although it’s interesting that we outpaced Brisbane and Melbourne for much of the 2000s. The share of attached dwellings is also tracking up strongly, and I’d expect it to keep heading upwards in the short term at least.

In “absolute” terms, we’re approaching 3,000 building consents a year for attached dwellings – less than we managed during the 2000s boom, but still significant, and continuing to grow strongly.

The upshot of all this is that John Key was absolutely right when he said “If you’re a young person buying your first place in Sydney or Melbourne or Brisbane, in most instances you’ll be going into an apartment.” If you’re wanting to buy in a big city – especially if you’re a first home buyer with less of a deposit or a lower income – an apartment, terrace or flat can be a great option, and they’re a big proportion of what is being built.

Want affordable apartments? Build heaps of them.

It seems like the relationship between planning controls and housing affordability is not going to go away any time soon, with Deputy Prime Minister Bill English noting recently that he thinks planning rules are a major contributor to inequality.

Planning policies have probably increased inequality amongst New Zealanders more than any other policies through higher housing costs, Finance Minister Bill English says…

…Mr English used the briefing to again emphasise the Government’s focus on addressing housing issues which featured in Prime Minister John Key’s Cabinet reshuffle yesterday.

However, when asked about his comment suggesting inequality was increasing — something he and Mr Key have previously refused to acknowledge — he said what he meant was that rising housing costs due to land supply constraints had prevented inequality from abating.

Mr English said the Government would “persist with housing reforms to make housing more affordable for more New Zealanders particularly low income New Zealanders”.

The issue of ‘land supply’ is somewhat of a red herring, as we know from valuation data that prices are rising quickest in inner areas and unless Mr English plans on filling in half the Waitemata Harbour for housing, increasing land supply is unlikely to have much impact on the increasing desire of Aucklanders to live centrally. What that requires is simply more housing, which in these areas means more terraced houses, more apartments, more townhouses, more granny flats and so on.

Yet we also know from looking at many apartment buildings underway at the moment that they’re not cheap. Decently sized apartments in many of the buildings going up in Grey Lynn or Herne Bay (admittedly high end suburbs) are pushing the million dollar mark. We’ve also been able to build some pretty cheap low end apartments like can be seen in places like the Hobson/Nelson St corridor. While at a macro-level providing more high-end or low end housing will at some point provide an affordability benefit, it seems like Auckland is yet to figure out how to build large numbers of affordable apartments that aren’t crap and/or that might be suitable for families.

Of course we are not the only city to struggle with housing affordability. Most highly liveable cities have expensive housing, it’s a sign of their attractiveness as a place to live. However, it does seem in other places there is more progress in providing relatively affordable housing in areas which aren’t way out on the urban edge.

Let’s take Vancouver for example, which regularly publishes statistics about average house prices for different housing typologies. Vancouver has very expensive housing on average, for a number of similar reasons to Auckland (an attractive place to live, strong immigration, growing population etc.), but that doesn’t mean all housing in Vancouver is expensive:

vancouver-prices

The average price for a detached house in Vancouver is pushing close to a million Canadian dollars, which is huge. However, the average price for attached houses or apartments is way lower than this, showing that there is plenty of housing supply in Vancouver at much cheaper prices than the overall average. Furthermore, unlike Auckland, it’s pretty likely that these more affordable places aren’t way out in outer suburban areas requiring us to spend huge amounts of money on transport.

So how has Vancouver managed to generate a supply of fairly affordable apartments and other attached housing typologies? Well without digging into it too deeply, it seems that critically they’ve built heaps of them. Let’s look at how the composition of housing types in Vancouver has changed over the past 20 years:

vancouver-dwelling-types

The graphs are a little confusing as the vertical axis is total dwelling numbers rather than percentages, but you can see that in 2011 two thirds of dwellings in Vancouver were not single detached houses. There were over 350,000 apartments. It’s not 100% the same but this shows similar data for Auckland broken down by Single Dwellings, Attached dwellings (flats/units/townhouses/apartments/houses joined together) or other dwellings (motor camps, baches, dwellings as part of a business or shop etc.).

Dwellings by Type

Next look at the comparison from Vancouver between new housing starts for apartments compared to detached dwellings:

vancouver-newstarts

Consistently it seems like 75-80% of new dwellings built in Vancouver in recent years have been apartments, terraced houses or other attached typologies. This ongoing supply seems to be holding prices for these typologies at reasonably affordable levels. Again by comparison for over the last year just 27% of new building consents were for apartments an attached dwelling type.

It also seems like Vancouver doesn’t have an irrational fear of building heights like Auckland, especially in its regional centres where major apartment developments seem to be proposed or occurring frequently – like this one:

While this scale clearly would only be appropriate in certain locations, it’s worth some consideration in areas along the rail network that will benefit a lot from City Rail Link and may not have typical heritage concerns – I’m thinking Morningside, Avondale, more at New Lynn, maybe Onehunga.

It seems that one lesson we can learn from Vancouver quite clearly is that if you build enough apartments it does seem like you can ensure they’re fairly affordable. Plus they’re likely to be within walking distance of rapid transit and a whole pile of key services. Sounds better than an “affordable” house out the back of Papakura or Silverdale where you need to drive 50km a day to do anything.