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.

Auckland can’t afford to price out the young

It’s no secret that Auckland has a problem with high-cost housing. House prices have risen significantly faster than average incomes in recent years. As a recent Treasury working paper (Skidmore, 2014) documented, Auckland’s house prices have quadrupled in the last generation, and rents have more than doubled.

Skidmore (2014) house price indexSkidmore (2014) rental price index

This is widely acknowledged as a problem, but it’s important to understand that it’s not necessarily a problem for all Aucklanders. Another Treasury working paper (Law and Meehan, 2013) shows that young New Zealanders – singles and couples between 25 and 34 – are significantly less likely to own their own homes.

Most middle-aged and retired people are on the property ladder and thus able to benefit from capital gains from Auckland’s housing market. Rising prices are often positive for older people. But they’re not very good for the young, who don’t own property and, increasingly, find themselves shut out by rising prices.

Law and Meehan (2013) home ownership rate

To make matters worse for young Aucklanders, rising house prices are coupled with falling real incomes. We aren’t merely standing still – we’re rapidly falling behind.

The chart below shows real income growth for employed people by age group from Statistics NZ’s LEED data on median earnings of full quarter jobs, deflated by the consumer price index. Since the global financial crisis, real median wages for people under 35 have fallen. But people over 35 have done pretty well over the same time period:

Generational divergence in incomes

Generational divergence in incomes

In short, Auckland seems to be developing a dangerous “two-speed” economy. Most middle-aged people can expect their wages to rise and the value of their houses to boom. Most young people are experiencing wages that are stagnating or falling while being shut out of the housing market by high prices.

This is the point at which older Aucklanders sometimes seem to shrug their shoulders and say, “so what – I’ve got it good.” But they shouldn’t be so complacent, because we don’t have to be here. If it becomes too hard to live in Auckland, young Aucklanders will leave. If we can get a better deal elsewhere – higher wages or cheaper housing – we can go there instead. And for many of us, this will mean leaving New Zealand.

Young New Zealanders are mobile. We’ve seen our friends and family abscond to Melbourne or Sydney, or go to London on OE and choose not to come back. We may have moved here from other places. While we want to be able to live in Auckland and participate in the city’s revitalisation, we’re keenly aware that we have options.

I’ve written before about how New Zealand has the opportunity to raise its living standards by investing in better cities. Well, the reverse is also true. Expensive housing and lower wages for the young is a recipe for long-term economic failure. If you’re middle-aged, this should worry you: We might not be around to pay your pensions and buy your expensive houses when you want to downsize. We’d like to stay and pay for your retirement – we really would! – but we need a pay rise and affordable housing options.

So what’s your plan to make Auckland affordable for young people?

Auckland property revaluations

The council is required to revalue every property every three years and the valuations are used in the setting of rates the council charges. The last revaluation was in 2011 which means a new one is due this year. The council have announced some early results and they present an interesting picture and show why home owning affordability is such an issue. Across the whole region property values are up by an average of 33% which is a massive increase over just three years. Here’s the press release:

Auckland’s three-yearly general property revaluation is well underway, with indicative data showing significant value movements across the region.

A report is going to Thursday’s Finance and Performance Committee:
http://infocouncil.aucklandcouncil.govt.nz/Open/2014/08/FIN_20140821_AGN_4759_AT.PDF

Auckland Council’s Registered Valuer Peter McKay says: “At this stage we are looking at an upward movement for the Auckland region of an average 33% since the last revaluation in 2011, which is broadly in line with expectations.

“Local board areas with the largest movements – of over 40% – are Kaipatiki, Maungakiekie-Tamaki, Puketapapa and Whau, reflecting a general value increase in the more central suburbs.”

“Average movements within the remaining local boards (excluding the Hauraki Gulf islands) range between 22% and 44%, with the larger movements generally due to proximity to central Auckland, with lower increases found in outer suburban and rural areas.”

“Local value movements will vary due to the type of property, its quality and condition, zoning, views and other factors.”

Property owners receive their notices in the mail in mid-November 2014.

“It’s very important to remember that Auckland’s property revaluation doesn’t determine the total amount of rates collected by the council – rather it helps determine each ratepayer’s share of rates.

“The revaluation exercise is used by the council to determine the allocation of rates, and doesn’t affect the overall amount of rates collection.

“Capital value, or CV, used as the rating valuation, is the likely price the property would have sold for on 1 July 2014. Its new value will be used to help set rates for the three year rating period beginning next year, 1 July 2015.”

All councils are required by law to revalue every property in their region every three years. Over 525,000 properties are being revalued in Auckland.

Council’s team of experienced, qualified valuers work closely with independent organisation Quotable Value Ltd. Before valuations are finalised, they have to be approved by the Valuer-General, who’s responsible for authorising rating valuations for the Government across New Zealand.

and they’ve provided this map showing the average change by local board area.

2014 property revaluations by local board

What’s most noticeable is the strong growth in values on the areas just outside the inner suburbs while the urban fringe and rural local boards are seeing much smaller average increases. This suggests people are moving as close to the city as they can currently afford and that would fit with other trends both locally and internationally we’ve seen over the last decade or so.

In addition the council have provided some notes about some of the influences in each local board area

Albert-Eden (37%)
Value growth in this central area is strong, particularly in the Grammar Schools zone with very strong demand for properties offering redevelopment potential.

Devonport-Takapuna (37%)
Demand is strong across all housing types in this established and sought after residential area.

Franklin (22%)
Demand is increasing in Pukekohe but is slightly more subdued in Waiuku. Remote areas and rural settlements are showing modest increases over 2011 levels in comparison to other areas. Development at Beachlands is continuing with a large volume of sections coming to market at present.

Great Barrier (-12%)
Value levels have declined since 2011 and sales volumes are low. There are a large number of properties available for sale and marketing periods of 12 months or more are common. Factors associated with remoteness and a decrease in demand for coastal properties is driving value levels.

Henderson-Massey (39%)
The Proposed Unitary Plan is influencing buyer expectations particularly in areas identified for more intensive land use, such as Te Atatu Peninsula and Westgate. Demand is strong for housing in all areas. Ranui, Massey, Henderson and Glendene are seen as affordable options for first home buyers.

Hibiscus & Bays (29%)
A consolidating residential locality characterised by homes dating predominantly from the early 1980s through to more recently constructed houses of above average quality, to executive style. Growth areas include Orewa and Millwater where average lot sizes are smaller. Weathertightness issues are still a factor in the market with housing that is subject to known weather tightness issues selling close to or in some instances below the 2011 roll values.

Howick (35%)
The market has moved fairly consistently throughout, with strong growth in the area of Flat Bush driving value levels.

Kaipatiki (41%)
A diverse area including character homes with views south towards the Waitemata Harbour, with easy access to motorway connections at Northcote and Birkenhead through to the more affordable housing areas of Beachaven and Birkdale. This area is showing an above average increase, especially properties with further development potential.

Mangere-Otahuhu (37%)
Buyers are actively seeking larger sites with further development potential in this area pushing value increases. Otahuhu provides relatively central but affordable housing compared to the inner city. Mangere Bridge has seen some of the strongest growth in values across the region since 2011, which is in part attributed to the community feel of the village, enhancement of waterfront areas with views to the Manukau Harbour, and the continual development of State Highway 20.

Manurewa (32%)
The introduction of the LVR is linked to a lower increase in this area, which predominately comprises a market for first home buyers and investors.

Maungakiekie-Tamaki (44%)
Value growth has been strong as the area is seen to be relatively central. Transportation and roading including recent rail development in Onehunga and new rail station in Panmure, as well as AMETI in the east and SH20 to the west, are also drivers towards value increases.

Orakei (35%)
These central suburbs have seen strong value growth; however growth has been weaker for high value coastal land and properties at the top end of the market ($4million-plus).

Otara-Papatoetoe (35%)
Buyers are looking to this area as being relatively central but affordable compared to the inner city. Demand is particularly strong within Papatoetoe for sites with development potential.

Papakura (26%)
While the area provides a range of housing for first home buyers and is one of the most affordable areas of the region, Papakura value movements are more modest than other areas, with travel times of 30 minutes to the CBD off-peak.

Puketapapa (41%)
Similar to Mangakiekie-Tamaki, housing in the Puketapapa area is seen as an attractive option for buyers looking to locate centrally and for generally less than $850,000. Transportation is improving as State Highway 20 development continues and the area is seen as more accessible than it was 10 years ago.

Rodney (24%)
Generally residential values increases are modest in comparison to the central suburbs, and land values of coastal sites have increased a slower rate than inland property.

Upper Harbour (31%)
Housing with known weathertightness issues selling close to or in some instances below 2011 values are impacting on overall value movements. Significant development is occurring at Hobsonville, with overall section sizes being relatively small.

Waiheke (10%)
Value levels on Waiheke have seen smaller increases relative to the isthmus with land values generally only showing modest increases.

Waitakere Ranges (32%)
The overall demand is weaker than in central locations with accessibility issues and development difficulties, such as steep bush clad sites, which can impact on desirability and value levels.

Waitemata (29%)
Waitemata has two distinct markets – CBD apartments and secondly, traditional inner city housing areas such as Freeman’s Bay, Herne Bay, Ponsonby and Grey Lynn. Value movements for traditional housing areas is similar to Orakei and Albert/Eden, while average movements for CBD apartments is lower.

Whau (41%)
The Proposed Unitary Plan is influencing buyer expectations, particularly in areas identified for more intensive land use such as New Lynn. The extension of State Highway 20 and the Waterview connection has contributed to increased interest in the area, and significant value growth has occurred over the last three years

We’ll have to wait till November before the details are available for each individual property.

Location affordability in New Zealand cities – is greenfield growth really affordable?

Several weeks ago I attended the annual New Zealand Association of Economists conference in Auckland. Geoff Cooper, Auckland Council’s Chief Economist, had organised several sessions on urban issues, and as a result there was a lot of excellent discussion of urban issues and Auckland’s housing market. You can see the full conference programme and some papers here.

At the conference, I presented some new research on housing and transport costs in New Zealand’s main urban areas. My working paper, enticingly entitled Location Affordability in New Zealand Cities: An Intra-Urban and Comparative Perspective, can be read in full here (pdf). Before I discuss the results, I’d like to thank my employer, MRCagney, for giving me the time and the data to write the paper, along with several of my colleagues for help with the analysis, and Geoff Cooper for suggesting the topic and providing helpful feedback along the way.

The aim of the paper was to provide broader and more meaningful estimates of location affordability that take into account all costs faced by households. In my view, widely-reported sources such as Massey University’s Home Affordability Report have too narrow a focus, looking only at house prices. However, a range of research has found that transport costs vary between different locations depending upon a range of factors such as urban form, availability of transport, and accessibility to jobs and services. And transport costs are pretty large for many households!

I used two methods to provide a more comprehensive estimate of location affordability in Auckland, Wellington, and Canterbury. First, I used Census 2013 data to estimate household housing, car ownership, and commute spending at a detailed area level within each of the three regions. This allowed me to estimate variations in affordability between areas within individual regions. Second, I used household budget survey data to get a sense of how New Zealand cities stack up against other New World cities.

My main findings were as follows:

  • First, rents (a proxy measure for housing costs) tended to fall with distance from the city centre. However, commute costs tended to rise with distance – meaning that outlying areas were less affordable for residents once all costs are included. This was consistent with previous work on location affordability in New Zealand and the United States.
  • Second, international comparisons suggest that Auckland and Wellington have relatively high housing costs and that this may be driving some of the affordability findings. While this finding lines up with previous research that’s focused on house prices alone, it’s important to note that the location affordability estimates suggest that a focus on greenfields growth alone may not save households money.
  • Third, while I didn’t identify any specific policy recommendations, I’d recommend that (a) policymakers should consider all location-related costs when attempting to address affordability for households and that (b) further research should focus on removing barriers to increasing the supply of dwellings in relatively accessible areas.

And now for some pictures.

These maps show two measures of location affordability within Auckland. The left-hand map shows estimated housing costs (i.e. rents) as a share of median household incomes at a detailed area level. Broadly speaking, this map shows that expected housing costs fall between 20% and 30% of household income in most of the city, although some areas are relatively less affordable.

The right-hand map, on the other hand, incorporates expected car ownership and commute costs. Overall location affordability is lower throughout the city. Expected housing and transport costs rise to 40-50% in areas of west and south Auckland, as well as the entire Whangaparoa Peninsula. The most affordable areas for their residents tend to be in Auckland’s inner isthmus suburbs.

Auckland map 1 Rent share Auckland map 2 HT share

(Click to enlarge)

I’ve also combined this data into a graph that presents location affordability by distance from Auckland’s city centre. The bottom (blue) line shows housing costs as a share of median household income, weighted across all area units within each 2-kilometre concentric circle radiating outwards from the city centre. It shows that, on average, households spend a similar share of their overall income on housing costs in both close-in and outlying suburbs.

The top (red) line shows that combined housing, car ownership, and commute costs increase as a share of household incomes with increasing distance from the city centre. On average, households that live further out of Auckland spend more on location-related costs, as lower lower rents are offset by added commute costs.

Auckland H_T distance chart

The results for Wellington and Christchurch were broadly similar – although with a few interesting differences related to their urban form and transport choices. However, as this is the Auckland Transport Blog, I’m going to suggest that you read the paper to see those results. It’s long, but it also presents a lot of new data on housing and transport costs in New Zealand.

House prices vs rents: the effects of inflation

As we all know, house prices have gone up massively over the last couple of decades, and much faster than inflation. On the other hand, rents haven’t gone up so quickly – lucky for the 35% of Kiwis (or 38% of Aucklanders) who don’t own the home they live in.

As someone with more than a passing interest in inflation, rents, yields and prices, I’ve thought for a long time that the growing gap between rents and house prices must have a lot to do with the switch from a high inflation environment to a low inflation one. It’s exactly what economic theory would predict. And luckily, another economist, Rodney Dickens, has come along and taken a look at it (hat tip to Bob Dey for the link).

First, some background. Up until the 80s, New Zealand often had very high inflation, as per the chart below:

Inflation

Inflation was particularly high through the 1970s (oil prices sustained at much higher levels than ever before, plus the switch to a floating exchange rate, and various other factors besides) and the 1980s, except for a brief period in the 1980s where Muldoon thought price freezes were a good idea. The 1989 Reserve Bank of New Zealand Act put a new focus on inflation targeting, and it wasn’t long before inflation rates dropped to well below 5% a year, where we’ve been more or less ever since.

Unsurprisingly, mortgage rates tended to follow a similar pattern to inflation, although they didn’t fluctuate as much:

Inflation and mortgage rates

Floating mortgage rates topped out at more than 20% in the late 80s, and fell dramatically through the early 90s. They’ve stayed below 10% for most of the time since.

So, if you’re an investor in the 1970s, and inflation is at 15%, and you can borrow money at around 15% (or put it in the bank and earn at least 10%), what kind of return do you expect on your rental property? You might expect a yield, or return, of 20%, say. Flipping that around, the property value is five times the net rent you receive.

OK, so now it’s the 2000s. Let’s put aside thoughts of capital gain for now – assume you just want a fair return on your money. You can borrow it at 8%, and put it in the bank at maybe 5% or so. Property seems like a fairly safe investment, so perhaps you’d be happy with 6% return. That means your property value is now nearly 17 times the net rent.

Of course, we wouldn’t expect the runup in asset values to happen just for property. We’d expect it for all types of income-producing asset – shares, capital goods, human capital. You’ll see it as a drop in yields for these assets, as for Rodney’s graph below, which shows yields both for residential property and for government bonds:

Rodney graph 1

As Rodney says:

“CPI inflation has been consistently lower since the early-1990s. In the first house price boom after 1990 – between 1994 and 1996 – rental price inflation increased much as had been the case earlier. But it would seem that by the time of the 2002 pickup in house price inflation the low inflation environment had taken over. It would appear that landlords began to struggle to justify or achieve higher rental inflation in an environment of sustained low general inflation.

This new, inflation-constrained behaviour is reflected in CPI and rental inflation living in similar ballparks since after the government interventions resulted in rental inflation turning temporarily negative in 2001. The result was that the relationship between house price and rental inflation largely broke down”.

He goes one step further, and looks at an issue closely related to housing affordability, as Stu has written before. Here’s Rodney on the issue:

This can also be viewed from the perspective of rents compared to incomes. This is another means by which lower general inflation, including lower income growth, will put a ceiling on rental inflation. The [chart below] compares the ratio of the national average house price to the average annual gross income (black line) with the ratio of the average national annual gross rent to the average annual gross income (blue line).
Prior to 2000 the two ratios largely moved in synchrony while since then the rent/income ratio has fallen and the house price/income ratio has skyrocketed.

Rodney graph 2

I quite like the way Stu puts it: housing is a commodity like anything else, and “you don’t measure the  affordability of cookies based on the cost of buying the cookie factory”.