AUT’s Briefing Papers initiative has kindly allowed us to syndicate their recent series on housing. The eighth paper is by investor and company director John Walley:
Auckland has a housing problem but this is not just a problem for Aucklanders, or new home buyers. Out of control asset inflation – as seen in the Auckland housing market – is toxic to the real economy, destroying our ability to deliver a long-run neutral balance of trade. High asset price inflation misdirects investment and lowers the competitiveness of the tradable sector resulting in lower average wages and falling returns to trade.
Under current conditions investment is largely focused on assets, not productive enterprise. In an effort to check rises in asset prices, interest rates in New Zealand are higher than other countries. Consistently higher comparative interest rates results in a stronger New Zealand dollar than would otherwise be the case, reducing export returns, competitiveness of manufacturers in our domestic market and lowering incentives to invest (key to future innovation, competitiveness and capability). Inequality is worsened, as house and land values contribute to higher living costs; this further damages our economic performance, as recent OECD research has shown higher inequality to be a drag on economic growth. As house prices rise, indebtedness rises in comparison to earnings, increasing vulnerability to economic shocks that can threaten financial stability.
Ever expanding debt, supported by banks and the large monetary stimulus programmes in the U.S, Europe, U.K and Japan, and even by the Reserve Bank of New Zealand (RBNZ rules favour land and buildings on bank balance sheets), fuel ever higher average house prices with respect to average earnings. This process is supported by the notion that prices will always rise and that debt will be paid by the (tax free) capital gain. The risk to stability is, of course, if prices fall. Research by the OECD estimated when household debt rises above trend by 10 percent of GDP there is a 40 percent chance of the economy entering recession in the following year, compared to 10 percent likelihood when household debt is rising at trend.
More generally, recent OECD research looking at the role of finance and growth suggested the following is the case in most OECD countries: more credit to the private sector slows growth; more stock market financing boosts growth; credit becomes a stronger drag on growth when it goes to households rather than businesses; and bank loans slow economic growth more than bonds.
Auckland house prices are high when compared to incomes. The graph below compares housing affordability (the ratio between median house prices and median annual household income) for each countries’ major markets – for New Zealand, this is the Auckland housing market. As of September 2014, the median house sale price in Auckland was 8.2 times median household income – the survey median was 3.8. The New Zealand national median house price-to-income ratio is also high, at 5.2. Demographia defines income multiples of 5.1 and over as ‘severely unaffordable’.
Household debt reached a peak of 162.2 percent of disposable income in the first quarter of 2015, after previously peaking close to this at 161.2 percent in the second quarter of 2009. New Zealand’s household debt-to-GDP ratio is at 95 percent, down somewhat on the peak of just over 100 percent in 2009. Research by the Bank of International Settlements (BIS) suggest that household debt over 85% of GDP can damage an economy, though greater sensitivity to economic downturns, and by boosting debt for non-productive assets, pulling resources from the rest of the economy to service it, including skills and investment.
This is the problem – for the whole New Zealand economy. Will building more houses in Auckland fix it?
Under-supply of housing naturally leads to higher prices, particularly with high net migration. Hence the solution to this part is to increase supply, open up new land for development, focus on increasing the number of houses built and responsibly reduce constraints and barriers to new builds. It is also important that such developments target high density development, particularly in larger cities such as Auckland, to reduce the cost of urban sprawl (some commentators have called for a debate on migration).
But supply side activity has a limited pace as the allocation of finite construction resources and labour has a limit, made worse when in catch-up mode, as seen in the large deficit in the cumulative net supply position in the graph below – this is a key area for the Government to do more, especially ensuring affordable housing is built. Low rent inflation suggests investors and speculators are contributing to house price inflation.
Graph Source: MBIE
Supply side efforts take a while to take effect, and the threats to financial stability and the damage to the tradable sector are with us right now. More needs to be done. The supply response in the last two decades has favoured more expensive housing, rather than affordable homes, exasperating the inequality effect.
Source: OECD Economic Survey – New Zealand
Intervention on the demand side, such as a register of foreign buyers, borrowing limits related to asset earnings and/or buyer earnings, higher deposits for landlords and capital gains enforcement can act quickly to reduce the growth in debt, slow price rises and thereby improve financial stability.
Other countries have acted:
- Last year the Bank of England reintroduced Loan to Income Ratios, where no more than 15% of mortgages issued can exceed a Loan to Income Ratio of 4.5. If you earn £100,000 a year, your loan would be capped at £450,000.
- The Central Bank of Ireland introduced Loan to Income Ratios, of 3.5 times of gross income and Loan to Value Ratios set at 80% (a 20% deposit is needed) with a lower ratio of 70% for those buying rental properties. For first home buyers this is set at 90% for properties up to €220,000, with 80% on any value exceeding this. This tougher requirement on rental investors reflects their higher default risk as compared with owner-occupied homes.
Research by the BIS suggests that such macro-prudential tools can be effective in slowing house price inflation and mortgage credit growth if they are introduced at a time when these are both high. In other words, they can be most effective in slowing a boom, and are less invasive at other times, keeping the lid on gently.
Another issue often cited as a factor increasing prices is demand from foreign investors. Unfortunately with no register of such ownership in New Zealand it is hard to judge the extent of this.
- Singapore introduced stamp duty taxes on non-resident buyers of property. This tax now sits at 15%, increasing from 10% when it was introduced in 2012. They also introduced a cap on debt repayment costs at 60% of the borrowers’ monthly income. These measures have seen prices fall 4% in 2014, and sales volumes falling.
- Australia: there are proposals to introduce such a register as well as fees on foreign investors: A$5000 fee for property up to A$1m, and investments over A$1m would incur an A$10,000 fee for each additional A$1m purchased. These measures are probably too small to make much difference but are a start. Foreign investors are limited to purchasing new build, and not existing property, and these rules may be strengthened. The state of Victoria is now also planning a 3% tax on foreign buyers of property.
- England, Ireland and Australia also have some form of Capital Gains Tax.
In a recent speech, the Deputy Governor of the RBNZ suggested New Zealand needs fresh consideration around tax settings for housing, particularly for investors, saying “housing is the most tax-preferred form of investment, particularly when it is highly leveraged. Indicators point to an increasing presence of investors in the Auckland market and this is no doubt being reinforced by the expectation of high rates of return based on untaxed capital gains.”
While we have seen positive steps forward by both the RBNZ and Government in addressing these issues, wider reform is needed. Limiting the expansion of private debt to both earnings and equity is important not only for those trying to buy a home, but to reduce the impact on competitiveness of the tradable sector through the exchange rate channel and cost of borrowing. More generally, the Government and RBNZ need to stop shying away from strong demand side changes, being sufficiently bold to tackle hard issues around the treatment of asset debt by the RBNZ, and fiscal policy changes by Government around the capital gains incentives.
In comments to a recent post I wrote reviewing recommendations from the Australian Productivity Commission’s review of public infrastructure investment, reader Brendon Harre raised an important question about transport cost-benefit analysis (CBA). He commented that:
AUT’s Briefing Papers initiative has kindly allowed us to syndicate their recent series on housing. The seventh briefing paper is by former Reserve Bank economist Michael Reddell:
There has been a strong sense this year that “something must be done” about high house prices, especially those in Auckland. To date, however, the policy responses display little awareness of how previous policy choices have made New Zealand housing increasingly unaffordable over the last couple of decades. Blaming investors or the tax system are largely distractions. And while non-resident Chinese purchasers may be bidding up house prices in Auckland (and Sydney, Vancouver and other cities) right now, these pressures are recent, while housing affordability problems are not. Increased demand for houses, whatever the source, doesn’t create problems if it is easy to bring new houses to market.
In 2013 Anthony King and Ivor Crewe published The Blunders of our Governments, which traced Britain’s experiences with various policy disasters over the previous thirty years. Unaffordable New Zealand house prices, especially in Auckland, are the predictable outcome of a similar blunder: the collision of two sets of perhaps well-intentioned policy choices.
In New Zealand, urban areas cover only around 0.7 per cent of our land. And land used for agriculture is just not that expensive. Prime dairy land at the peak of the boom in 2008/09 was selling for around $50,000 a hectare. Residential sections in Auckland, of less than a tenth of a hectare, are selling for ten times that much. The comparison isn’t precise – subdivisions need streets and footpaths etc, so one hectare of farmland doesn’t generate one hectare of residential land. But in research published in 2007, Arthur Grimes and Andrew Aitken found that land just inside the Auckland Metropolitan Urban Limit was selling for 10 times the price of land just outside the limit. Even if we had a construction industry that was as efficient and productive as any in the world, our house (house plus land) prices would still be very high just because central and local government together have created artificial scarcity. Auckland’s geography is certainly difficult, but that is all the more reason for having as few restrictions as possible on the ability of owners to use and develop land for housing. Land use restrictions appear to have become a much more serious constraint in the last 25 years. By contrast, in the 1950s and 60s, with a much stronger policy emphasis on home-ownership and house-building, planning restrictions (and especially land use restrictions) had a much less serious impact.
Of course, there are land use restrictions in place in local authority areas all over the country. Councils – staff and councillors – seem to feel a need to plan and central government legislation allows them to do so. But house prices in Auckland are four times those in Invercargill. That difference is really down to population growth differences.
In places where there is no population growth, land use restrictions still impose costs, but they don’t have much impact on house and urban land prices. And where land use restrictions aren’t very important, rapid population growth also won’t do much to boost house and urban land prices. An example is the big US city of Houston, where there are few land use restrictions. Over the last 35 years, Houston’s population has more than doubled while real house prices have actually fallen a little.
New Zealand’s land use restrictions are similar, in effect, to those in a range of other Anglo countries. House and land prices are extraordinarily high in places as diverse as Auckland, Sydney, Melbourne, London, Vancouver, and San Francisco. In each of these places, the inability to easily bring new land to market and use it intensively for housing runs into the pressures of rising demand from a growing population. When those two pressures collide, house prices rise. High house prices in these cities are not the result of aggressive and unwise lending by banks. They aren’t the result of speculation. They are just what happens when land use restrictions run head-on into population pressures. And housing demand is, in the jargon, quite inelastic. Existing residents of high-priced cities mostly don’t move somewhere else, partly because the big cities are where the jobs are. Sometimes the resulting high house prices are discussed as some sort of market failure, when it is a sustained failure of governments to allow markets to operate.
Where does the population pressure arise from? In the post-war decades most advanced countries experienced a high birth rate. Demand for housing rose strongly on account of this natural increase in population. Government policy choices didn’t have much to do with that source of demand, and governments in free societies generally don’t attempt to influence the rate of natural increase.
But natural population increase is now quite small in most advanced countries. Even in New Zealand, which has a relatively high birth rate by advanced country standards, the birth rate is only around replacement level. And for the last 40 years or so, New Zealand has had a large net outflow of New Zealanders, pursuing a better life abroad for themselves and their families. This outflow swings around a lot from year to year, but in total around 870,000 New Zealanders (net) have left in the last 40 years.
With little or no natural increase, and a substantial average annual outflow of New Zealanders, New Zealand’s population would now be falling slightly even with the modest rate of inward migration of non-New Zealanders we had in the 1980s. There would be no population pressure on the housing stock in the country as a whole, and probably only modest pressures even in Auckland.
But around 25 years ago, New Zealand immigration policy was reformed to encourage a much larger annual net inflow of non-citizens. The current annual target, reconfirmed by Cabinet only last year, is around 45,000 to 50,000 permanent residence approvals each and every year. That is one of the largest rates of non-citizen immigration (as a share of population) of any advanced economy. As one would expect, a disproportionate share of the migrants settle in our largest and most diverse city.
No one envisaged the impact on house prices when the land use restrictions became progressively more binding, or when the more expansive immigration policy was adopted. With hindsight the contribution of these two directly contradictory sets of policies is pretty clear. Land use restrictions might do little harm in a country with low or no population growth (the situation in many OECD countries today). And rapid rates of non-citizen immigration would have no adverse impact on housing affordability if land could be as freely used for housing as in Houston. As it is, the young and the poor, disproportionately of Māori and Pacific origins, find it almost impossible to purchase a house in our largest city simply because of the choices – blunders – of our governments. It is time for our government to confront that responsibility and to bring about change. If sufficient reform of land use restrictions is not possible – and the overseas precedents are not encouraging – the case for a significant reduction in the target rate of non-citizen immigration is pretty clear.
AUT’s Briefing Papers initiative has kindly allowed us to syndicate their recent series on housing. The sixth paper is by economic commentator Bernard Hickey:
We’re now having a fractious debate about foreign buying of houses, but the more important and tougher debate we should be having is about migration.
Does it actually generate the right type of long term economic growth, or does it just pump up house prices and interest rates, suppress wages and reduce the incentives for New Zealanders to obtain the necessary skills for a modern economy?
Neither of the three biggest parties, National, Labour or Green, have challenged the consensus of at least the last 15 years that New Zealand needs plenty of skilled and unskilled migrants to juice the economy along.
There are plenty of employers who regularly argue that they need both types of migrants to keep their businesses, hospitals, hotels and farms running and growing. The Government has a target of allowing around 45,000 to 50,000 new permanent residents each year, including around 60% who are skilled migrants, over 32% who are family reunifications and over 7% who are approved for humanitarian reasons.
It may argue that one reason for high net migration is the uncontrollable movements of New Zealanders and Australians (who are often ex-pat New Zealanders), but that’s not the whole truth. The Government does control that Residence Programme and various schemes for international students, working holiday visas and seasonal workers.
Over 300,000 migrants have arrived over the last 15 years encompassing the current National and the last Labour Governments.
Understandably, New Zealanders see themselves as the descendants of migrants in one form or another who have an open and welcoming approach to new migrants. That is all good.
But migration that is too fast can put a strain on the economic system and the key variables of interest rates, the exchange rate, house prices and unemployment show the stresses involved of the latest migration surge. When there are restraints on the supply of houses, schools, motorways and hospitals, as there are in Auckland, then prices and interest rates respond.
Former Reserve Bank economist Michael Reddell pointed last week to Reserve Bank modelling showing a 1% rise in population will lead to a 10% rise in house prices. Last year Reserve Bank and Treasury separately forecast that a surge in net migration to over 45,200 and over 41,500 respectively would increase the Official Cash rate by between 50 to 100 basis points and increase nationwide house price inflation by four percentage points.
Net migration alone is increasing New Zealand’s population by more than 1% per year at the moment and that’s before natural population growth adds to the pressures.
“Rapid population growth and a low responsiveness of supply have led to housing and urban infrastructure constraints,” the OECD concluded in its report on New Zealand earlier this year.
All this creates costs for taxpayers and ratepayers alike because the infrastructure costs and rent subsidies triggered by net migration has to be paid for with higher rates and taxes. Auckland’s ratepayers may blame the Auckland Council for their near-10% rates increase this year, but they could just as easily blame New Zealand’s migration policy makers.
The other costs are borne by the rest of New Zealand’s businesses and exporters through interest rates and the exchange rate being higher than they otherwise would need to be. New Zealand has had strangely high long and short term interest rates over the last 20 years relative to the rest of the world and there’s a strong case that our high migration is at least partly to blame.
The other losers are resident workers and the unemployed because the high net migration has helped suppress wage growth and kept unemployment stubbornly high at over 146,000 or 5.8% of the workforce. This may be as good as it gets.
The latest migration tweaks announced last weekend show how responsive the Government has been to the calls from employers to make it easier to solve their labour shortages by importing workers. The rule change to allow long term migrants on temporary work visas in the South Island to apply for permanent residency is one example.
Wage growth has been much lower than everyone expected in the last two years, which is at least partially due to strong net migration soaking up the pressure that would otherwise have been applied to wages.
It also begs the question: why can’t we train or educate some of those 146,000 unemployed for these jobs? Is the Government and society collectively taking the easy option of migration to avoid the much crunchier problem of ensuring kids graduate from schools and tertiary institutions with the literacy, numeracy and life skills needed for these jobs?
Turning full circle, the migration debate is also inevitably intertwined with the debate about foreign buying of houses. New Zealand may discover after October 1 when the tax residency status of buyers will be recorded that much of the money being pumped in from overseas is going through the accounts of new migrants, students and those on short term work visas, all of which would be recorded as local buying.
Ultimately, taking pressure off house prices, interest rates and unemployment will require lots of hard work to improve the supply of houses and skills, but in the short term a debate about the number of migrants is needed.
Last week I started taking a look at publicly-owned golf courses. I argued that they are different from public parks in several important respects. While public parks are freely available to all Aucklanders, golf courses are only open to paying golfers. As a result, we need to treat golf courses differently – not as a tax-funded public good, but as a business that must pay its way.
This week, I will take a look at some of the “opportunity costs” associated with using land for golf courses rather than alternative uses, such as public parks or housing. My central question is this: Do the benefits of using land for golf outweigh the benefits of developing the land for housing? Or is it the other way around?
Let’s start with a look at some broad trends. First, here’s what’s happened to the price of housing over the last two decades: it’s gone up significantly. This is a strong indication that demand for housing (and more intensive urban land uses) is increasing. While predicting the future is difficult, most people expect housing demand (and prices) to continue rising in the future.
Second, here’s a short-term forecast of revenues for Auckland’s 39 golf clubs from a 2013 report on future prospects for golf facilities. According to the report, golf club membership has been declining by around 1.6% a year. Unless something major changes, this trend will continue and put many golf courses under financial pressure:
Effectively, rising demand for housing and falling demand for golf mean that using large amounts of publicly-owned land for golf courses will become increasingly inefficient. Here’s one way of thinking about the benefits of the status quo (to golfers) versus the benefits of redevelopment (to people who otherwise wouldn’t be able to buy or rent homes in the area).
I’m going use Chamberlain Park as a case study, but the same approach could be generalised to other publicly-owned golf courses. Here’s a picture of the course, which occupies 32 hectares in Mount Albert:
According to the local board, Chamberlain Park currently hosts over 50,000 rounds of golf a year. Let’s be generous and call it 55,000 rounds. According to the club’s website, green fees are $30 on weekends. This means that the total annual value of golf rounds played at Chamberlain Park is $1.65 million. In present value terms (i.e. extending this forward 40 years into the future and applying a 6% discount rate), this equates to $26.2 million.
Now, let’s consider alternative uses for the land. Let’s assume that we would develop it for housing and commercial uses, with a substantial amount of land reserved for public parks. We don’t have to look too far to find a good example of this kind of development. It’s exactly what’s happening at Wynyard Quarter, which will have a mix of medium-density residential and commercial buildings, a substantial waterfront park, and a linear park running the length of Daldy St:
The important thing is that if development is master-planned appropriately, it can lead to more housing and better public spaces. That’s certainly happening at Wynyard, but it could also happen in Chamberlain Park if redevelopment enabled better connections between new public parks, the Northwestern cycleway, Western Springs, and Mount Albert in general.
So let’s start by assuming that we would reserve one third of Chamberlain Park – 10 hectares – for new parks and playing fields. That’s the same size as Grey Lynn Park, which attracts 100,000 people to the Grey Lynn Festival on a single Sunday – i.e. twice as many people as Chamberlain Park sees in a year.
The remainder – around 22 hectares – could be developed as new neighbourhoods, possibly along the mid-rise, mixed-use lines of Wynyard Quarter. I’m going to assume, further, that around 25% of that space would be devoted to streets, which is pretty typical of new developments. That means that after providing some sizeable public parks and laying out all the streets, we’d have around 16 hectares that could be built on.
Now, current land values in the Mount Albert area are in the range of $1500 per square metre, or possibly higher. That’s a reasonable estimate of the value that people place on the opportunity to live in the area. That means that the total benefit of redeveloping Chamberlain Park for housing is around $240 million (i.e. $1500/m2*16 ha*10,000m2/ha). These benefits would accrue primarily to the people who end up living in the area, but it could also keep housing prices from rising as rapidly and thus have wider benefits.
In short, the benefits of redeveloping Chamberlain Park – even after leaving aside a substantial area for public parks – are nine times larger than the benefits of the status quo for golfers (i.e. $240m/$26.2m = 9.2). Because demand for housing is rising at the same time that demand for golfing is falling, this figure is likely to increase, not fall.
This doesn’t necessarily mean that we have to redevelop Auckland’s publicly-owned golf courses, but it does raise some questions. First, given the fact that redevelopment is likely to be vastly more beneficial than the status quo, why isn’t it being put forward as an option in the Chamberlain Park consultation?
Second, why isn’t the opportunity cost of using lots of land for golf being recognised the prices charged by golf courses? As we’ve seen, people would place a quite high value on being able to live or work on the land occupied by some golf courses. In principle, that should be factored in to green fees, but in practice it isn’t. In the next instalment, I’ll explore this question further – it turns out that publicly-owned golf courses enjoy a large subsidy from ratepayers.
What do you think about the benefits of alternative options for using golf course land?
AUT’s Briefing Papers initiative has kindly allowed us to syndicate their recent series on housing. The third paper is by University of Auckland economist Ryan Greenaway-McGrevy:
As of May 2015, the average house price in the greater Auckland region was $828,502. In May 2012, it was only $562,454. That is nearly a 50% increase over only three years. Can anything justify this incredible growth in prices, or is it all a bubble?
Peter C.B. Phillips and I address this question in a recent article to appear in New Zealand Economic Papers: Hot Property in New Zealand: Empirical Evidence of Housing Bubbles in the Metropolitan Centres. One of our key conclusions is that there is an ongoing bubble in the Auckland real estate market.
In Hot Property, we try to restore some objectivity to the difficult task of determining whether or not there is a bubble in New Zealand’s real estate markets. But what exactly is an asset bubble, and how can we spot one? A bubble describes a situation in which an asset price is substantially inflated relative to the asset’s fundamental value, which is the present value of expected income from the asset. But while we can easily observe asset prices, it is harder to observe expected fundamentals. Many arguments over the existence of asset bubbles boil down to whether or not high asset prices can be justified by expected incomes. These arguments sometimes persist long after the prices have come crashing down. For example, see this exchange between Eugene Fama and Ivo Welch from 2002 on the famous NASDAQ bubble: http://www.ivo-welch.info/teaching/famaconversation.html. Fama is one of the most frequently-cited financial economists, and is known for the efficient markets hypothesis. Arguments over the existence of bubbles lead to a large experimental literature that has established the existence of asset bubbles in the laboratory setting (see, for example, Smith, Suchanek and Williams, 1988). Outside of the lab, however, it is remains difficult to spot a bubble by focusing only on asset prices, because we never really know what market participants’ expectations are.
It may be more productive to focus on the growth rate in prices, rather than the price level, when trying to spot a bubble. Bubbles occur because sufficient numbers of market participants purchase an asset in anticipation of future price increases. This can generate a self-fulfilling prophecy, in which asset prices spiral upwards simply because market participants think that prices will increase. As more and more buyers enter the market in anticipation of future returns, prices increase, and they increase at an accelerating rate. As I will discuss below in more detail, it is harder to justify this accelerating price growth in terms of changes in expected future income from the asset. We therefore look for accelerating price growth when trying to spot an asset bubble. This general approach to bubble detection was first proposed in the 1980s (See, e.g., Diba and Grossman, 1988).
The statistical bubble detection tests we employ are designed to establish whether prices are growing and at increasing rate. Peter and his other co-authors provide the theory for these statistical methods in a series of papers (Phillips, Shi and Yu, 2015a; 2015b). A key feature of the methods is that acceleration in price growth must occur over a sustained period in order for us to identify it with any acceptable degree of statistical precision: We are not talking about accelerating price growth over a few months, but a few years. The methods provide not only an indicator of whether an asset is currently experiencing a bubble, they also provide date stamping mechanisms for identifying when the bubble begins and ends. In other empirical applications the methods have proved to be very adept at capturing the onset of bubbles in other asset markets, such as stocks and commodities. And importantly, the end of the bubbles always coincides with a fall in the nominal price of the asset in these empirical applications.
Using this method we identify an earlier, broad-based bubble in most of the regional real estate markets of New Zealand. The bubble appears first in Auckland and Wellington in mid- 2003, before spreading to the other main centres. The onset of the bubble suggest that it was part of a broader global bubble in real estate. The bubble burst with the onset of the worldwide recession in 2007, and coincided with about a 10% fall in nominal house prices.
More recently however, the tests show that Auckland once again entered bubble territory in mid 2013. As yet, the bubble in Auckland has not ended, nor has it spread to other parts of the country.
Many readers will disagree with our conclusion and argue that the accelerating price growth in Auckland is entirely justified by the fundamentals. We mitigate these concerns to an extent by normalizing house prices by an indicator of asset income – in the paper we use either rents or incomes – before running our battery of statistical tests. By doing so, we rule out the possibility that asset prices have been growing exponentially because rents and incomes have been growing exponentially. This leaves open the possibility that price growth reflects exponential growth in expected future fundamentals. But while it is easy to generate a fundamentals-based narrative that results in price growth, it is difficult to construct a narrative that can generate accelerating price growth over a prolonged period of time. This is because asset prices incorporate news relatively quickly, and certainly not over a period of several years. Consider, for example, that the Reserve Bank recently cut interest rates and signalled the beginning of monetary easing in the economy. If this cut was a surprise, and all else being equal, this should lead to an increase in house prices, but not an acceleration in house price growth over the next few years. Many of the common rationalizations for high prices in Auckland – such as lower interest rates or high migration rates – fall into this category. An unexpected increase in migration, or an unexpected decrease in mortgage rates, is good news for property owners, and should lead to a relatively quick increase in real estate prices. But in order to generate accelerating price growth over a sustained period, we would need a sequence of good news that persists over several years. No one is that lucky.
Do bubbles always collapse? Nobel Laureate Jean Tirole provided the conditions for a bubble to survive in an economy (Tirole, 1985). These conditions include durability, scarcity, and common beliefs, and housing sure does appear to be scarce right now. Up until this point in time, urban zoning restrictions have tied real estate to land in Auckland: We do not have the same high density planning as many other cities in the world, and so the number of dwellings per unit of land has been more-or-less fixed. Right now, housing is scarce because land is scarce. If this link between land and real estate persists, then we may just be sitting on a rational bubble. Happily however, the current version of the Auckland Unitary Plan allows for a potentially large increase in the number of dwellings within the city limits. If approved, the land restrictions on dwellings will be significantly relaxed, allowing supply to better respond to the price signal.
Where to from here for Auckland? Unfortunately, the empirical bubble detection literature currently offers little in terms of predicting the future. It is apparent, however, that it can be a long time between when the bubble is first diagnosed and when it finally collapses: Periods of five years or longer are not uncommon. It would be foolish for me to make any claims regarding when the best time to buy or sell a house is, or whether prices will increase or decrease next month. But can real estate price growth continue to accelerate indefinitely? I wouldn’t bet the house on it.
Diba, B. and H. Grossman (1988). “Explosive Rational Bubbles in Stock Prices?” American Economic Review 78, pp. 520-30
Greenaway-McGrevy, R., and P.C.B Phillips (2015). Hot Property in New Zealand: Empirical Evidence of Housing Bubbles in the Metropolitan Centres. New Zealand Economic Papers, forthcoming.
Phillips, P. C. B., Shi, S. and J. Yu (2015a). Testing for Multiple Bubbles: Limit Theory of Real Time Detectors, International Economic Review, forthcoming.
Phillips, P. C. B., Shi, S. and J. Yu (2015b). Testing for Multiple Bubbles: Historical Episodes of Exuberance and Collapse in the S&P 500, International Economic Review, forthcoming.
Smith, V. L., Suchanek, G. L., and A.W. Williams. (1988) Bubbles, Crashes and Endogenous Expectations in Experimental Spot Asset Markets. Econometrica 56, 1119-1151.
Tirole, J. (1985). Asset Bubbles and Overlapping Generations Econometrica 53, pp. 1499-1528
AUT’s Briefing Papers initiative has kindly allowed us to syndicate their recent series on housing. The second briefing paper is written by Motu Institute economist Arthur Grimes:
Housing affordability is a multi-faceted, complex issue. Concentration on just one aspect of the issue – be it housing supply, land supply, interest rates, construction costs or migration – will miss important aspects of why house prices vary in different locations at different times. In this briefing paper, we illustrate how differing facets of the housing market combine to produce diverse housing outcomes.
Common sense and observation of recent trends indicates that house prices reflect variables such as: population and migration, land availability (which is affected by both geographical and planning constraints), construction costs and financial factors (credit availability and interest rates). Government-funded rent and mortgage subsidies will also affect how much people can afford for housing and so will affect prices. These factors are included here in a simple framework, providing a systematic approach to understand house price outcomes. The approach is based on, and extends, published papers by the author as well as other influential papers on housing markets.
Four important relationships
The framework draws on four simple relationships that are at the core of determining housing market outcomes. These four key relationships combine to give outcomes (at the city level) for: house prices, population, land prices, and the housing stock (i.e. the number of dwellings in the city). These outcomes are driven by developments in other factors such as finance costs, construction costs and natural and civic amenities.
The first key relationship is for house prices. Theoretical and empirical work shows that house prices are determined primarily by the ratio of population to the housing stock and by finance costs. As the population rises relative to the available housing stock, house prices increase since people have to bid more to purchase (or rent) a dwelling. As interest rates (and other costs of servicing a mortgage) decline, people can afford to increase their expenditure on housing, so house prices rise. Another (often overlooked) feature of financing costs may also be very relevant for house prices. The greater are government-funded subsidies such as accommodation supplement, the greater is the amount that most renters and lower-income house buyers can afford to spend on housing, so rents and house prices will increase in price.
The second key relationship is for regional population. People are attracted to regions that have high wages, attractive natural amenities and attractive civic amenities. Their choice of location is also affected by the cost of housing (both rental and owner-occupied). If population is very responsive to housing costs then extra supply of dwellings may have little effect in dampening house prices since demand (through internal and external migration) will increase to fill the extra dwellings at near existing prices.
The third key relationship to consider is the responsiveness of new housing supply to changes in prices and costs. Over time, the supply of houses increases (or stagnates) until such time as the market price of houses equates to the sum of all costs of producing a new house. These costs include the price of land associated with the dwelling (i.e. the “lot price”), construction and other costs (including regulatory costs), plus a normal rate of return on capital. The sum of these costs ultimately equals the house price, with changes in the lot price being the most important factor in equating house prices to costs.
This brings us to the fourth key relationship, which is for lot prices. For a given city, the average lot price rises as the local population rises. As the population increases, the price of existing land close to the city centre (or to town centres) becomes more sought after so increases in price. While the lot price on the urban fringe may stay low – though this will be determined crucially by the strength of planning and geographic constraints – the increased price of land in existing parts of the city will increase the average lot price of the city.
The four relationships described above all relate to long term outcomes. While short term outcomes may diverge temporarily from the long term relationships (e.g. due to “fads” or to short term migration swings), an understanding of these four relationships enables us to trace through how economic shocks (e.g. a change in global interest rates) or policy shifts (e.g. a change in costs levied on developers) eventually affect house prices, land prices, population and the housing stock.
We demonstrate the inter-relationships within the housing market by adopting a systems approach that incorporates all four long term relationships just described. We can use this system to evaluate the effects of various developments on housing outcomes. We base our model on published estimates of the effects of the various factors on New Zealand housing market outcomes. Informed by recent Auckland experience, we allow the lot price to form half of the total house price (e.g. a $700,000 house comprises land worth $350,000 and a building worth $350,000). We do not have strong evidence on the effects of population increase on land prices, but assume initially that a 1% rise in population results in a 1% rise in average land values; we also assume that a 1% rise in house prices results in a 0.2% decline in population as people migrate out of the city.
These parameters give us a baseline estimate of responsiveness of the housing market to specific developments. The development that we will concentrate on here is an increase in the number of people wishing to move to Auckland. The assumed increase in population is equal to 10% of Auckland’s existing population holding all other factors constant (we term this a “population shock”). In fact, all other factors will not be constant and the adjustments to these other factors (such as house prices) will affect the final number of people who end up moving to the city.
The first group of bars in the accompanying figure show the baseline estimate of the impact of a 10% flow of people to Auckland on house prices, land prices, actual population and the number of dwellings. Land prices rise (by an estimated 9.1%) in response to the influx of people and this land price rise pushes up house prices by 4.4%. The rise in house prices has two effects. It leads to greater house-building, though this is constrained somewhat by the higher land prices, so the number of dwellings increases by only 6.9%. Higher house prices also deter some people from moving to Auckland, so the population rises by around 9% rather than the full 10% of people initially wanting to move to Auckland. There are now more people per house than previously since the population rises faster than does the housing stock (i.e. crowding increases).
The second group of bars simulates the same population shock but now we assume that land prices are very responsive to the extra population (e.g. because planning laws are very restrictive in allowing extra land for housing). Now we find that land prices skyrocket by almost 25% in response to the same population pressures. This leads to an 11.6% rise in house prices. These house price rises curtail the population inflow, so that population increases by only 7.6% (rather than the 9.1% in the baseline simulation). The skyrocketing land price restricts new housing development so that the stock of dwellings now increases by only 2.4% and household crowding becomes much more severe than before.
Thirdly, we assume the same responsiveness of land prices to population as in the baseline simulation, but now change the responsiveness of population to house prices. We now assume that every 1% rise in house prices reduces population by 1% (rather than by just 0.2% in the previous two simulations). This yields the third set of bars in the figure, again in response to the initial 10% population shock. The rise in land and house prices following the initial population pressures now deters people from settling in Auckland so that the population increase is just 6.6%. The reduced population inflow means that there is less pressure on house prices which now increase by just over 3%. Crowding pressures are no longer as severe as in the other cases as the housing stock increases by 5%, just short of the population increase.
What do we learn from these examples?
These simulations tell us that each aspect of the housing market interacts with each other aspect as a system. One cannot look just at housing supply, or housing demand or immigration to judge its impact on housing outcomes. All these aspects must be considered together. The same shock (e.g. a sudden rise in the number of people wishing to settle in Auckland) can have very different housing outcomes depending on the responsiveness of some factors to others.
Two facets of responsiveness that we have concentrated on here are: (i) the response of population to house prices, and (ii) the response of land prices to population. If population is very responsive to house prices, then house and land price movements will be more muted than when the responsiveness is low. This factor essentially reflects one aspect of the demand for housing.
The second factor relates to the supply of housing. If land prices are very responsive to population size, then house and land prices will react strongly to an influx of population. That the same shock can lead to either a 6% rise or a 25% rise in land prices depending on just these two factors shows the importance of considering all responses in determining what happens to housing outcomes following economic shocks.
We may have little power to affect how people’s location choice responds to house prices, but we do have some ability to affect how responsive land prices are to population pressures. Planning laws that constrain the amount of greenfields land available for new housing or that limit the ability to intensify in existing areas (i.e. the ability to use less land per dwelling) increase the responsiveness of land prices to population inflows. The increased rise in land prices then induces a larger rise in house prices for the same population shock.
Thus while many demand and supply factors interact with each other to affect house prices, we are able to moderate their final impacts through policy choices. It then becomes a political economy question as to whether or not we wish to implement policies to counteract a situation whereby house prices have become so high as to price many ordinary New Zealanders (and almost all poorer New Zealanders) out of buying a house in Auckland. Our work shows that we do not need to accept this situation.
One avenue to help address it is to increase the availability of land (both through enabling intensification and opening up greenfields land) so as to bring land prices and house prices back down to more affordable levels. Even then, however, we have to consider how all the factors appearing in our four relationships interact with each other to understand the overall effects of such a policy change on the outcomes of policy interest. If population flows are rather unresponsive to house prices, freeing up the land supply should bring down house prices and have little effect on population levels. By contrast, if population flows are very responsive to house prices, then freeing up land supply will be reflected principally in an influx of population with only a secondary effect on land and house prices. The responsiveness of population is an empirical issue, but one that may be affected by some policy settings such as migration policy and housing assistance policies. For instance, if housing assistance does not rise with an increase in housing costs, then a house price or rent rise may deter significant numbers of people from living in Auckland. Again, it is a political economy issue as to how the populace and policy-makers wish to treat these various outcomes.
 Arthur Grimes & Andrew Aitken (2010) “Housing Supply, Land Costs and Price Adjustment”, Real Estate Economics, 38(2), 325-353; and Arthur Grimes & Sean Hyland (2015) “Housing Markets and the Global Financial Crisis: The Complex Dynamics of a Credit Shock”, Contemporary Economic Policy, 33(2), 315-333. An analysis of regulatory costs in relation to Auckland housing is reported in: Arthur Grimes & Ian Mitchell (2015) “Impacts of Planning Rules, Regulations, Uncertainty and Delay on Residential Property Development,” Motu Working Paper 15-02, www.motu.org.nz.
 For instance, based on Grimes and Hyland, op. cit., we assume that house prices rise by 2.2% if the population rises by 1% relative to the housing stock in a city.
 Specifically we now assume that a 1% rise in population induces a 3% rise in land prices.
Greetings from Amsterdam, where I’m happily ensconced in a multi-storey apartment building. Just now I had a look at the New Zild Herald, where I was disappointed to read this article from Bernard Orsman. Titled “Suburbs could get more apartments”, the article seems primarily designed to whip up fear, which is something I’ve criticised the Herald for previously. In this post I pick out some specific comments with the article that I found particularly disappointing.
“They believe large swathes of the city where single houses sit on a single site will be rezoned to allow developments with no density controls.” Oh dear. So much is wrong with this statement. Later on in the article Bernard (finally) acknowledges that what we’re talking about is the extent of the Single House Zone (SHZ), which Council have suggested might be better replaced with a Mixed Housing Zone (MHZ) in some places. While the MHZ allows development of up to three storeys, it is not equivalent to “no density controls”. Indeed, developments within the MHZ are still subject not only to height limits, but also a myriad of other density controls, e.g. landscaping rules, boundary set-backs etc etc. Bernard buries most of this information at the back of the article, rather than presenting it up front where it seems to belong.
“It basically destroys a lot of the character of the inner-city suburbs like Grey Lynn, Ponsonby, Herne Bay, Parnell and Mt Eden,” said Christine Cavanagh of the Herne Bay Resident Association. The issue with this statement is that the SHZ is not intended/designed to preserve “character”, but instead to control development intensity. Development intensity is quite different from character, which is why Council has separate rules for the latter, e.g. demolition controls on pre-1944 buildings and site coverage ratios. Christine may think that character is intrinsically linked to low development intensity. If so, then she needs to explain why all of Auckland’s inner-city suburbs have quite intensive multi-storey apartment buildings, many of which have existed for a long time. Below are some of my favourites, but there are many others.
My final criticism is for Pete Sinton, who describes the mixed housing zone as “high intensification“. In what dystopian world could three storey developments qualify as “high intensification”? Maybe only a world where people’s feet had been chewed off by zombie rats so that nobody could get up stairs anymore?!? In reality, three storeys is a perfectly normal level of development most places in the world. It’s shorter than most mature, fully grown trees. Three storeys is less than many large (rural) houses that are found in places like the Netherlands and Sweden.
So is there a silver lining to this article?I actually found two.
The first silver lining comes towards the end, where Bernard includes some comments from people who support intensification. This includes business owners in Mission Bay, and some residents who are happy with development up to four storeys. The second silver lining I found in this article is actually Penny Hulse, who manages to explain why the Council is reconsidering the extent of the single house zone, i.e. to balance the need for more housing. Penny generally does a marvellous job despite all the bullshit thrown her way by the likes of Bernard Orsman and Christine Cavanagh.
In a more balanced world the title of the article would read “Auckland allows more housing”. True Storey.
From the Auckland Plan, how Auckland has developed since 1840.
There have been many issues in the debate how Auckland should develop and a lot of it comes down to preferences and in particular housing preferences. On the one side of the debate there are those – who are often baby boomer generation or older – who claim that no-one wants to live in an apartment and that we all want big standalone houses. They extrapolate that to mean we should focus on building a lot more standalone houses on the urban fringe.
We (and others) have long said that a range of dwelling types are needed in many locations to give people choice in where and they live. That allows people to make trade-offs based on their location/amenity preferences and how much they’re prepared to pay. That means even you would prefer a large house, if living closer to the city is important to you then you may be prepared to live in a terraced house or apartment rather than have a large house on the outskirts of town. Of course many also prefer higher density living.
Previous research in to the issue of preferences was often simplistic not taking into account the real world constraints and trade-offs people make. As reported by the herald yesterday, new research for the council finally addresses that missing part and has some interesting findings. The report is here (4mb).
Perhaps its key finding is that while there is a majority of people who would prefer a standalone house, the current housing stock more than satisfies that demand that outside the city centre there is a shortfall of units and apartments.
The research divided Auckland up in to eight general sectors “according to land value and spatial location” as shown below. This was used to help in identifying where people currently live and where they would be prepared to live based on various factors.
Respondents were asked to identify the relative importance of 58 features grouped across five categories without considering any constraints. The five categories are:
- Convenience and access (14 features)
- Proximity to facilities (9 features)
- Local environment (9 features)
- Property features (13 features)
- Dwelling features (13 features)
Each feature was ranked as either ‘very important’, ‘of some importance’ or ‘not at all important’ and then they had to pick the top five of the ones they ranked very important. That resulted in this outcome for the five categories
The top 15 individual features are shown below. As you can see a safe neighbourhood is by far and away the most important thing while a standalone dwelling is just over half as important. I was a little surprised that none of the amenity (proximity to facilities) featured in the top 15.
Below are how the respondents rated features in each of the categories – remember these rankings are without any constraints.
The second stage of the survey looked at what happens when a financial constraint is added in. Key findings from this were:
- Almost half of the respondents (47%), when faced with a set of housing options that they could afford, chose a final housing option that was within the location that they had initially preferred. The match between initial preference and final choice is strongest for Sector 2 (Auckland Isthmus), Sector 3 (North Shore Coastal) and Sector 7 (East Auckland).
- There was a difference in final location choice according to whether people were buying or renting. Buyers selected final housing options across all eight sectors while 75% of renters made a final choice in three sectors: North Shore Coastal, South Auckland and Auckland Isthmus.
- The choice of housing types strongly favoured medium (61%) and large (26%) sized dwellings as defined by bedroom number, with renters showing more acceptance of medium sized dwellings.
- Detached dwellings were the final choice of just over half (52%) of all respondents. This preference was similar for both buyers (54%) and renters (50%). Interestingly, the choice experiment shows that there is also a strong preference for other typologies, with 25% of respondents picking an attached dwelling (joined unit), 15% selecting low rise apartments and 8% selecting high rise apartments.
- Just over half (51%) stated that their final housing option reflected the actual housing choice they would make, if they ‘planned to move tomorrow’, while almost one in five (19%) selected ‘don’t know’. A smaller but nonetheless significant proportion indicated that the final option did not meet their housing preferences (30%).
- In general, following the choice exercise, respondents reported that dwelling value and house type were of more importance in their decision-making process than was location or dwelling features.
The table below shows the results of the once costs were considered. The numbers in green show the 9% who would move to a more expensive area after considering the implications. The blue is the 47% would stay in the same area they were in and the red represents the 40% who would shift to lower priced typologies if they were available. As you can see the isthmus is the preferred option followed by the coastal North Shore and East Auckland i.e. coastal areas.
The report highlights that there is clearly a mismatch between what housing stock exists, what is being currently being consented and what people would choose if it were available. They say the idea of high density in the city centre and low density elsewhere doesn’t match the preferences shown in the study highlighting that we need more dwelling options in a lot more places. The question is whether our future planning laws will allow for that.
In particular what we need is the missing middle
Of course those boomers who think no one wants an apartment and that everyone wants a stand alone house refuse to believe it and continue to spout that it’s the council’s fault for not allowing unlimited sprawl.