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Opinion: Local govt. failure led to speculative property behaviour
July 6th, 2009
By Hugh Pavletich
Within this recent New York Times article Fair Game – So Many Foreclosures, So Little Logic , a report from the United States Comptroller of the Currency, indicates that there is promising data regarding loan modification trends in the United States.
However – research by Assistant Professor Alan M White of the Law School at Valparaiso University, of 3.5 million Sub Prime and Alt A Wells Fargo mortgages written between 2005 and 2007, seems to paint a different picture – indicating that modifications are declining.
The average monthly payment adjustment for modified mortgages was found to be just $173. This would suggest the loan modifications are a “sideshow” – at best.
In June, the data show almost 32,000 liquidation sales: the average loss on those was 64.7% of the average $223,000 loan balance – or a loss of $144,000 each – up from 56.1% loss of the loan balance last November and 63.3% in February this year.
Belatedly, international discussion is occurring of the New Zealand and Australia housing markets and the Banking institutions ability to cope – refer Analysis of Australian Bank Fundamentals — Seeking Alpha
Housing bubbles are a local issue - as clearly illustrated by the Annual Demographia International Housing Affordability Surveys (2009 5th Edition) of the 265 major urban markets of the 6 English speaking countries and the Harvard University Median Multiple Tables.
The latest Demographia Survey illustrates that of the September Quarter last year, the Median Multiple nationally of the major urban markets overall were – the United States 3.2; Canada 3.5; United Kingdom 5.2; Ireland 5.4 with New Zealand 5.7 and Australia 6.0.
If housing exceeds three times annual gross household income it is in bubble territory.
For example, housing prices bubbled out to around 9 times annual household income in California (the ‘epicenter’ of the Global Financial Crisis), while there were no bubbles in Texas, where housing stayed at around 2.5 times annual household income.
To maintain market share, financial institutions’ mortgage lending had to reflect the Median Multiples of the housing markets they competed in.
The size and structures of the mortgages simply had to reflect the Median Multiples (house prices divided by the household incomes) supporting them.
To illustrate, it would appear (from this City Data – LA sample insured mortgages – refer bottom of page) that average conventional insured mortgages in Los Angeles during 2007 was $403,000 – with refinancing mortgages around $430,000. Indeed – Herb Greenberg in Mortgage Mess illustrates how lending in California ballooned out to 11 times annual household earnings, where for example those with a gross annual household income of $90,000 were borrowing a million dollars.
In contrast, let’s consider Houston (City Data – Houston – sample insured mortgages – refer bottom of page and Houston Association of Realtors latest Monthly Report) where it would appear that during 2007 average conventional insured mortgages were $143,000 – and refinanced mortgages $139,000.
It appears that financial institutions in Australia are currently lending 5 to 7 times annual household earnings and in New Zealand, in the order of 4 to 5 times annual household earnings. These are well above the historical norm and current affordable markets, where housing does not exceed 3.0 times household earnings, requiring mortgage debt loads of around 2.5 times annual household earnings.
To date, economists, property commentators and the media generally have failed to ask two extremely simple questions:
Firstly – why were the sizes of the mortgages in Houston substantially lower than they were in Los Angeles and other bubble markets globally?
Secondly – what are the real costs and consequences of lending in to housing markets, where there are artificial regulatory scarcities in place, as a necessary foundation for speculative bubble behavior to get underway?
Put simply they could not write $400,000 mortgages on $150,000 houses in Houston.
Yet too many economists “put the cart before the horse” in suggesting the finance sector is responsible for the housing bubbles in certain markets globally – when this is clearly not correct. The finance sector simply provided the debt finance “fuel” – investors and speculators the rest with often ‘bubble equity”.
Clearly, Local Government failure put in place the artificial scarcities, allowing speculative bubble behavior to get underway. Local Governments have been deliberately starving land supply on the fringes of our cities for years – indeed decades – where now in Australia and New Zealand for example, people are forced to pay $200,000 through $300,000 for fringe sections/lots when they should only be paying $30,000 to $60,000.
These artificially inflated fringe section/lot prices are just a nonsense that must be dealt with as soon as possible.
__________
Hugh Pavletich, FDIA
Performance Urban Planning
Christchurch, New Zealand
Tags: Demographia, Housing, Hugh Pavletich, Income, Local government, Performance Urban Planning
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July 6th, 2009 at 1:17 pm
Hugh is quite correct in targeting the insane price of snotty little plots even in ‘blink and they’re gone’ towns, but if he expects they will “be dealt with as soon as possible”,
then sorry Hugh but no hope of that. The last thing the RBNZ would want is for the banks to be faced with massive losses on dumb lending. Ditto the fools in the Beehive, who will bend over backward to ensure property remains unaffordable. If this were not the case the RBNZ would implement policy rules at midnight to impose lending criteria that froze mortgage finance to no more than 3 times the national annual household earnings and put an end to second mortgage finance on any property. In a matter of two weeks property prices would collapse and families would be able to buy them.
July 6th, 2009 at 1:21 pm
Hugh, I always like your logic and agree house prices are over valued how-ever if cheap sections and housing came available undermining existing bank mortgages shorely this would lead to banks collapsing just like the US and Briton.
I’m not saying that this would be a bad thing but it would certainly cause chaos.
July 6th, 2009 at 1:36 pm
Hugh,
This is apples and oranges analysis. Letting NZ’s pancake citys spread out further by making available cheap fringe sections is simply not practical (or desirable). Take a look at Auckland (already absurdly spread out) and Wellington’s topography and have a quick compare with Texas.
It’s the lack of consents to build upwards that’s the issue. Frankly anytime anyone trys to build up the clamour from the affected neighbourhood is so loud consents become practically impossible to obtain.
July 6th, 2009 at 1:44 pm
Hi Hugh
I support your premise about housing being “over-valued” – particularly older housing. But I feel I’ve read the same article a number of times – 2.5x h/h income is affordable, higher is a bubble. What I’d like to debate is why 2.5, and what is the possible way forward?
Is it all about the staring point in housing, or the average debt to income?
I have a h/h income of $100k, a mortgage of $250k is managable, but $400k isn’t. So an older house in a less desirable suburb may be my lot for a first house.
But later down the track I have a house that will sell at $250k and a mortage of $100k. I sell and buy at $400k, my debt:income ratio is $250k:$100k still, but my income:house price has shot up to 4.
The argument in point one above is an important argument about the marginal purchaser. But, as above, they would purchase at 2.5x or $250,000, and may buy a more expensive house later, or stay in place and save as income increases or themortgage falls relative to income.
The second question is possibly about land, but also about material supply monopoly/duopoly, building productivity and lack of scale. I get the economic analysis, but the soluton is necessarily political. What is your political path to reform land supply?
July 6th, 2009 at 2:17 pm
What about the argument that as a city spreads outwards speculators cream off the increase in land value and that increase could have gone towards providing new infrastructure (land tax argument)?
Another thing to think about is that between 1990 and 2004 the population increased by 21% (mostly through migration) and while migration increases GDP the effect on per capita GDP is “equivocal” according to a recent treasury paper……….. so whugh is creaming it (whose made all the money -own up now!)?
July 6th, 2009 at 2:19 pm
I have just read the report in The Herald about Brit expats being given the bums rush by the immigration dept. Am I wrong in expecting National to play the immigration card to pump the economy! Or is this more a case of the dept officials not yet being told what the real policy is. No doubt the word doing the rounds in the UK will be ‘bugger New Zealand’ Not a good time to wear ones ‘I’m a Kiwi’ T shirt in the UK.
If I have been wrong, it may signal an end to the humbug that property prices will be supported on a wave of immigration. Anyone have a clue what’s going on?
July 6th, 2009 at 2:36 pm
Wally,
I’m pretty sure unemployment is rising here.
Given that, I’m not sure why there would be loads of migrants. They can’t retire here. They need a job. In fact with the work visa problem, it seems more likely more will be leaving than arriving.
I guess that means house prices will be going down LOL
July 6th, 2009 at 3:34 pm
I agree that property is way overpriced and have no doubt that land-use restriction helps keep the price high but I’m in agreement with Mitch above that relaxing zoning in New Zealand is not the solution.
In Auckland it would lead to nothing but further sprawl and motorway carparks.
I don’t believe that objection to sprawl is just some commie pinko leftist scare.
The end of cheap energy (aka peak oil) is coming soon whether one chooses to believe it or not. I think that discussions about how and where we live we need to at-least take into account the real likelihood of peak oil.
July 6th, 2009 at 4:34 pm
Just responding to some of the points made above -
1) There is ample land supply in NZ with just 0.7% of our land area urbanised. We are actually burning up more land with splatter forcing people out to rural areas and outlying times. This i, turn forces people in to heavy transportation costs. You may like to go to my website and read “Land Use Mythology” for further discussion of this issue.
New Zealands land area with a population of about 4.3 million is about the same size as the United Kingdom with 61 million people and Vietnam with 85 million people. We are very lightly populated.
2) Openning up fringe land supply impact on rest of housing market. Even if this happened – it would likely take 10 – 15 years to bring our housing back to affordable levels. Prescriptive planning has degraded our construction performance so badly – refer the article on my website “How prescriprtine planning degrades construction prtoductivity” for further information on this serious issue.
3) I will be most interested in learning in due course what the New Zealand Government puts in place – to assist Local Authorities to appropriately deal with long term infrastructure financing. This is really the major reason Local Authorities giot in to difficulties – and thus created the conditions allowing these unnecessary housing bubbles to get underway.
4) Forcing people in to dense developments. There is a saying – preference always trumps policy – and in this regard, there is no way Kiwis will be forced in to for example the British style rat hole developments. Hell will freeze over before that happens. And further to this – there is no reason whatsoever why Kiwis cant have good quality housing thats affordable and meets their (not what some wise guy thinks they need) needs.
Hugh Pavletich
July 6th, 2009 at 7:36 pm
Hugh -thoroughly agree with your 4th point about the dense developments.
Your article needs more analysis of this question:
“Firstly – why were the sizes of the mortgages in Houston substantially lower than they were in Los Angeles and other bubble markets globally?”
A better question would why was there such a difference in the lending/annual household income ratios between California and Texas?
And can you be sure that that data used has been matched for demographics?
July 6th, 2009 at 8:01 pm
“NZ with just 0.7% of our land area urbanised”
those sort of figures need a lot of qualification.
“there is no way Kiwis will be forced in to for example the British style rat hole developments. Hell will freeze over before that happens. And further to this – there is no reason whatsoever why Kiwis cant have good quality housing thats affordable and meets their (not what some wise guy thinks they need) needs.”
I wonder what Jane Jacobs would say of the “rat hole” developments. I had an old neighbor who used to go weepy (homesickness) when he saw Coronation Street (and what about new urbanism)?
The people who settled Christchurch were high minded people who set aside hagley park when there were only about 500 people living in the district but those values have been sold out to a more merchantile bunch.
Business interests lobbied government re changing the rules around foriegn ownership and migration and as Gareth Morgan has pointed out it has been a (“third world solution)” to drive our economy. Much of Christchurch has ugly infill, an old house jazzed up and a new one down a drive. You could blame zoning but you could also blame greed. I recall a prominent lawyer (about thirty years ago) saying “the thing to do is buy a corner section and subdivide it”; (these people don’t give a s***t). Christchurch reeks of cheap and nasty profit driven developments which have externalized costs which last for lifetimes. The idea that market forces produce good urban infrastrucure is disproved in Christchurch. We need the “wise guys” who care beyond their back pocket
July 6th, 2009 at 8:04 pm
Most of Auckland is the same…
Lots of the Chch houses will be reclad soon.
July 6th, 2009 at 8:06 pm
jh, you think ChCh is ugly, come to Auckland!!!
In fact I was in chch recently and marvelled at the standard of architecture compared to Auckland
but maybe all that proves is Auckland is rubbish and Chch is just a bit better
July 6th, 2009 at 8:21 pm
Wally where did you read that article? i would love to read it, i knew all along that was going to happen..
July 6th, 2009 at 8:38 pm
Trev, maybe the memory of the the Savings & Loan collapse in Texas in the late 80s / early 90s may have had something to do with bankers behavior in Texas as opposed to the rest of the US. The epicenter of the S&L collapse was Texas.
http://www.dallasnews.com/sharedcontent/dws/bus/stories/072108dnbusBankCrash.76a5c90e.html
So the bankers in Texas remembered it all going pear shaped during a previous boom. I wonder what the bankers in California were thinking…
July 6th, 2009 at 8:48 pm
Trev – yiou are quite right about the quality of information regarding mortgages and foreclosures in the United States. This City Data informatio was the best that I could find at this stage – with these large sample mortgages in LA and Houston. I suspect they are a likely fair reflection of the average size of the mortgages for both these cities in 2007.
Its a truly massive difference $400,000 for LA – just $140,000 Houston. They sure love being mortgage slaves in California, New Zealand and Australia. No wonder the ANZ Bank has convinced itself there are sufficient houses in New Zealand. They would be petrified to see average size of house mortgages at $NZ140,000.
I was amazed to read that the average loss of mortgage balances for foreclosed housing in the USA is about $140,000. I recall reading siomething Prof Robert Shiller wrote earlier in the year suggesting the average loss wasin the order of $80,000.
July 6th, 2009 at 9:17 pm
Gibber – thanks for that. It makes more sense now.
July 6th, 2009 at 9:25 pm
Too right we don’t want to live in high density environments, that’s why there are no kiwis to be found in the inner suburbs of Sydney and London.
But seriously, this complaint that we must be allowed to sprawl is shortsighted. Firstly, there is plenty of vacant land being wasted within the existing metropolitian urban limits, particularly in those cities where the council gives land bankers a free ride by putting rates on things other than land value. More importantly, removing the artificial limits to sprawl only allows us to approach the unavoidable physical limits more quickly. What then? The amount of land available to live on within X of A will never be more than pi times X squared. You can go and live in a city which has filled in that entire budget without parks etc. if you like. You will find many in China, maybe Texas too. Enjoy.
Even so, I would be happy to scrap the MUL and other artificial controls on sprawl if we also removed the opposing distortions which make them necessary by encouraging sprawl. Those distortions include height controls, but most importantly the fact that we let landholders keep the increase in the “capital” value of their land, even though such increase in value is due to population growth, investment in infrastructure by government and neighbours, and changes in zoning, none of which reflect any effort or sacrifice on behalf of the landlord. If speculators didn’t have such a massive incentive to get their land rezoned for housing (and to lobby to make that easier) they wouldn’t do it.
July 6th, 2009 at 9:41 pm
good points Ghost
By the way, great name!:)
Hugh – what progress are you making with govt? You have rambled on re: the same points over and over for months and months. We want to actions not just words!!!
July 6th, 2009 at 9:48 pm
With all due respect, you are talking crap that new section values should be only $30,000 – $60,000.
Hugh – do you have any idea of what the development process is with respect to providing utilities, consultant’s designs, contractors etc. to achieve a new titled section and what these costs are?
Here is a run-down for a simple Mt Wellington sub-division section in Auckland;
Subdivision costs are as follows:
a) Survey Fees – $8000.00 plus GST
b) Council Fees – (Processing 223, 224 c Certification – $3500.00 plus GST
c) LINZ Fees – (Survey approval for two (2) lots) – $400.00 incl GST
d) Legal Fees (Two (2) lots solicitor’s fees) – $2000.00 plus GST
e) Development Contribution (estimate) – $23000.00 plus GST
f) New Vehicle Crossing (Construction plus Council fees)- $4300.00 plus GST
g) ROW easement (Constr, design plus Council fees) – $9500.00 plus GST
h) Soak holes (Drilling , plus engineer’s soakage report) – $4000.00 plus GST
i) Private Drainage – $12000.00 plus GST
j) Provide water, electricity and telephone connections – $9000.00 plus GST
k) Allow a 10% contingency – $7600.00 plus GST
Total Estimated cost – $83,300.00 plus GST
This estimate is from a registered surveyor.
Now, assuming the land is free, your labour and risk is free, and you have no holding costs, how the hell can you possibly achieve a section for less than circa $100,000.
So to achieve a section value of $30-60K please tell me how you get the above costs down by 50%?, and how you get free large parsels of land in the first place, with no holding costs?? And for no profit!
Fringe sections costs $200-300K throughout NZ for a reason and it has nothing to do with the Council’s keeping a tight control on land. In Auckland there is a surplus of cheap sections for sale – just look on Trademe at all the mortgagee sales out south, Albany and out west. You could buy thousands of sections tomorrow if you wished!
If you can find land for under $100K, I suggest you buy it, because you are getting it at less than cost!
July 6th, 2009 at 11:48 pm
Paul Miller – Fascinating numbers!
Now why dont you put up the Texas numbers as well – where new starter houses on the fringes of 235 square metres on 700 sq metre lots are being sold for $US140,000 – $US110,000 for the actual house construction and $US30,000 for the service lot. Normal markets should have Development Ratios of 17 – 23% serviced lot – the balance house construction.
Fringe manufactured housing of 160 sq metres on large lots for $US73,000 – $US20,000 for the serviced lot and $US53,000 for the manufactured house.
The numbers for subdivisiobn costs you outline above are “bubble pricing” – created by decades of prescriptive planniing degrading the performance of the New Zealand residential construction sector.
It sure is going to take us many years to wind our way out of the current mess to restore the construction industry to international affordable performance standards.
Matt in Ak – Dont underestinate the big job it is to sort these issues out politically.
July 7th, 2009 at 8:18 am
Hugh – the only “bubble pricing” is the development contribution which is a council tax or rates subsidy (depends on how you look at it – if everyone paid ’say’ $200 more in rates a year, the cost of sections would come down $20K)
For all the other costs to come down, people will need to chare less for their services, work for less salary or become far more efficient at their jobs. Alternatively we could build new houses that don’t require concrete driveways and concrete vehicle crossings?
July 7th, 2009 at 9:06 am
UCLA economist Edward Leamer believes you can calculate P/E ratios for housing by dividing the median home price in cities by the annual rent for a two-bedroom unit. He uses this formula to track trends in cities. Perhaps someone could try this method to determine whether or not we are in a bubble?
A real estate boom in Dallas in the 1970’s almost bankrupted Texas. The State passed The Homestead Act afterward that limited debt to equity lending to 80% of home value. This made the Texas market unattractive to speculators. Municipal rates in Texas are higher than those in Nevada, California, Arizona and Florida. This discourages the growth of sprawl.
July 7th, 2009 at 10:04 am
Houston a lanky adolescent?
Like many neighborhoods inside Loop 610, Cottage Grove in recent years has experienced a flurry of construction of large townhomes that loom over 80-year-old cottages next door. Two or three dwellings crowd sites where one house stood previously. Streets are cluttered with vehicles parked every which way. Water stands in the streets after heavy rains.
“It was shocking to see this jewel of a neighborhood in this condition,” said former Pittsburgh Mayor Tom Murphy, a senior fellow with the nonprofit Urban Land Institute who toured Cottage Grove two years ago. “It was about the ugliest thing I’d ever seen, to be honest with you.”
The issues in Cottage Grove and other central Houston neighborhoods are on the minds of city officials,
http://www.chron.com/disp/story.mpl/metropolitan/6502059.html
July 7th, 2009 at 10:30 am
This is a better approach than a CGT:
The State passed The Homestead Act afterward that limited debt to equity lending to 80% of home value. This made the Texas market unattractive to speculators. Municipal rates in Texas are higher than those in Nevada, California, Arizona and Florida.
We already have the high rates.
July 7th, 2009 at 10:48 am
Paul Miller – thank you for your comments regarding subdivision costs. Bear in mind historically – these are well known Development Ratios for normal markets – that sadly have been severely distorted by decades of prescriptive planning, degrading the performance of the construction industry.
May I suggest you, your QS and other readers research the actual breakdown of subdivision costs in Texas and other affordable North American markets directly. As a first step it is worthwhile obtaining a copy of the standard US Construction Cost Handbook R S Means via Amazon or wherever. Bear in mind these numbers are inflated above market.
Better still encourage construction cost people in Texas to post comments on this website.
Note too – Development levies are a nonsense – and in Texas Municipal Utility Districts as vehicles for bond financing of infrastructure are employed. Generally all services other than the roading are paid for by bond financing – and homeowners pay the cost of the interest charges within their rates / property taxes. Very sensible – as those who own the assets are responsible for the long term financing of it.
The Government has already stated it intends to focus on proper infrastructure financing – and I would expect announcements from them before long on how the appropriate infrastructure financing is put in place in this country.
Hugh Pavletich
July 7th, 2009 at 10:58 am
All readers – the title for this article appears to have thrown some off what the main theme of it is. It had originally gone out as “Housing Bubbles: Economists ‘cart before the horse’ problem” – and had been changed at interest co nz – which of course is just fine.
The main theme is that the debt financing mirrors the specific market pricing – which I illustrated with the contrasts of Houston and LA. Its land use regs that determine pricing NOT Banks as such. If it was the latter – both Houston and LA pricing would be the same.
I am staggered by the hits the US Banks appear to be taking on the foreclosures.
I will not be able to respond to comments going forward as I will be away from email contact for a while. I do hope you all keep this important discussion rolling along.
All the best guys
Hugh
July 7th, 2009 at 2:56 pm
Doug said:
“A real estate boom in Dallas in the 1970’s almost bankrupted Texas. The State passed The Homestead Act afterward that limited debt to equity lending to 80% of home value. This made the Texas market unattractive to speculators.”
Interesting point – you obviously know a bit about Texas Doug.
Perhaps that regulation has been just as critical, if not more so, than the limited planning regulation in keeping housing affordable in Texas????.
July 7th, 2009 at 3:08 pm
Trev, Doug, Matt in Auck – yes, Texas, living proof that the OCR needs a mate in the guise of a credit volume control. As for CGT/LVT, that’d still useful for other reasons, ie, further rebalancing investment behaviour and rebalancing taxation, as BH found from IRD, including such in the tax mix could bring us to a flat 23% – something to look forward to eh?
July 7th, 2009 at 3:08 pm
“The Homestead Act” now that’s what we need Matt. Only not just an 80% loan limit. Throw in a maximum total sum limit at 3 times the average annual income with no second mortgages allowed. That would limit loans to about $150ooo! What would it do to the property sector????
July 7th, 2009 at 4:46 pm
Carefull Matt you might end up taking Hugh horse away, without Dallas Texas his argument that we can vomit suburbs up on the fringe without consequence starts to look a little shakey(er)
Neven
July 7th, 2009 at 6:44 pm
Doug,
do you have a link for that. When I google “The homestead act” I get a plethora of links to an act from the 1800’s where settlers could get a Ranch.
July 7th, 2009 at 8:39 pm
Yeah good point Gibber I got the same
Doug if you could oblige I’d be grateful too
July 7th, 2009 at 10:04 pm
I put a note on http://www.dallasnews.com, hopefully we’ll soon get input soon from Texas direct.
I for one have difforcuilty understanding the need for all the fees, which Paul Miller, explains add up to about $83ooo. The development costs in both countries should be the same. As a house is a house.