By Ryan Greenaway-McGrevy*
Property in Auckland is amongst the most expensive in the world when measured relative to what you can earn there. The average house is selling at ten times the average annual household income. That’s more expensive than London, New York or San Francisco.
To their credit, the Auckland Council has set itself a target for housing affordability. It wants the average price of a dwelling to be priced at five times the average household income by 2030. That seems reasonable. But at current income levels, that would require house prices to halve. Former Reserve Bank Chairman Arthur Grimes agrees, recently calling for a forty percent reduction in house prices.
In contrast, the stated policy target of our government is slower house price inflation. That is not good enough. If house prices do not come down, incomes must at least double to make housing affordable again. That is simply not going to happen anytime soon.
Let’s do a quick back-of-the-envelope calculation to understand why. Suppose that house prices stood still, and that nominal household incomes grew at 3% per year, which is slightly higher than the 2.7% average rate of general inflation since 2000. It would take about twenty-four years for nominal incomes to double. That would lock a generation out of the property market. (And that is with an optimistic inflation rate; there are significant deflationary pressures in the global economy that could be here for the long term.) Another way to look at it: If house prices stay at the levels they are at now, household incomes would have to grow at about 5.1% to hit the Council’s target by 2030. Unless we strike oil in the Hauraki Gulf, that is just not going to happen.
The calculus is inescapable: House prices have to halve. They have to go back to 2006 levels. That is a difficult reality to come to terms with. And it will be even more difficult to actually achieve.
We often see demand-side policies tabled as a solution to the problem, and I think all cards should be kept on the table. But it is clear that only the most heavy-handed of these policies would do enough to cut prices in half. Banning or taxing foreign investment would not do it, and this is probably not a realistic option anyway. Drastically reducing immigration or implementing a proper capital gains tax would not be enough. Even a low and broad land tax would not be sufficient: The Tax Working Group estimated that a one-percent land tax would bring down land values by only 17%.
The only demand-side policy that could do it would be to ban private investment in housing, full stop. This would ensure that demand for housing would be determined by what people can actually earn living and working in Auckland. Housing New Zealand would have to pick up the slack, buying-up the forced sales and renting them to the people who cannot afford property even at rock bottom prices, or who otherwise prefer to rent.
Like I said: only the most heavy-handed demand-side policy would actually cut prices in half.
It is possible that some combination of the more reasonable demand-side policies would succeed in bringing down property prices by fifty percent. But such a policy would be quite reckless, and possibly push the economy into recession. It would come at a huge cost to those who have diligently used housing as a savings vehicle. And it would also push the mortgage on many recently-purchased homes underwater. That is a terrifying prospect for many families, because it massively increases the downside of involuntary unemployment for the breadwinner(s). Moreover, the reduction in household wealth would likely cause property owners to cut back on spending, lowering economic growth, and exacerbating the risk of recession.
Any policy that caused property prices to halve would not be fair to these groups of people. But the status quo is not fair to prospective home buyers either. The only policy option that is fair to both groups is to increase urban density.
To understand why, first note that there is a distinction between the price of a property and the price of a dwelling. With increased density there will be an increase in new dwellings supplied to the market, putting downward pressure on dwelling prices. But this does not mean that the price of property has to fall. Property that can be redeveloped under the relaxed density restrictions will retain its value: You can always bulldoze the villa and build two homes that make better use of the available space. That option to redevelop will be capitalised into the value of the property – and could in fact increase property values – provided that the unitary plan grants the right to redevelop.
Which brings us to the crux of the issue.
Increasing urban density is the only policy that ensures that both current and prospective home owners can win. Any other policy – including the status quo – will punish one of these groups. With increased urban density the average price of a dwelling will come down – allowing families to purchase a home at a reasonable cost – but the price of developable property will retain its value – ensuring that many current property owners won’t lose on their investment.
Property owners that oppose increasing urban density in their suburbs should be aware that properties that cannot be redeveloped could fall in value once the supply of dwellings increases. If they are not comfortable with a capital loss, then they should be lobbying for greater density in their neighbourhood – not opposing it.
Some will argue that young Auckland families should forget about home ownership and get used to the idea of renting. Perhaps. But there are, however, substantial benefits to home ownership that should not be glossed over. But more importantly, rents are only going to follow house prices up. That puts further pressure on household budgets.
There will be other costs to increased density that everyone in Auckland will have to bear. More traffic. Upgraded infrastructure. Loss of character neighbourhoods. But with sensible urban planning some of these costs can be mitigated and, more importantly, shared across all the residents of Auckland – and not heaped onto the people living in lower socio-economic neighbourhoods.
And to be frank, the time for gripes over traffic and loss of character neighbourhoods is over. Next time you are stuck in rush hour gridlock, just be thankful that you have a home to get to, and that you won’t be spending the night in your car. Auckland desperately needs more housing.
The current version of the unitary plan does not go as far as the version that was voted down in February. But it still allows for big increases in urban density. The Auckland Council will decide on whether to go ahead with the current version of the plan next month. The time has come for the Council to do what is right.
Dr Ryan Greenaway-McGrevy is a senior lecturer in economics at the University of Auckland Business School