By Chris Parker*
Auckland’s housing market still dominates’s debates, and it has even been described as “the major political issue of not just the year, but maybe of this decade”.1
The issues are two-fold: sustained inequality, and macroeconomic instability (i.e. the risk of a rapid house price deflation that harms the wider economy, with significant social consequences).
The inequality risks are well articulated in Shamubeel and Selena Eaqub’s new book Generation Rent.2 They argue New Zealand is at risk of creating a class structure of families that are ‘haves’ and ‘have-nots’ that could echo through generations.
Many families forced into renting also don’t have the same security of tenure and implicit retirement saving that home owners do.
Possibly not a bubble yet, but we’re not far from it
I suggested in the March Auckland Economic Quarterly that one stylised reason that Auckland’s house prices are high (as well as high relative to rents and incomes) is because future capital gains are capitalised into land prices now. Those gains are not because rents will rapidly escalate, but because existing land can be redeveloped to accommodate high levels of growth in the coming decades. And more density means more potential revenue overall to each section of land – this potential is being priced in now.
We had NZIER run some numbers to test the above idea, and their results support this – at a stretch.3
Without development and intensification, house prices seem about a third over ‘fair value’ (fair value is the total present value of future rental income). But that gap could possibly be explained by land owners anticipating that:
a) housing can be intensified as per the Proposed Auckland Unitary Plan as notified (‘the notified Plan’), which alone would halve that overvaluation; and
b) the cost to build homes will reduce by 10-15% (that is, people might be anticipating average annual productivity gains of one percent per annum over the next 10-15 years); and
c) the council can minimise risk and uncertainty to developers and builders; and
d) intensification will be modestly greater than the notified Plan (because the final may have more, or because developers will seek resource consent for them anyway).
All of these factors that the market may be anticipating would need to be realised in order to minimise the risk of unwanted and painful rapid house price depreciation. It would require the public sector to work very hard. Undue costs, risks, delays and barriers to development and construction need to be overcome.
There are still risks of a bubble for various reasons that need careful management. For example: the prices in housing markets tend to overshoot the sustainable price; some of the redevelopment potential may not be commercially viable; the building productivity gains the market seems to be anticipating may not be likely; and the rate of construction might be surprisingly slow.4
Achieving this scale of development and intensification will help housing affordability in future by increasing the supply of homes generally, and by increasing the volume of lower priced attached dwellings specifically (this is despite actually increasing land prices, which is good for current owners too). Intensification will not only benefit younger generations by providing them more affordable homes closer to where they work and play. It will also help older people in retirement to cash in on their wealthy properties and to live in a downsized modern home without needing to move away from their community.
The Treasury5 also thought it was possible to explain Auckland’s high house prices, but with a different approach. The Treasury’s calculations are based on the assumption Auckland would not sort out its supply issues and that interest rates would stay at record lows (they too warned of the risk of a housing bubble).
Debate on demand side measures
There is a lot of debate on tools to address the demand side as well. A key question is whether foreign investment in Auckland property should be restricted. Australia, for instance, allows foreign ownership only for new dwellings bought off the plan from developers.
It has been suggested that the Free Trade Agreements we have with other countries prevents any policy that singles out foreigners for restrictions. To help us to understand the full package of measures to tackle Auckland’s house prices, we asked NZIER’s trade specialists whether it is true that it is a non-starter.
Their advice was that it might be technically feasible (although it is not clear), but it would likely be difficult and risk significant diplomatic and economic costs. Where any recent agreements treat investment more liberally, these concessions automatically flow through to most of our existing agreements. These agreements most likely do prevent New Zealand from specifically restricting foreign investment in any meaningful way, and in particular prevent New Zealand restrictions on investors from individual countries.
Why can Australia do this whilst also having Free Trade Agreements? They preserved policy space to allow them to impose measures that are excluded from the usual provisions of their agreements that relate to treating foreign investors the same as Australian investors. Why didn’t we do the same? That probably relates to the facts that we did not already have such policies, and that we were already on the back foot with the number of concessions that we could bring to the bargaining table. After all, New Zealand is a small open economy that is already largely free of tariffs and not strongly aligned to defence treaties.
Remember though that these Free Trade Agreements are the products of multiple successive governments. They have meaningfully contributed to New Zealand’s relatively strong economic performance through the tough years in the wake of the Global Financial Crisis of 2007–2008.
There’s no shortage of wisdom on how to deliver
It amazes me how many people think that nothing can be done about Auckland’s house prices. It’s simply not true.
A range of publications have come out in the past two months on how to fix Auckland’s housing crisis: the Productivity Commission’s draft Using land for housing supply, the OECD’s Economic Surveys New Zealand, and Generation Rent. The Grattan Institute of Australia earlier this year released its book City Limits on the same topic (plus the Productivity Commission had already done a Housing Affordability Inquiry in 2012). Some of the key themes across these (with a little embellishment from my own unit’s work) include:
• The wider public sector needs to figure out how to make growth more profitable for ratepayers so that local communities can prosper from growth and development too. Both the OECD and the Productivity Commission talk about the need for councils to share in some of the tax take from the regional economic growth that is enabled. It would help fund needed infrastructure for growth, and help mitigate community opposition to redevelopment and intensification.6
• We need to economise on the massive amount of urban land we already have, and use it to its best effect. Auckland needs to treat its land like gold dust, and a little needs to go a long way. As well as making the size of the city bigger, there needs to be more dwellings like townhouses, low-level apartments, high-rise apartments where demand is highest (especially the inner suburbs). This provides more choices of lower-priced homes. It benefits current owners by realising higher land prices now.
• We all need to get the costs of building down significantly to change the development equation. This means:
° addressing regulatory distortions that make building firms small and fragmented. The largely atomistic industry structure in turn makes it really tough to achieve project management, quality assurance, upskilling, and scale efficiencies
° lower prices through the supply chain (e.g. by importing more building materials from overseas) and ensure product approval regulations are not excessively precautious
° right-size regulatory hurdles (health and safety7, design requirements etc, so that it is not the good intentions of regulation that dominate, but that benefits exceed costs)
° working with industry and the community to minimise sources of uncertainty for developers and builders (i.e. with resource consents and building consents) whilst maximising the scope for innovation and therefore productivity
° make the sector more attractive to builders and tradespeople to come to, or to stay in, New Zealand (by making building more productive and therefore pay better, and making sure their liabilities aren’t punitive). This will stimulate more competition and help address capacity constraints.
• The existing transport network can enable more land for housing if congestion charging is used to manage overuse
• prevent the network from boiling over through overuse
• support more housing supply from the transport infrastructure we have already got (i.e. we can consent more developments without needing to build more road capacity)
• fund alternatives such as public transport that allow greater transport choice to those facing the congestion charges
• give price signals to incentivise future developments to locate where accessibility is better
• provoke more people (because it’s more in your face) into challenging the quality of transport investment cases, and so to improve the quality of investment decision making.
These supply-side measures are only a sample of the things that could and should be done. Additionally some demand-side measures are needed to manage the emerging risks of a housing bubble, like the mortgage deposit requirements being taken by the Reserve Bank of NZ, and the new ‘bright line’ capital gains rule being introduced by the government.
This is a very tough problem, but the good news is that it is actually easier to figure out the solutions than some other tough challenges for governments like poverty and crime.
1. Dr Bryce Edwards, Political Scientist, Otago University, Q&A, TV1 14 June 2015
2. Eaqub, S and Eaqub, S (2015) Generation Rent: Rethinking New Zealand’s Priorities, BWB Texts, Wellington, New Zealand
3. Drew, A (2015) “The impact of intensification on Auckland housing valuations” NZIER report to Auckland Council
4. NZIER (2015) Quarterly survey of business opinion, July 2015
5. The Treasury (2015) Housing Options: Budget 2015 Information Release, 24 April 2015, treasury.govt.nz/publications/informationreleases/budget/2015/other-i-r/index. htm#revenue
6. This is a key point of the following new report too: Local Government NZ (2015) Funding Review 10 point plan: incentivising economic growth and strong local communities lgnz.co.nz/assets/In-background/LGNZ-Funding-Review-Full-17-July.pdf
7. For example, see NZ Initiative (2015) A matter of balance: Regulating safety. nzinitiative.org.nz/site/nzinitiative/files/A%20Matter%20of%20Balance_final.pdf
Chris Parker is the Chief Economist of Auckland Council. You can contact him here. This article was first published in the August edition of the Auckland Economic Quarterly. It is here with permission.