English bemoans effects of Council planning and infrastructure decisions on housing affordability and inequality; wants more clarity for Councils on infrastructure incentives

By Bernard Hickey

Finance Minister Bill English has given a broad-ranging speech on Auckland's housing affordability problems, focusing on the effects of Council planning and infrastructure spending decisions on house price volatility and inequality.

He also suggested delays in planning could create an eight year gap between a demand shock in Auckland and an eventual surge in supply, which had been shown to cause housing crashes in other markets.

The speech previewed a shift in Government thinking around the planning processes and incentives for Councils to build infrastructure needed for housing. Without specifying new funding models, English's speech was in line with the Productivity Commission's draft recommendations to consider allowing Councils to use congestion charges and other tools to pay for roads, railways and other infrastructure needed to support new housing. The Commission's final report is due next month.

Speaking to the Victoria University Business and Investment Club in Wellington, English pointed to the beneficial effects of regulatory and market changes in electricity that had recently led to the market working correctly.

"We're shutting down excess capacity, and excess capital is being withdrawn and returned to the owners of that capital. After years of litigation and legal contest over the rules, the energy market is now starting to work. Which brings me to the housing market," English said.

"This is probably the largest market in New Zealand where the rules need to be reshaped. The most evident indication of a problem is Auckland house prices. I’m yet to find a housing market anywhere in the world where prices go up at over 20 per cent a year without stopping and then starting to come down again. It may be that we are unique – but that seems unlikely," he said.

English said the housing market had profound effects on every household and how the Government was better understanding the planning process.

"The process probably looks unexciting to most people – something busy-bodies and councils do. But actually it’s the process by which one of our largest and most significant markets is regulated," he said.

English said the Auckland housing market had been the single biggest imbalance in New Zealand's macro-economic system, with the housing market there taking around eight years to respond to a shock to demand.

"In part that is because changes to council plans can take years, in some cases over a decade. Resource consents on a housing development regularly take 18 months, including pre-application times excluded from the official statistics. When combined, those very real delays can exceed the length of the house price cycle," he said.

'Poor planning drives big price swings -- up and down'

"The point is that when the supply of housing is relatively fixed, shocks to demand – like migration flows increasing sharply as they have recently – are absorbed through higher prices rather than the supply of more houses. Long lead times in the planning process tend to drive prices higher in the upswing of the housing cycle. And those lead times increase the risk that eight years later, when additional supply arrives, the demand shock that spurred the additional supply has reversed. The resulting excess supply could produce a price crash."

English said studies in the United States since the GFC had found that the most intensely regulated housing markets also had the highest house price volatility.

"That is, the steepest price increases and the sharpest falls are in areas where regulation is strongest," he said.

Rules that prevented cities from growing and prevented workers from moving to the biggest cities also created an opportunity cost of lost GDP.

"It's only relatively recently that economists and politicians have understood the scale of those effects. So when we're talking about something as apparently dry as the Auckland Unitary Plan, we're talking about a set of rules that will have a major impact on the city, on current and future residents – but also on the wider economy," he said.

'Poor planning worsens inequality'

English then repeated previous comments about poor urban planning being one of the biggest drivers of inequality.

"Poor regulation of housing has the largest proportionate effect on the lowest quartile of housing costs and rents. So when we're having the debate about whether there is sufficient land available, we have to recognise that the people who lose the most from getting that decision wrong – and who stand the most to gain from fixing those decisions – are those on the lowest incomes," he said.

"Income inequality in New Zealand has been flat for 20 years, but the gap between incomes measured before housing costs and after housing costs is growing. Housing costs are becoming a larger proportion of incomes – and that matters the most at the bottom end of incomes among people who have few choices."

English pointed out that the portion of new homes priced in the lowest quartile of prices had dropped from around 30% 25 years ago to only 5% now. There were parts of Auckland where no new houses were at the affordable end of the market.

'Poor planning favours insiders'

"Planning is often seen a public good activity that must address the needs of those who are most-vulnerable and have the lowest income. In fact there is a strong argument to say it does exactly the opposite. Poor planning favours "insiders" – homeowners – on high incomes and who have relatively high wealth," English said, adding  developers had told hime they needed to build a house worth NZ$600,000 for it to be commercially viable.

"That’s because it is difficult to build cheap housing on expensive land – particularly in view of the planning rules. Those rules include urban limits, minimum lot sizes which prevent subdivision below a certain size, and maximum site coverage rules which prevent a house covering more than a certain proportion of the lot," he said.

English said these higher housing costs were creating fiscal costs and political pressures for the Government.

'Govt subsidises 60% of all rentals'

The Goverment was now spending NZ$2 billion a year on accommodation subsidies through accommodation supplements to private landlords and rent subsidies to Housing NZ tenants. This meant 60% of all rentals were now subsidised by the Government.

"So these are the reasons why the Government pays attention to the housing market and issues stemming from poor planning," he said.

"For those among you who are economists, I would go so far as to say that while the justification for planning is to deal with externalities, what has actually happened is that planning in New Zealand has become the externality. It has become a welfare-reducing activity. And as with other externalities, such as pollution, the Government has a role to intervene, working with councils to manage the externality."

Costs of regulation identified

English pointed to studies showing rules setting minimum floor space requirements and minimum balcony requirements added NZ$50,000 to NZ$100,000 to the cost of an apartment, while the costs of minimum car parking requirements were at least six times the benefits.

"That’s a rule that should never have been made. It has probably cost the economy millions of dollars. Fortunately, now that we're digging in to these issues, that rule has been mostly scrapped – and credit is due to Auckland Council for doing so," he said, adding that the Metropolitan Urban Limit had also artificially inflated land costs.

English said Councils needed to better understand the costs and the benefits of their infrastructure decisions, given many decisions were currently contradictory, arbitrary and often driven by the tastes of individuals.

"Like central government, councils have historically made decisions on substantial long-term infrastructure projects with a minimal understanding of costs and benefits, and how the infrastructure will be supported over time. Like central government, councils do not always know a lot about their infrastructure. And therefore they don't know how to price it," English said, adding that pricing infrastructure was difficult.

"One of the big issues for getting a more-flexible supply of land is connecting the financing of the next piece of infrastructure with the value of the land it services. Land is made more valuable when it is serviced by infrastructure," he said.

'Change the incentives for councils?'

English said planners who believed infrastructure to support growth was too expensive, they would be reluctant to release land for development, either up or out.

"The funding base for councils is increasingly people on low fixed incomes. That is a product of an ageing population. So you can understand why councils are under pressure not to expand if they think an expanding city is going to push up rates for existing ratepayers," English said.

"Councils need clear funding models so that development worth having can occur and future homeowners and current renters who might want to buy are taken into account."

English did not specify how those funding models could be different from the current property rates system, but Local Government New Zealand has called for the Government to allow other funding tools such as congestion or user charges.

"If we better understand the economics of what is happening we can make better choices about housing regulation. And that depends on one of the most important parts of public policy, which is the institutional arrangements by which those decisions are made. That means looking at the incentives confronting an individual sitting in a council when making a decision about whether to allow a new subdivision," he said.

English referred to the upcoming final report from the Productivity Commission on the regulation of land supply that is due next month, without specifying its likely recommendations. Its draft report suggested

"We are seeing new thinking on a range of issues affecting housing, including from councils. Often politicians are accused of being focused on the short term. That’s one of the reasons this issue has never been dealt with properly in the past. The Government is taking a long term view."

The Commission's draft proposals included creating Urban Development Authorities with the power to compulsorily acquire land, making Government pay rates, using land values to calculate rates rather than capital values, adopting congestion charges, exempting foreign developers from the OIO and removing restrictions on apartment heights and the need to have balconies and car-parks.

It also suggested the use of targeted rates to pay for infrastructure, greater use of debt by councils and statutory controls on overly restrictive covenants on developments. It also suggested the greater use of debt by Councils to fund infrastructure.