House Prices in Auckland – the RMA scapegoat

HouseGraphCartoonOn 20 January, Environment Minister Nick Smith released brief particulars of plans to substantially overhaul the Resource Management Act (‘RMA’). His, and the Government’s position is this: the price of housing in Auckland is increasing because the supply of land is constrained by the RMA. If those constraints are removed, the supply will increase and the price will reduce, thus making housing more affordable.

With a focus on Auckland and detached dwellings there, that position will be examined by considering:

  • The main factors which affect both the supply and demand for housing
  • The influences which the Government can exert on those factors
  • Whether the Government is willing to exert those influences

Reports On Housing Affordability

Since 2008 there have been many reports on housing affordability, including:

Also relevant is:

The Housing Market, Housing Affordability and House Price Inflation

According to economic theory, prices in the housing market are set by the interaction of supply and demand. If a government provides housing directly to citizens, there is a level of demand by citizens and a level which a government is prepared to supply. But this is not a market, because a market requires multiple buyers and sellers, the definition of a market.

The market mechanism only determines the price. In doing so it makes no ethical statement, that is, whether it is fair or not, or whether it is affordable by anyone other than the buyer. So housing affordability is a social issue, not a market issue. It considers whether at the price set for a house in the housing market, who has the ability to purchase that house, and whether that is fair according to the ethical standards society determines from time to time through it’s government.

There appears to be no agreed-on definition for house price inflation. I am using the phrase similar to that for goods and services inflation ie. an increase in the price level of houses. Applying such a definition, house price inflation only means an increase in the price level of an unchanged house ie, the same product. The addition of a bedroom increases the price but is not inflationary – it improves the standard of the house. Home improvement is not inflationary, but it does make the home less affordable.

House price inflation mainly affects first home buyers because it reduces the purchasing power of their money, both to buy a house and to service borrowings. It also has a destabilising effect on the economy as the rate of inflation increases.

Housing as Three Products

Housing is a product which people live in, whether houseowners or renters.

Housing is also an investment product for owner occupiers, landlords, and speculators.

Finally, housing is a product whereby indirectly the houseowner acquires a collective share in the infrastructure of the city. The infrastructure is mostly used and paid for by the ratepayers and taxpayers of the city, but you don’t have to be a resident of that city to enjoy its infrastructure.

City infrastructure is owned by a variety of entities. Both the quality and quantity of the infrastructure contributes to the ‘attractiveness’ of a city and thereby impacts on the price level of housing.

The factors which influence supply and demand vary for each of these three products.

The Factors of Housing Supply and Demand

As already stated, the price of houses is set by the interaction of supply and demand. There are various things that influence supply and demand – the factors of supply and demand. This is stated in the HPU Report (at p.23) this way:

‘The trends in house prices are the net outcome of all the factors that affect supply and demand.’

Following this statement, the HPU Report provides a supply/demand diagram adapted from the Australian Productivity Commission:

SupplyDemandDiagramThe supply factor Costs of housing related infrastructure not only includes the capital costs related to a section, such as roading, services and development contributions, but also ongoing rates payments which contribute towards infrastructure capital and maintenance costs.

The level of household income is an important demand factor. Perhaps the third demand factor in the above diagram (Economic growth and employment levels) could be expressed as Economic growth and employment/household income levels.

Each of the above factors are discussed below.

(a) Availability of Housing Land/Land Release and Development Processes

Most of the housing reports consider the role of legislation in the supply of land. They clearly state that the legislation affecting supply is not limited to the RMA. In particular The Productivity Commission Report considers that the regulatory framework relevant to the supply of housing (ie. land, buildings and infrastructure), is mainly contained in the RMA, Local Government Act, Land Transport Management Act and the Building Act.

Appendix C of the Auckland Council Regional Policy Statement records that the Statement is issued under the RMA, but in doing so they are required to also consider other legislation which deals directly or indirectly with resource management. That other legislation includes 30 statutes, for each of which the Auckland Council has variable degrees of responsibility.

The influence of legislation on this supply factor is not necessarily clear or quantifiable:

  • The Metropolitan Urban Limit (‘MUL’) is a line drawn on regional planning documents to define the allowed extent of urban development. The Productivity Commission Report (see p.115 and Appendix C) maintains that the MUL in Auckland has contributed to land price increases by comparison of land just inside the MUL, to that outside the MUL. The HPU Report states (p.45) that they were unable to assess the impact of the MUL in Auckland and that other factors existed which would have driven up land prices irrespective of the MUL.
  • Another example is the Motu Report. It calculated that the requirements of the RMA added $15,000 to cost of a section in Auckland. It failed to assess the cost/benefit of this $15,000, or by how much it might be reduced. However, if that cost could be reduced by 75%, for a $750,000 house property that would reduce the price by 1.5% ($11,250), or for a $500,000 property by 2.25% ($11,250). Assuming that the whole of the cost reduction is passed on to a purchaser this is unlikely to create a downward trend in house prices when they are increasing annually at the rate of 10-15%.

The Government can influence the supply factor of Availability of Housing Land/Land Release and Development Processes by reform of all relevant legislation with an emphasis on the RMA, Local Government Act, Land Transport Management Act and Building Act.

(b) Cost of Housing Related Infrastructure

Auckland Council’s infrastructure is valued at about $35bn, comprising mainly of infrastructure relating to transport (roads, railways, bridges), water (drinking, storm and waste), buildings, and social and recreation facilities. It extends to owning the Ports of Auckland and a share in Auckland Airport.

Another portion of the infrastructure in Auckland is owned by the Government (ie. the Crown) relating to road, rail, education, health, recreation, sport, and law and order. Public companies and public/private entities own a portion too, mostly relating to energy and telecommunications.

When a person buys a house in Auckland they are essentially buying a share in this collectively owned infrastructure – this is part of the purchase price. If the house is new, they pay for a portion of the subdivision roading and services. They also contribute to the capital cost of additional city infrastructure needed for the house by way of development contributions. When they own the house they contribute to both the maintenance and development of infrastructure through their rates payments. And they contribute to Government owned infrastructure through their taxes.

In the housing reports, the proportion of the section cost to the building/dwelling cost in Auckland has increased by about 30% in 1970 to about 60% in 2014. Part of that may be attributable to land price inflation. But most of it may simply reflect that the share of Auckland infrastructure they are buying into has substantially increased in quality and quantity since 1970. This contributes to Auckland being an attractive place to live, but as the cost is borne primarily by Auckland houseowners, it does have an effect on housing affordability.

In respect of new houses, both the Government and Auckland Council can reduce the price house buyers pay for their collective share in infrastructure by considerably reducing subdivision development contributions. However if ongoing infrastructure improvement is to be maintained, the burden of this will need to be allocated to existing house owners.

There are various bureaucracies involved in the planning, design, building and maintenance of housing related infrastructure, with each bureaucracy contributing to total infrastructure cost. Bureaucracies invariably have their own legislation, depending on the form of infrastructure and the form of ownership. Reform of this multiplicity of legislation may result in a reduction in the bureaucratic component of infrastructure cost, but it involves more than just RMA reform. The Productivity Commission Report (at P.102) comments on this issue:

Planning must take account of the Local Government Act, the Resource Management Act and the Land Transport Management Act. These statutes have different legal purposes, timeframes, processes and criteria. With multiple participants and decision -makers, there is no single mechanism for facilitating engagement, securing agreement among participants and providing information for robust decision-making. There also appears to be an absence of a framework in which the impacts of local government decisions on wider government policies, programmes and objectives can be examined.

The Government can influence the cost of Auckland housing related infrastructure factor by:

  • reforming all legislation relevant to the forms and ownership of infrastructure
  • specific reform of the Local Government Act to reduce/increase the development contributions payable on subdivision
  • increasing/decreasing Government funded infrastructure in Auckland

(c) Cost of Building Materials/Labour Costs

I don’t wish to comment much on these supply factors as they are well covered in The Branz Report and The Productivity Commission Report.

It appears that the housing construction industry is dominated by small firms building bespoke one-off designs. These bespoke houses, with low people/dwelling ratios, tend to be built for those in the higher income/wealth population quintiles for whom housing affordability is not an issue. However bespoke houses do contribute to the attractiveness of Auckland and as such are part of the housing diversity there.

Standardised housing also forms part of the housing mix. A large firm building to standardised designs can build many good quality low cost housing. This happened in NZ during the 1940’s/1950’s when a combination of Fletcher Construction, Ministry of Works and government funded state housing built a substantial number of standardised houses of lasting quality.

The Government could influence the cost of building materials/labour costs in Auckland by building low cost housing in a similar same way to the 1940’s/1950’s project. This is happening to a limited extent by the Government continuing with the previous Government’s stand-alone development in Hobsonville (part of Auckland). I am not aware of any reports which assess the effect this project is having on Auckland house prices.

(d) Taxes

The various forms of taxes substantially influence demand for each of the three housing products. There are a number of tax reforms (ie. changes in tax legislation) the Government could undertake to influence the demand for housing. In particular tax reforms could reduce the demand by speculators and increase the (effective) demand for lost cost housing.

  • Income tax. An increase in the top tax rate and a decrease in the bottom tax rate would increase housing affordability for those in the lowest income quintile.
  • Capital gains tax. There is a form of capital gains tax in NZ applying to those who purchase property with the intention of selling it to make a profit. This tax is paid by genuine property developers but rarely by speculators. A capital gains tax would remove this anomaly as well as reducing the profitability of housing as an investment product.
  • Land tax. A land tax levied on the value of a property (land and buildings), especially a progressive land tax, affects those people who live in large houses with low people/dwelling ratios more than those who live in smaller houses with higher people/dwelling ratios. It especially affects those who own essentially unoccupied houses (eg. beach houses) which comprise about 10% of housing in New Zealand.
  • Rates. In Auckland, rates could be levied progressively on all properties owned by the same proprietor. This would work in the same way as a land tax, except it would specifically address housing affordability in Auckland.

(f) Population Growth

The housing reports include consideration of the effect of population growth on the demand for housing in Auckland. People have migrated there from other parts of NZ, NZ citizens have returned from overseas, and Auckland is the primary destination of foreigners immigrating to NZ. In part this reflects the attractiveness of Auckland, including its infrastructure.

The Government has little control over NZ citizen migration to Auckland, although it can influence this by ensuring that a fair proportion of infrastructure spending is allocated to other parts of NZ.

The Government can influence population growth by controlling the number of foreigners migrating to NZ.

(g) Cost of Finance and Availability of Credit

Bankers affect the demand side of the housing market by the interest rates they set, loan/value limits and their willingness to grant credit. Lesser affects arise from the proportion that housing comprises in their lending portfolio, documentation requirements, lending fees charged, interest free periods and other similar cash incentives, the use of mortgage brokers as their primary marketing strategy and the degree of oversight of these brokers.

Banks benefit from continuing house price inflation as this increases the quantum of lending and thus the quantum of interest received. Over the last 30 years, the equity share of houseowners in their houses has decreased from 81.5% to 71%, with the share of bank household lending correspondingly increasing from 18.5% to 29% (from the Reserve Bank of New Zealand statistics ‘C18 Household Financial Assets & Liabilities’). In the USA and UK, on average people have a 50% equity in their house with 50% being owed to the bank.

Banks can control their lending internally, but they can also be controlled by the Reserve Bank. This was done recently done by the Reserve Bank imposing a 20% minimum deposit requirement for house buyers.

The Reserve Bank contributes to the setting of interest rates set by banks via the official cash rate. The traditional purpose of this was to control goods and services inflation. However the Reserve Bank has to face the present quandary of wishing to reduce the official cash rate to stimulate the goods and services economy, while wishing to increase the official cash rate to cool the housing market in Auckland.

Previous Governments have reduced the cost of finance and availability of credit to first home buyers and those in the lowest income/wealth quintile through state funding via the State Advances Corporation/Housing Corporation. During the 1950’s – 1970’s most New Zealanders acquired their first home with a 3% interest rate and 25 year term loan from State Advances /Housing Corporation. This is being done on a limited scale at the Hobsonville project.

The Government can influence the cost of credit and availability of credit by:

  • Amending the Reserve Bank of New Zealand Act to give the Reserve Bank specific powers to control housing lending in Auckland, including minimum deposits, interest rates for different classes of borrowers (owner occupiers, landlords), prohibition on lending to speculators, loan/valuation ratios based on acquisition value and not present (inflated) value, etc.
  • Reintroduction of state funding for first home buyers and those in the lowest income/wealth quintile. This could be funded as part of Government spending, or by specific legislation enabling Kiwibank credit creation capability not available to other banks.

(h) Economic growth and employment/household income levels

In Auckland for at least the last five years, household incomes have been increasing at about 2-3% per year, although less so for the lowest quintile of the population. During the same time house prices have been increasing at the rate of 10-15% per year.

This increasing house price/income ratio is an indicator of decreasing housing affordability. It also indicates that income levels in Auckland are not a factor in increasing demand for houses there.

While the Government might hope that increasing GDP will increase housing incomes, it is unlikely that GDP will increase sufficiently to match present increasing house prices.

Housing affordability and household income equality are closely linked. The classical government policy response in achieving income equality is redistribution, that is, the use of taxation, transfers and subsidies to move resources from those with more to those with less, although it is rarely as simple as this (see The Brian Easton Report).

(i) Investment Demand

A substantial part of the present increase in house prices in Auckland centres on housing as an investment product.

In Auckland, as elsewhere in NZ, genuine landlords play an important role in the housing market by providing good housing to those who, for various reasons, choose not to own a house. Their investment relies on long term fundamentals such as rental returns relative to investment, house and finance costs and projected house price inflation similar to goods and services inflation. As such the landlord investor demand factor, as one of all the factors of supply and demand, is likely to be reasonably constant over the long term.

If, as in Auckland, house prices start to rise above long terms trends, investor expectations can ignore fundamentals. Whether those expectations are well informed to ill-informed is irrelevant. If the dominant investor expectation is that house prices in Auckland will continue to rise at the rate of 10%-15% per year then this becomes the dominant demand factor, and the long term landlord demand factor becomes essentially irrelevant.

This creates a housing market bubble. The investors in a bubble are mostly speculators. They make easy money – a 10%-15% annual price increase on a $500,000 house in Auckland equates to an increase in wealth of $50,000-$75,000 per year, tax free. They do not care about the negative effect they have on housing affordability, the building industry, local authorities, the Auckland economy and the long term creation of Auckland as an attractive place to live. They are certainly encouraged by forceful marketing from banks and real estate agents.

The Auckland bubble will burst (see for example Bryan Gaynor – www.tvnz.co.nz/national-news/nz-house-prices-could-fall-up-25-brian-gaynor-6221786). I hope the bubble bursts sooner than the speculators expect and they lose their money.

It is considered that all houseowners have a sense of wellbeing if the capital value of their house is continually rising. But there is no logic to this. If their house value is rising because of house price inflation, then so are others. They can’t utilise the increase in value to purchase a better house, because other houses are rising in value too. They only make money if they sell to buy a lesser value house, or they sell to buy in another city where prices are less.

It is unlikely that the Government can influence people’s expectations. However they can:

  • When all the evidence shows that a bubble exists, publicly state this, and not use RMA reform as a scapegoat for the bubble
  • Legislate to enable the Reserve Bank to prevent banks lending to speculators
  • Restrict foreign investment in NZ housing, and prohibit speculative investment
  • Support genuine landlords, and genuine property developers

Conclusion

Prior to 1985 we lived in an egalitarian society. Since then the top tax rate has been cut in half – from 66% to 33%. The top quintile of households now receives 40% of income, while the bottom quintile receives 8%. The top quintile of households own 60% of the wealth in NZ, the bottom quintile less than 1%. These statistics do not indicate a fair society, nor an egalitarian society.

A house price set by a properly performing market will reflect the material content of a house, the section and the collective share in Auckland’s infrastructure. But markets cannot deal with house price inflation any more than they can deal with goods and services inflation. Nor can markets create housing affordability. House price inflation and housing affordability both require government action, either by the direct provision of housing, or intervention in the market to influence the factors of supply and demand.

The Government has done this, but only in a very limited way, with the via Hobsonville project, the removal of landlord’s tax deduction of depreciation, via the Reserve Bank intervention with loan to value ratios, and the planned RMA reform.

To seriously address housing affordability, particularly Auckland house prices, requires considering all policy options and legislation relevant to the supply and demand of housing, including the main ones – the Local Government Act, the Land Transport Management Act, the RMA, the Building Act, the Income Tax Act and the Reserve Bank of New Zealand Act.

The remedies for housing unaffordability all exist in numerous reports, most of which were commissioned by or for the Government. Minimal response by the Government, while continuing to voice the RMA as a scapegoat, is simply evidence that it does not wish to address house price inflation or housing affordability in Auckland, nor believe in a fair society there.


 

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