The Labour-led government has put out a five point plan for urban areas, called an urban growth agenda (well, at least according to the Infrastructure NZ website, See Note 1).
The five points are:
1. Turning on the tap of infrastructure finance, for example, infrastructure bonds serviced by a targeted rate, building on the work done with Crown Infrastructure Partners;
2. Designing a more pro-growth planning system that allows the city to make room for growth instead of choking it off;
3. More robust spatial planning by central and local government;
4. Investigating a GPS-based network or transport pricing system. This will allow us to fully internalise transport costs so that roads and motorways aren’t a disguised subsidy for sprawl; and
5. Possible legislative reform to support this new approach.
This agenda is looking better than previous announcements. Nothing explicit about removing the RUB, while the potential for infrastructure to work against good urban form is acknowledged.Are there gaps? Nothing explicit about inequality in terms of equal access across the city to affordable housing, employment opportunities and city amenities like open space. Anything about adapting to climate change? What about good quality urban design? I could go on. Perhaps these topics are all part of robust spatial planning. The signal that government will participate in the spatial planning (rather than just complain about the outcome) sounds positive.
Lurking behind the agenda appears to be the constant call for more competitive and efficient housing and land markets - markets that can supply more housing, more cheaply. Reduce regulatory barriers, free up more land and ramp up infrastructure roll out seems to be the recipe.
In doing so, there appears to be more than just a bit of a hope that the private sector will take on more of the heavy lifting with regard to the provision of housing that the middle class can afford. That is, the market needs to meet most of the demand for housing for the middle and upper ends of the market, and arguably exceed demand to cope with growth spurts and ensure a steady ‘flow down’ of units into the lower cost parts of the housing spectrum.
Even with the re-entry of central government into social housing provision and a 10 year (but still one -off) boost to market rate affordable housing via KiwiBuild, there seems to be a reliance on the typical response to any endemic social and economic problem: the answer is to create a market. This call for a more market approach is understandable to an extent due to the constraints on government finances.
But is the five point plan up to the task of stimulating housing production?
Meanwhile, the most recent Auckland Council monitoring report on housing capacity (November 2017, see Note 2) shows a drop in feasible development capacity within the Auckland urban area, compared to previous assessments. This is with the Unitary Plan rezonings in place.
Council estimate that plan-enabled capacity in residential zones in the urban area ranges between 120,000 and 1.07 million dwellings (under an infill and redevelopment scenario respectively). Feasible development capacity in the urban areas is estimated to be 140,000 residential dwellings. This estimate (140,000) is quite a lot less than the 270,000 estimated when the Unitary Plan was being finalised. No doubt this reduction in feasible capacity within the urban area, coupled with assumed on-going under build of housing compared to demand, will be followed by calls to free up more greenfields land and reduce other barriers.
But is the reduction in feasible capacity real or is it more to do with the workings of the land market, or the model the Council uses?
The Council’s report says the reduction in feasible capacity reflects higher build costs and flat to declining sale prices. These two factors can be expected to continue. The whole point of lots of capacity is stimulate supply and bring down sale prices, while labour and material costs are likely to continue to rise, unless the average floor area of dwellings reduces. Does the Council’s model change the average floor area? Does it adjust land values if sale values reduce?
Back to the government’s agenda. Setting aside the question of internal consistency within the agenda between trying to free things up on the edge of the city while at the same time removing subsidies for expansion (transport and infrastructure funding); while in turn not giving any real signal about how urban redevelopment is to be managed so as to avoid exclusive gentrification and find the funding for the the investment needed in upgraded amenities and the environment of areas to be redeveloped; the bigger and tougher issue lie around the way that the urban land market operates (or doesn’t operate).
First up - there seems to be a fixation by many on high land prices. High land prices mean high house prices. This is often stated as a fact. This is true if the size of the house and the section stay the same, as land increases in value. Reduce land area per house and possibly floor area, and house prices do not need to go up as land prices increase. But to say that implies that the large stand alone house is doomed. So easier to say that the government will tackle high land prices by making more land available. Add a bit more competition into the mix and hopefully land prices will come down more - folk can afford a stand alone house and don’t need to cram up in a townhouse or apartment. Sounds simple.
But what determines land prices? Once the land is zoned for development, infrastructure is in place and transport networks available, what sets prices of the land? A report by the UK housing pressure group Shelter (Note 2) identifies that:
The price of development land is based on the sales value of the homes that can be built on it. But unlike any other market, the price that new homes will fetch is determined by the market in existing homes. Land differs from all other raw materials in this regard: for example, the price of steel to build new cars is not dependent on the price of second hand cars. Understanding (lands) particular characteristics is central to our analysis of the failure to build enough homes.
Auckland University’s Professor Larry Murphy makes the same point in an article for the Better Homes,Towns and Cities science challenge (Note 4):
Developers and their financiers assess the merits of a possible development proposition in a very different way from that generally assumed. It is commonly assumed that developers are involved in a cost-plus industry and that they passively take land prices as part of their costs. The reality, however, is that developers, financiers and valuers actively make land markets. Of particular importance is their use of residual valuation.
Residual valuation essentially involves determining land value through subtracting total development costs (including profit allowance and finance costs) from the estimated gross development value of the completed development (ie sale prices). The residual is what is available to purchase land.
So having more landowners willing to sell to developers may not make that much difference to land prices. Landowners understand residual valuation methods and the value of homes in the area just as much as developers do and so have a good idea of the value of their land. Why accept a lowball offer? Landowners also know that it is not easy to substitute one development site for another. If the price of steel for a car manufacturer is too high, then a different supplier can be sourced, but land is fixed.
What if the number of dwellings possible on a site is increased? Same issue. Increase development potential and land prices go up for sites that could be redeveloped. We have already seen this in Auckland - for example work by Auckland Council’s Chief Economist shows that in the most densely upzoned areas of the Auckland Isthmus, upzoned properties sold on average for a premium of more than $90,000 when compared to neighbouring properties that were not upzoned. This is over the period 2013 to 2016. (See Note 5).
Dr Ryan Greenaway, as reported on the website Interest.Co (see Note 6), takes things a step further by noting that the upzoning premium is stronger for sites with development potential. He found that between 2011 and 2015, sites with a low ‘intensity ratio’ - being the ratio of existing improvements to land value (and thus a low opportunity cost of redevelopment - think the proverbial run down bungalow on an expensive quarter acre section close to a town centre or the beach) that were rezoned for the highest permissible residential density appreciated in value by approximately 18% more than sites already developed with multi-units in the same planning zone, and by about 20% more than housing located in areas that were not upzoned.
The lessons is that land will always be valued close to the point where development feasibility (returns minus costs) is marginal. Development feasibility is strongly influenced by zoning, but changing zoning does not necessarily improve development feasibility, but it may change what type of development is feasible.
As an aside, Dr Greenway notes a contradiction between land and house prices, an increase in land price does not always mean a shortage of housing:
Intensification increases the value of land, which means that (existing) dwellings that can be probably redeveloped to support additional dwellings are likely to increase in value. But if intensification succeeds in bringing supply to the market, we should also expect a decrease in the price of high intensity housing, such as apartments and terraced housing. This bifurcation in the housing market makes it difficult to track the effect of intensification policies on house prices using conventional price indices that aggregate across all transactions.
Getting back to house prices, what would depress prices of the existing housing stock (or at least stop their growth), which would flow into, hopefully cheaper, land values? Apart that is from a housing market bust, an economic recession or population decline.
Housing is both a stock and a flow. If the price of new housing is generally set by the price of the existing stock, then a big flow of housing is needed to reduce, over time, the sale prices set by the existing stock. Have a big enough flow and some of that will filter on down the housing ladder as people move up the ladder. But it is generally held that housing supply has not kept pace with demand and that most housing supplied has been at the more expensive end, a feature not unique to Auckland, for example ….
Most of the growth in housing supply has been taking place in mid-to-high price segments, rather than low price segments. Unfortunately, we are not witnessing a trickle-down effect whereby households buying new housing free up vacancies in the established housing stock that housing stressed households are able to move into at lower prices and rents.
That is the finding of a recent Australian study on housing supply responsiveness (See Note 6). It is a point echoed by Professor Murphy:
production of dwellings in the lower quartiles of value remains low. Considerable evidence suggests new-build production in special housing areas is not making significant inroads into housing undersupply or generating affordable stock for low-income and middle-income households.
You would think that high house prices would stimulate house production with landowners lining up to sell and volume builders ready to enter the market to offer cheaper “mass produced” product. So there must be some barriers and blockages in the system. But is it that straight forward? The study by Shelter starts to unravel the dynamics of the housing market, starting with land and development opportunities.
Inherent scarcity makes the land market operate differently from other markets. Naturally limited supply, concentrated land ownership and a restrictive planning system means that the normal economics of supply and demand fail to operate, as higher demand for land does not translate into an equal supply side response of more houses.
Typically, supply elasticity will be higher in the longer term, as companies have time to change their factors of production, or the type of housing built to meet demand. In the shorter term, housing markets are very inelastic. A technical report cited in the Shelter study (See note 8) notes:
The price elasticity of demand and supply is always dependent on the scope for substitution between products. The price elasticity of housing supply is impacted by ease of substitutability between land and non-land inputs, responsiveness of land supply, and share of land and non-land costs.
Cities that have geographical constraints and significant investment in already developed areas are likely to see an even slower response to population and price pressures. Urban areas that are hemmed in by hilly or even mountainous terrain will then be disadvantaged when it comes to meeting population growth pressures. Past development is also a potential constraint. The presence of capital improvements on land implies that new supply on that land can only come about through renovation or demolition and clearance in preparation for new build.
Sounds a bit like Auckland.
Added to this basic dynamics of housing markets not being very response in the short term, is a lopsided approach to the potential for down-side risks.
In addition to the differences in the timing of responses of supply and demand to market conditions, the reaction of supply to market changes is also asymmetric. When house prices increase, supply does not necessarily increase as a result, or, if it does, the response may be sluggish. On the other hand, as was observed in the recent recession, finance problems and lowered demand meant that construction decreased quickly in response to falls in the price level. This asymmetric response accentuates undersupply problems.
In the relatively short run, house prices can be volatile and they react swiftly to changes in overall economic conditions and in credit supply. Inevitably supply will respond more slowly than prices when prices rise, due to the unavoidable time taken in planning, building and selling homes. Further, if developers are concerned that house prices are rising too far, they will be cautious about committing to new sites and higher volumes.
But when prices fall, the potential losses which would be incurred if developments continue to be built out (and prices have to be heavily discounted) mean that developers have the incentive and the ability to reduce new supply quickly.
These findings suggest that housing supply is price inelastic in the face of rising demand – thus contributing to the exaggerated booms in house prices in the recent past. This is supported by Glaeser et al (2008), who find that bubbles are common and last longer in areas where supply is inelastic.
The asymmetric and inelastic housing supply response will then lead to an undersupply of housing over the cycle.
Rapid swings in population growth rates from up then down migration and the financialization of housing do not help (and probably accentuate) the problems of the asymmetric and inelastic short term response of the housing market. So too would geographic constraints and the problems of the durability of capital (not much of the city is ripe for redevelopment because of old and run down housing stock).
These issues do not excuse poor planning, but they do put planning in context. This from Shelter:
But although the planning system institutionalises the scarcity of land, and provides a political mechanism for allocating its use, planning is not in itself responsible for land being scarce. It is the other way around: all modern societies have some sort of land use planning system because land is inherently a scarce resource.
And this from the Ahuri Report:
Thinking on Australian planning reform as a supply measure should extend beyond the simplistic interpretation which assumes that the mere presence of a control is a barrier to supply. Indeed, our econometric modelling results suggest that planning measures may not be a key factor influencing housing supply.
But what then is the role of the planning system in addressing the issues associated with dysfunctional land and housing markets? More capacity will not solve all housing issues. A bit more certainty and less 'ups' and 'downs' may be more important, once a base level of capacity is in place.
Here are some thoughts:
1. At a city-wide level, more capacity for housing is helpful, rather than less capacity. It is more a matter of where and how. ‘No go’ areas need to be well defined, while strong infrastructure planning and funding systems are needed to help shape (and incentivise) where growth should go. A long term view is needed.
2 Certainty provided by planning over where growth is to go may be a good thing across a city as a whole, but the costs and benefits fall in different ways. We need to look at means of reaping some of the benefits to help overcome some of the costs.
3. Providing more capacity in existing built up areas is likely to be more beneficial than capacity out on the edge, but expanding capacity is existing areas will always be a political hot potato. Hence the need for strong infrastructure planning and funding. This is an important missing link in urban planning, and particulalry important where there are natural and built constraints to redevelopment.
4. We need a bit more uncertainty in the planning system as to how much growth and development can occur in the areas identified for change. Too much certainty and landowners grab the benefits of that certainty in terms of land values, while neighbours and communities dig in behind the assumed barricades to more development, created by the plan.
5. Zoning needs to become more ‘fluid’. Mixed use zones are good in the ability to swap between compatible uses and activities, so too would be zoning that could automatically tick over from one lot of height settings to another when certain thresholds are met. Zoning also needs a discretionary ‘layer’ to it, with the ability to tap into that layer dependent upon some form of ‘sharing the benefits’ as between landowners, developers and communities.
Note 1:
https://infrastructure.org.nz/media-releases/5603624
Note 2
http://infocouncil.aucklandcouncil.govt.nz/Open/2017/11/PLA_20171128_AGN_6728_AT_SUP.PDF
Note 3: http://www.shelter.org.uk/__data/assets/pdf_file/0019/802270/Building_the_homes_we_need_-_a_programme_for_the_2015_government.pdf
Note 4:
http://www.buildingbetter.nz/news/case_studies/land_costs.html
Note 5:
https://www.aucklandcouncil.govt.nz/about-auckland-council/business-in-auckland/docsoccasionalpapers/how-unitary-plan-value
Note 6:
https://www.interest.co.nz/opinion/90626/ryan-greenaway-mcgrevy-probes-how-well-know-whether-unitary-plan-helping-improve
Note 7: https://www.ahuri.edu.au/__data/assets/pdf_file/0018/13257/AHURI-Final-Report-281-Housing-supply-responsiveness-in-Australia-distribution-drivers-and-institutional-settings-Executive-Summary.pdf
Note 8:
FTI CONSULTING UNDERSTANDING SUPPLY CONSTRAINTS IN THE HOUSING MARKET REPORT PREPARED FOR SHELTER JULY 2012
