Circa 2005-2006 the Auckland housing market was dubbed ‘unsustainable’ and a ‘dangerous bubble’. Six years post-Global Financial Crisis (GFC) we are in a very different place – in many ways a worse place. The government response to GFC was pressure on interest rates downwards, making expensive mortgages significantly cheaper, thus spurring house price growth. House price inflation is sending Auckland (and to a lesser extent Christchurch) values to stratospheric levels. It is a contagion that is spreading to other towns in the upper North Island. But perversely, despite the highest house prices and mortgages (compared to average wages) in New Zealand history, housing is largely more affordable that it was immediately pre GFC.
Auckland increasingly has little to nothing to do with the housing market in much of the rest of the country. Securing a modest starter home in Greymouth with an affordable mortgage? No problem. How about a residence close to CBD and shopping in Wellington at the seat of government? Very reasonable. But the media contains articles on a daily basis of how young, low income or critical worker families find it impossible to buy a home in our largest city. The imposition of a demand dampening 20% loan to value (LVR) on mortgages has made the difficult task of generating sufficient savings for a deposit yet more unobtainable for those not already on the property ladder.
Prior to the most recent spasm of the ‘affordability crisis’ in Auckland between 2012-2016, productivity initiatives were the ‘agenda du jour’ driving behaviour and new initiatives in the construction industry. Both government and the media have waded in to this conversation. The principle axes of effort were in addressing construction process costs, planning, materials costs, productivity, skills, regulatory framework and materials importation. These issues represent the usual pantheon of systemic construction problems always being raised. Huge efforts were made in targeting and addressing increasing granular issues for the construction sector producing. As a result, ever more verbose explanations of the problem have been brought to the public. Sadly, we are in danger of producing the most precisely located economic shipwreck in the ocean of house building history.
Choices are made by consumers of housing – but also by its producers. It is not possible to force a company to produce more of its principle products. Just because a producer can build more, no one can compel higher production. The ‘producers’ of housing – i.e. builders, contractors, developers – in the construction sector want to have a life as well. They want to go on holiday, go fishing and all the other lifestyle choices that New Zealand is famous for. You cannot compel a commercial entity to accept more procedural, long-term and short-term risk than it wishes to bear. A critical point for all (older) builders is that they have experienced in living memory major housing booms and busts. Thus they will take on only that much work that allows them to continue to reliable earn a living without taking on board any more risk. If they built at a rate that forced down unit costs of houses they would in effect build themselves out of a job.
So let us assess the current issues in the housing market from the perspective of builders. Construction has had historically very poor productivity growth and has been extensively commented upon, by NZIER, among others. According to commentators in general and government in particular, this is a major element affecting housing affordability. Absolute rubbish. The reality is that productivity is not synonymous with affordability and never will be. Productivity is only important in affordability if a builder passes on the productivity savings to the customer directly. Efforts made to increase productivity actually only increases profitability of construction companies. Rationally, will a builder pass on all savings to a purchaser when they can charge a standard $2000-$3000/m2 rate? Is it unreasonable for a builder to sell construction services at a high price into a hot market? Businesses – especially builders – are not charities and in spite of the polemic feeling of ‘exploitation’, builders are operating in a free market.
Larger houses are more expensive to build because their costs increase lineally (i.e. on a wall by wall basis). However, as they grow on a side their floor area increases at a square function. Furthermore, the total living space (house volume) increases on a cubic function. The ‘fixed’ elements of expenditure – scaffolding, corner structures, windows etc – form a lesser component of the overall costs. Thus a bigger house can be sold for a lower unit rate (typically around $2k/m2 for a 250m2) at a greater profitability level than a smaller ‘affordable’ house (typically around $3k/m2 for a 120m2 home). Perversely the economics of construction compel speculative builders to build the largest, most expensive house possible. Even more perversely those same economics drive builders to construct low density housing – single storey, stand-alone properties, that require less scaffolding and structures to support multi floor patterns. Similarly, individual members of the house commissioning public are incentivised to construct larger houses, since residual values are increased in the longer term and the unit cost per square metre added is relatively low compared to ‘affordable’ housing. Builders have historically been at the bottom of the profitability pile, averaging around 6-7% margin, with relatively high risk profiles and business mortality compared to the remainder of the economy. It is therefore no shock whatsoever, given that we are dealing with free market economics, to discover that all of the ‘affordable’ new dwellings in the much vaunted Special Housing Areas (SHAs) are not actually being constructed – to the point that they are being rescheduled for ‘normal’ housing. Cheaper affordable housing in less desirable areas are not as profitable for builders and therefore are not prioritised. It has been alleged that affordable homes in SHAs have translated into the land bank of developers instead.
Another mechanism for reducing builder costs for construction has been touted as being through the introduction of prefabrication. However, the history of the New Zealand construction industry has been strewn with attempts to improve productivity and reduce costs through the introduction of building systems and prefabrication. Unfortunately, the size of the market and the lack of scale inherent in our tiny market reduce the adoption of these measures in any meaningful way. The nett effect is that a minimal amount of new technology and systems are introduced, meaning that builder profitability stays low. The lack of profitability and low scale in the New Zealand construction market reduces investment in new technology. Additionally, there is a pervasively negative view of prefabricated building as being cheap, shonky and relatively low-value compared to the bespoke, low productivity housing solutions that are the norm across the sector.
Sadly, in the absence of concerted governmental action to make the market, we have conditions ideal and self-reinforcing to retain the status quo. We have societal needs crying out for increased cost effectiveness, better quality and faster construction rates in the house building sector throughout New Zealand. At the same time, we have buyer behaviour, government policy and technical solutions that (entirely rationally) leverage the slow, bespoke construction of entirely the worst types of housing necessary to solve our problems. If there was ever a market for a ‘how not to do it guide’ for housing development and policy, the New Zealand construction market in general, and housing in particular, has a great story to tell.