The Auckland housing market is a bubble. A bubble is ‘trade in an asset at a price or price range that strongly deviates from the corresponding asset’s intrinsic value’[1]. At the moment the fundamentals of Auckland housing as a whole very much demonstrate that position. According to the last census, mean household income in Auckland was $76,500. The census also showed there are a fraction under 500,000 dwellings of all types in Auckland. Mean property prices in June 2016 were around $900k. That gives in Auckland housing an astounding $450bn of notional capital value, as well as a greater than 10x multiplier on average earnings for the associated average mortgages. The proposition that in any market can sustain permanently a decoupling of asset values from average incomes is just plain wrong.
We know that whatever is the cause of the bubble, the only way ultimately we can get out of this situation is by making more houses available for purchase by customers. So how to achieve this?
What can be said is that recent concentration on the supposed failings of the building industry, foreign investors or any of the plethora of scapegoats presented to the general public, is all obfuscation. The fact is that the operation of the housing commodity market is the source of the problem, and will be at the root of the solution. Doing nothing about that underlying reality is an abdication of responsibility by government and planners.
What is not the problem
Immigration: The upward pressure on house prices is not – admittedly – helped by immigration. However, immigration is not the crux of the problem. It is a neat polemic explanation that can be rolled out to blame ‘others’ rather than ‘highly responsible’ society for its own behaviour. The bulk of the demand is coming from internal New Zealand sources.
Productivity: 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? If a builder can sell a house at a higher price into a hot market why should they pass on any savings? Businesses – including builders – are not charities. Productivity is an input parameter which helps constructors improve or maintain margins but does not affect affordability per se.
Land supply: Land availability is an input parameter to the housing affordability problem, not an output parameter. The bare land to completed house process is relatively simple to understand. However, there are very clear decision points and value additions that drive the sequence to ultimately deliver a house. Bare land has value as farmland, but the cost and rate of return is low from $5k/hectare to $205k/hectare for horticultural uses. However once the land has been flagged for house construction, value per hectare dramatically increases. Once buried infrastructure such as drainage, power and water is in place, depending on location, the value increases to around $10-16m/hectare in Auckland (based on current sections for sale in Pukekohe and Riverhead as examples). The construction element is, by comparison, a very small element of the price escalation. At each stage within that process there is always a strong urge to do nothing with the land, spend no further money on it and have appreciation taking place with zero further capital exposure. As soon as work starts on the ground for improvement and infrastructural additions, this represents attributed costs to the owner. It also increases the absolute need to ensure that any onwards sale more than covers the capital expenditure on improvements. This is the very simple reason why Auckland has seen multiple special housing areas (SHAs) announced that after years of development have relatively limited numbers of developed houses in place. Each year developers put in place infrastructure for just those properties that they know they can sell, plus maintain a market for the future. Most SHAs currently in operation release about 10-15% of the total number of titles – thus sustaining the value of the sections that would otherwise collapse if all the sections were ‘dumped’ onto the market at the same time.
Just making more land available by selling crown land, or permitting subdivisions, or easing green belt restrictions for development does not radically change the market. Nobody is compelling land acquisition. No one is compelling development. No one is forcing builders to build. The market cannot be forced to operate at a loss or at a rate of production it does not wish to, or for that matter sustain economically. Ergo very limited increases in total output (i.e. constructed houses) are seen.
The solution
The only way to increase the total number of houses constructed on land made available is to compel its rapid development and use ahead of the free market. To do otherwise simply allows the market to settle at an equilibrium that sustains prices and values just at the very limit of what is supportable by the general public with access to low interest rates. What that translates to in reality is that government needs to compel industry through the profit motive and economies of scale as they have in the past – i.e. building state, council and/or co-owned housing for low income households – to deliver large numbers of properties outside of the normal market delivery rate. This means getting ahead of the demand that currently is attenuated by drip feeding properties into the market to maintain values. We need to significantly boost house availability (thus affordability) by building large numbers of state-owned properties not subject to the housing commodity fluctuation. An artificial ‘glut’ of housing would force down rents in the buy to let property market throughout the city. Reduced rental yields coupled with a capital gains tax incremented according to the number of properties held, would make such investments much less attractive to property speculators.
We cannot leave matters to the free market and then continue to be stunned by the inconvenient fact that the market will act in its own best interests: land banking; rationing land release to keep prices high; and building large and expensive homes whilst ignoring demand at the bottom end of the market. Developers, builders, house buyers and the public all act for their own best interests. All of these stakeholders will not act as charities pro bono publico. To think otherwise is naïve in the extreme.
[1] King, Ronald R.; Smith, Vernon L.; Williams, Arlington W.; van Boening, Mark V. (1993). “The Robustness of Bubbles and Crashes in Experimental Stock Markets”. In Day, R. H.; Chen, P. Nonlinear Dynamics and Evolutionary Economics. New York: Oxford University Press. ISBN 0-19-507859-4.
