Offshore demand for houses

What to make of the housing data released by the Labour Party, and of the subsequent debate?

I’m writing this partly to help clarify my own thoughts.

First, can the data be relied on?  Well, no, but then no one really suggests that it can be.  Even if we assume that the data Labour obtained are reported accurately, they are still only a partial snapshot, and report something that is likely to be aligned, but not that closely, with the subject of interest –  purchases of residential property in Auckland by non-resident investors.  It isn’t ideal, but then neither are other contributions to the debate (eg searches on juwai.com, or anecdotes from people on either side of the debate).  There is a reasonable argument that there are no particular grounds for official statistics to be collected in this area.  But if so then informal statistics and surveys are likely to be the best there is.   And for those who do favour official data collections, well they are being put in place but the results won’t be available for months, since the data requirements don’t come into effect until 1 October.

Frankly, it seems reasonable to suppose that buying by non-resident Chinese is a material part of the market at present.  If so, that is not a normal state of affairs.  Generally, people do not buy individual residential properties in other countries as a part of a balanced investment portfolio.  In particular, they do not buy such property in small cities at the end of the earth.   People might, on occasion, own holiday houses abroad.  The super-rich might have second houses in great world cities such as New York and London.  But normal middle and upper middle class people in developed market economies don’t generally invest for their retirement in rental properties in faraway cities.  Apart from anything else, monitoring costs are high.  In fact, when people do own residential rental properties they are usually owned in locations quite close to where the owners themselves live.

In the 175 years since British government was established here, I expect this is the first time we’ve had this particular debate in New Zealand.  And it is a different debate than one around immigration and housing.  Reasonable people can differ about how much immigration we should have, and even where we might welcome migrants from, but if we are going to allow people to settle here they need to live somewhere.

“Capital flight” is a different issue.  In Latin America, Africa, and now China, people who have acquired money in ill-governed countries – many of the gains themselves might be ill-gotten, but many won’t be – want safety and security for themselves and their families.  That might be protection against a rickety domestic financial system.  Or it might be protection against the current ruling elite cracking down on political enemies (as much of Xi Jinping’s recent “anti-corruption crackdown” seems to have been).  It might just be protection against the risk of a substantial depreciation in the local exchange rate (which would probably be an appropriate course of action in China now, from a Chinese perspective).  In countries where many forms of capital outflow are illegal, people have to take what routes they can.

So, I think people who talk of offshore-Chinese interest in residential property abroad as something we just have to get used to, or an inevitable feature of globalisation, are wrong.   This demand is a function of the failure of China, not its success.  There was never a time when British or American savers were managing their investments by buying houses in Sydney or Auckland.  They were well-governed countries with rule of law protections.  China, to date, is not.

People are also wrong if they suggest something odd in singling out Chinese purchasers.  In most places around the world, the issue at present is about Chinese-sourced flows –  and, of course, unlike many of corrupt countries from which capital has previously flown, China now has one of the largest economies in the world, so any spill-over effects potentially matter more.  But if it were Russian or Argentinian buyers (which it isn’t, and has not ever been here), it would be just as much an issue.

Which is why I thought the intervention of the Race Relations Commissioner in this debate was particularly unhelpful and ill-judged.

But why might non-resident purchases of houses in Auckland matter? And to whom?  I’d argue that they matter only because laws and administrative practices make new housing supply so sluggishly responsive to changes in demand.   There is apparently substantial Chinese buying interest in Houston too, but when housing supply is much more responsive to changes in demand, foreign interest in local properties is largely beneficial to the local economy and its permanent residents.  It is, in effect, just another export opportunity.

But things are different when supply is so sluggish – and when it is mostly government policy that makes it so.   If supply were sluggish enough, even a few percentage points of additional demand could have material implications for house and urban land prices.  I’d be surprised if anything like 20 per cent of demand in Auckland was from non-residents, but if the true number is five per cent (which wouldn’t surprise me) it could still be making a material difference to prices in the current rather over-heated environment.  The Reserve Bank’s current and proposed lending restrictions are only likely to increase the relative importance of such offshore demand in explaining continuing price increases.

If most of any offshore-purchased houses are quickly put back on the rental market, offshore demand does not affect the availability of accommodation in Auckland.  If anything, it would probably drive further declines in rental yields (though not in nominal rents).  But it would still put home ownership further beyond the reach of New Zealand citizens and permanent residents living in our largest city.

The implications would be more serious if (and we don’t have the data) any material proportion of the offshore demand is being bought and left (largely) empty –  perhaps occupied two weeks a year if the owners take a holiday here.  Again, if housing supply were responsive, this demand would be pure gain (as at a holiday resort town), but in a city with tight housing supply restrictions (imposed, maintained and administered by central and local government), such demand would represent a reduction in effective accommodation supply, with consequences not just for the affordability of home ownership, but also for rents.  In that case, there are gains from offshore demand for the immediate sellers of the property (at least if they are leaving Auckland) but the distributional consequences for the wider Auckland population look pretty awful.  It doesn’t affect existing home owners, but the young and the poor typically end up worse off –  and in Auckland, as David Parker has noted, those on the margins are disproportionately of Maori and Pacific backgrounds.

Bernard Hickey has suggested that offshore demand should be welcomed if it is accompanied by large scale apartment building, perhaps directly financed by Chinese capital.  I’d have no objection at all to such investment, although as one who is a little sceptical of the estimates of the scale of any “shortage of physical houses”( the issue is mostly a land price issue), such a huge building programme could well sow the seeds of a subsequent collapse in Auckland property prices if the offshore demand for Auckland property proved not to be a long-term phenomenon.  Real overbuilding tends to be more economically damaging than simply price overshoots.

In the longer-term I suspect (hope?) the offshore non-resident demand is a second or third order issue.  Indeed, it may not be an issue at all.  A more liberalised Chinese financial system would allow savers to diversify their holdings offshore through much more efficient investment vehicles.  And Auckland is still a small city (and not exactly London, Sydney or San Francisco), compared to most of the others in which Chinese investors are reported to be interested, suggesting that demand would reallocate away from New Zealand if prices in Auckland got too high.  In the medium to longer-term, it is still likely that the interaction between tight land use restrictions and high target rates of inward migration  (which permanently boosts the population and demand for housing) will be more important for house and land prices in Auckland, and housing affordability.  As I remain sceptical that housing supply can (politically) be substantially liberalised –  I’m still curious to learn of any overseas examples where the controls have been substantially unwound –  winding back the target level of inward migration needs to be discussed.  It would be a more useful place to focus policy debate than overseas purchaser restrictions (and easier to implement effectively).  Again, this is an issue that should be able to be debated without accusations of “xenophobia” or ‘racism” being flung around by the great and the good.

I favour a relatively unrestricted environment for foreign investment, putting foreign investors on the same footing as New Zealand citizens and residents (though not as more favourable footing, as ISDS provisions have the effect of doing).  Most of our current restrictions appear unnecessary or counter-productive.

But when the government makes it hard to use urban land and increase housing supply, we are moving into a world of considering second or third best policy options if there is a large sustained source of offshore demand to own New Zealand houses.  Policy should be made in the interests of New Zealand citizens and permanent residents, and it is not clear what interest of New Zealanders is served by allowing an unrestricted inflow of offshore demand (if indeed it is substantial).  I heard David Mahon on Radio New Zealand this morning suggesting that even raising the issue would adversely affect our image in China, highlighting some deep “latent xenophobia”.  Perhaps it will affect our image, but I rather doubt it will affect how much milk powder is sold, or the price at which it is sold.  And when the country with the largest population in the world is both sufficiently ill-governed that many of its people just want to get their money out any way they can (after one of the biggest, and least disciplined credit booms in history), and just sufficiently liberal that there are some legal vehicles for those outflows, it is not inappropriate that other countries’ citizens might be wary about the implications.  China  –  and the choices of the Chinese rich – matters for other countries in a way that Zaire mostly did not.

Are there easy answers?  I doubt it.  People talk of the Australian policy of allowing non-resident purchases only of new houses – which sounds not totally implausible in principle, but doesn’t appear to have worked that well in practice.  If the government is confident that its registration scheme will produce robust data, perhaps an “offshore investor levy” –  akin to Treasury’s dubious “Auckland investor levy” –  could be considered.  But I suspect any such provision would run into problems with provisions in any number of our free trade agreements.  The same might go for banning non-resident purchasers altogether (eg from anyone without New Zealand citizenship or residence).

I’m not sure what the answer is, in a third best world.  But in this debate, I reckon the medium-term interests of people needing accommodation in Auckland, and wanting to buy their own home, need to be the policy priority.

And good quality debate around what could be an important issue isn’t help by sloganeering from people on any side of the issue.  I rather liked the guidelines for debate that Bryan Caplan and David Henderson have posted on Econlog in the last few days.  I’d add just one other –  to win a debate, and deserve to win it, one has to engage with the strongest arguments of those on the other side, not the weakest.  Attacking straw men perhaps has its satisfactions, but doesn’t really advance understanding, or the cause of good policy.

15 thoughts on “Offshore demand for houses

  1. Nice piece. Sympathise with the ‘clarify my own thoughts’ comment! I’d got as far as your ‘just another export opportunity’ and your ‘favour a relatively unrestricted environment for foreign investment’ but still somewhat bogged down on distributional impacts.
    By coincidence I was moderating a panel discussion of CIOs a week or two back and one of them commented that “any market dependent on Chinese flows is liable to suffer whiplash roller coaster moves. It’s going to be very difficult to manage going forward”. Pretty good call.
    In passing the French have a policy of not collecting statistics by ethnicity on the grounds that all citizens are equal in the colour-blind eyes of the Republic. Which while being all very admirable in principle, has the happy effect of suppressing the rate of North African/Arab unemployment in the banlieus. Feel something of the same is going on here….

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  2. Thanks Donal. I sympathise with the implications of your comment about the French practice. Unfortunately the new forthcoming data will still not distinguish between the properties held and rented out, and those left empty. In a supply-constrained world, the latter are probably the most concerning.

    Also interesting to wonder what another 25% TWI fall might do to demand – balancing “cheaper entry levels” vs the headline effect of the MTM losses on existing holdings in CNY terms.

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  3. You say, and I agree with you, that if the supply of land (not houses or apartments) could be freed up, there would not be a problem. If the supply of land could be freed up, immigration would not be a problem either.

    So why is there a reluctance at the national and local levels to freeing up the supply of land? Partly it is doctrinaire ‘smart city’ stuff – hard but not impossible to debate. Partly I think it is fear of bursting the bubble or at least of having a negative “wealth effect”. Instead of being defeatist, can we focus on ways of creating a controlled easing of land supply? I am sure it is possible. There seems to be a gradual increase in popular understanding that land supply is the issue, what we need to provide is a mechanism to address it.

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    • I don’t know the answer to your question (partly why I keep asking if people know of successful cases abroad where land use restrictions have been wound back). Often packages of policy initiatives are one way of neutralising potential opposition, which is also why I suppose I would favour a combination of reducing target migration (underlying demand) and working on the supply side.

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    • I believe the problem with “controlled easing of land supply” is that it would not reduce land and house prices. In Spain they had several years of crazy supply increases without the slightest effect on house prices, only the eventual bust was far more severe. The reason this was possible, is that the “supply chain” for the controlled releases of land – even in substantial quantities – was around 7 years long.

      It is interesting that when Portland imposed a growth boundary with an alleged “20 years supply of land” within it, prices began to inflate just 4 years later. Alan W. Evans, writing about this phenomenon, suggests that the only regime for supply of land for housing that would keep prices stable, could not possibly actually “control growth” – it is either leaving it all open – totally liberal – or nothing.

      The crucial difference is in the behaviour of land owners. Land owners who have been granted a share in some quota of “X years supply of land” behave quite differently to land owners for whom all land owners within automobile commuting distance of a city, are effective competitors. On the open road, cars can cover such long distances in such a short time, that a mere 10 minutes drive beyond the fringe may well contain sufficiently superabundant land supply that prices will be kept stable. Indeed some developers may develop master planned communities 20 minutes away because of local scenery etc. Growth boundaries with only a few years supply of land effectively limit car access to some travel time like 2 minutes beyond the existing fringe.

      And of course there is a radius/circumference effect that means the supply of land increases exponentially to the actual distance. I strongly believe that Germany’s housing prices are surprisingly affordable because so much high speed travel by car in multiple directions from most cities, is possible. Imagine Auckland with literally 20 times as many Pukekohes and Warkworths accessible in the same travel time.

      When, as in the case of Spain, you have site owners even of “abundant” quantities of land extracting the maximum possible economic rent, and a supply chain from application for development permission to actual completion, of 7 years long, when the bust comes, you are going to have a LOT of work in progress and sites land banked, with bubble equity in them to be destroyed. In contrast, Texas supply chain is famously 6 to 7 weeks long, no land price inflation is involved, and any downturn in demand results in marginal small builders packing up their pickup trucks and going home to concentrate on maintenance and additions and joinery and so on until housing demand picks up again.

      In Spain, the motivation for zoning of abundant but NOT “LIBERAL” supplies of land, was the chasing of fee income by local government. If supply of land is totally liberal, there is nowhere near the same scope for chasing fee income. The fee income under bubble conditions, is fee income of a higher level, brought forward. After the crash of course the revenue dries up.

      If we are not prepared to totally liberalise land supply, all we can do is engineer a bigger bust eventually by virtue of having built more houses and “released” more land banks onto the market. As Spain illustrates, you can have affordability eventually, but……!

      One of the intellectual issues involved is the efficiency or otherwise of “splatter” development. Liberal, “unboundaried” growth occurs in messy splatter patterns when planners want a nice incremental carpet growth gradually pushing out. Actually there is no intuitive reason to assume the latter is more efficient. Doing trunk infrastructure in long runs is more efficient than forever breaking into it to add short runs; and the market and government can far more efficiently work out how to use the undeveloped bits of land left in between the splattered developments, compared to planners trying to allocate every bit of it incrementally. In fact planners generally have failed dismally in setting aside rights of way and parcels of land for public use and so on. Buying land years too late is costing the public through rates and taxes, far too much already. Councils actually have the gall to charge DC’s according to the inflated land prices they are paying, when they could have set it aside near-costlessly with truly “good” planning.

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      • I agree with Phil that efforts to provide a controlled increase in land supply to date have been singularly unsuccessful. My understanding of how they work in Auckland and I believe other places is that some formula is used to calculate the amount of land to release. The incentive is always there for land bankers, other speculators and indeed the current owners to simply add the released land to the speculative pool with little or no impact on the price to end users. I had something different in mind – I would propose a policy of increasing land availability whenever the ratio of urban to peri-urban land prices exceeds some maximum, with that maximum scheduled to reduce gradually over time until the restriction is removed entirely.

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  4. Why need real overbuilding be especially damaging in this case?

    I can see the case if there were, say, piles of banks here who’d advanced loans for it and then had issues. But if it’s all fuelled by overseas capital, then we get a larger and better stock of housing, they lose money, rents drop, and Auckland becomes affordable.

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    • Yes, there wouldn’t be loan losses on the development of those apartment blocks, although the losses on rest of the housing stock could be much larger, since the price correction would be deeper if physical oversupply happened. But I have to be consistent and say that the banks looked well-capitalised, and stress tests suggest they are robust.

      I think the argument about real over-supply is about a combination of diverted real resources (say there is a temporary demand for empty apartments, which is met by increased supply, and then demand dissipates) which have little social use, and about the ability of the economy to absorb the labour devoted to the construction activity in the first place. A huge building boom for 5 years (which would drive the real exchange rate even higher) followed by the bust could well be a nasty recession. Yes, the Rb can cut the OCR and the exchange rate should fall, but as (say) Australia is finding reabsorbing resources after an investment boom can be quite slow (and hence costly).

      Now if the PC estimates of the shortage of physical housing are right, the offshore-financed building strategy would be win-win. Temporary Chinese capital flight boosts effective housing supply, and then the demand dissipates leaving us with the housing we need at much cheaper prices. But if there are more or less enough houses, and expensive land is the main issue, we might just end up with too many houses. Perhaps I should just be content with “the market will sort it out”, and since I don’t propose restricting such developments (and agreement with your subdivision land point) I guess I am.

      Will look forward to the ideas on easing zoning. Do you know of cases where land supply use restrictions have been materially, and sustainably, eased/unwound.

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      • I do not believe there are any examples of “land supply” reforms that introduced (or re-introduced) sufficient liberalisation to bring prices down immediately. There ARE examples of supply being increased substantially, usually because local government loved the fee revenue from it, but this does not cause prices to fall until after a bust.

        The State of Florida around 2011, abolished the Statewide mandate for urban areas to have growth boundaries. Of course it was too late then to have a noticeable effect until the next cycle – this is “watch this space” stuff. Of course some cities in Florida still have boundaries on their own initiative. Tennessee did enact a Statewide mandate in around 2002 but in practice local developers and landowners found so many ways around the controls, that they never had an inflationary effect, and possibly the mandate has been softened more recently anyway because of push-back. A culture of freedom and “this resource is given to us by God to USE”, might be surprisingly important in “affordable housing” US regions.

        Albert Saiz, a colleague of Glaeser at Harvard, believes this is important enough that he controls for “proportion of population that are Evangelical Christians”, in his studies of the importance of relative factors on housing supply elasticity by city.

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  5. Q: If China allows a large investment in NZ [large in a NZ sense not relative to China] and then China suffers a major economic contraction driven by its slowing exports and what I think is over inflated internal credit bubble collapsing…would I be right in thinking that NZ could benefit much as the US did when Japan inc had to sell chunks of its investments in US real estate back in the late 80’s/early 90’s? i.e. they would have been a net wealth transfer to NZ when China based investors sell out of NZ real estate to prop up home operations if such an economic event occurred in the PRC?

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  6. (all else equal) then yes that sounds right. Selling your assets and high prices and buying them back cheaply sounds attractive. Of course, it isn’t the same individuals who will gain or lose, and all else is never equal (a nasty Chinese adjustment isn’t likely to be good for the rest of the world).

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  7. Letter from me to NZ Herald yesterday, one of dozens that the Herald does not see fit for publication:

    Auckland’s housing problems, and NZ’s, need more intelligence in their discussion and analysis. Your opinion piece from Matthew Goodson last week had some excellent insights that should not be overlooked.

    Overseas investment is often good for an economy, but it is all bad when all it is doing is pushing up the price of existing housing and creating a speculative bubble that has to burst eventually.

    Intelligent analysts including Matthew Goodson consider “infrastructure bonds” as a good way to finance the infrastructure needed for growth. Requiring upfront “contributions” from developers, which are then lumped into the price of housing, is part of the current problem. Obviously overseas investment could be channeled into infrastructure bonds; overseas residents wishing to invest in NZ property should be required to invest in a matching level of these bonds first. Plus; investment should only be in newly-built property, not existing stock. The nationality of the investors should be and can be irrelevant.

    NZ actually needs whole new mini-cities and this is the way to do them. Expecting intensification to provide significant new supply has been a dismal failure in decades of planning experimentation in the UK – housing shortages just worsen, Plan after Plan.

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  8. Michael, on the tricky subject of “housing shortages”, you are right to be skeptical. But part of the problem is that high prices themselves limit demand by forcing people to not form new households.

    I like the approach of John Stewart in the UK; he estimates “expected longevity of existing housing stock at current rates of replacement”. When he started doing this in the 1980’s the expected longevity was around 1000 years and a couple of decades later it had risen to 1800 years. The UK is THE illustrative basket case example of where the planning insanity leads, that hands holdout powers to land and site owners, Plan after Plan after Plan, then wonders again and again “what went wrong”?

    THIS is an excellent engagement with REALITY on the ground in heavily-planned quota-schemed London:

    http://blogs.lse.ac.uk/politicsandpolicy/why-arent-we-building-enough-homes/?utm

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