The local Wellington magazine, Capital, which seems to be a curious mix of the serious and the lifestyle, earlier in the year asked if I would write a piece on house prices. That article outlined the story I’ve run here repeatedly, that durable and very large reductions in house and land prices are quite possible – we see everyday examples in perfectly pleasant urban areas in the United States – but are only likely to happen if there is genuine aggressive competition among owners of land beyond existing urban areas. It is that sort of competition, from land whose best other use is probably for something agricultural in nature, that would durably lower land (and house) prices in existing urban areas.

That article ran in April. In late September the editor got in touch and asked if I was interested in doing another piece. Since there had been numerous policy announcements around housing this year – from the government, from the Reserve Bank, sometimes from the government to the Reserve Bank – I suggested that a piece along the lines of “sound and fury, signifying not much at all other than some new inefficiencies and distortions” might be in order. That article is in the issue on sale in Wellington now, and the text is here. I will include the full text at the bottom of this post.

I wrote the article four weeks ago. It isn’t quite the article I would write today because since then we’ve had the joint Labour-National announcement on new legislation that is being rushed through which will allow more intensive (but still relatively low-rise) development in existing urban areas of our larger cities, but appears to do nothing of substance to free up land-use beyond existing urban areas (and, as I noted in both articles, there is lots of undeveloped land in greater Wellington, much of it with little economic value in alternative uses). But if I’d write a slightly different article today, the bottom line does not change: there is no sign (from ministers, Opposition spokespeople, city councillors or whoever) that those who hold power have any interest at all in delivering much lower house prices on a durable basis. They refuse to express any such interest, and nothing they have done or are now doing seems likely to bring about such an outcome. Urban density may be all very well and good, for those who like that sort of lifestyle (and good luck to them), but the international evidence offers no example I’m aware of in which allowing much-greater density in cities has been followed by move towards house/land prices dropping back towards what we see in (typically quite low-density) cities in much of the US.

In the article I suggested that much of what had been announced this year was little more than “performative display” – doing stuff for the sake of being seen to act, seen to care. That seems right for most of the initiatives, since typically the supporting advice that has been published doesn’t suggest any likelihood of a sustained impact on prices. It is possible that the parties to the latest deal actually believe that this initiative might actually make a difference – partly because they have been cheered on by some people from the genuinely pro-liberalisation side of things. But even if they do believe that – and refuse to openly say so for fear of scaring some heavily-indebted voters – they are almost certainly wrong.

The second reason for scepticism I included in the article was this

The second clue is that prices have kept on rising, and at best are perhaps expected to fall back just a few percentage points over the period ahead (despite the huge increases we’ve seen). If people – smart people with lots of money at stake – really thought that the policy changes already made (tax rules, access to finance) or those in the works (such as the replacement for the RMA, or the National Policy Statement on urban development) were going to make an enduring difference, we’d see to
see it in the prices of the assets already. That is how asset markets work, whether stock markets, foreign exchange markets, or (a little more murkily) land markets. But there are no signs or reports of substantial falls, whether for existing properties or potentially-developable land

I still reckon that is basically right, but were I writing today I might put more emphasis on the possibility of quite a shakeout over the next year or two, even while the structural problems are unchanged. In a way, this is just the sort of point the Reserve Bank has been making in its discussion around “sustainable” house prices. “Sustainable” in their terms does not mean affordable, or US-style normal. It really just means where a market might be expected to settle given all the policy-settings and distortions in the system (that underpin land prices well above best alternative use price). One can see material, even significant, falls in house prices in such markets without the longer-term structural fundamentals being fixed at all. Such falls aren’t likely to last (and in New Zealand aren’t likely to pose a financial stability threat) but they could get the headlines for a time. Many of the falls in house prices that happened around 2008/09 were of that sort – whether those in San Francisco (now incredibly expensive), New Zealand (now incredibly expensive), or even Dublin.

Building activity in and of itself does not solve the underlying problem – land prices – but it can still lead to shorter-term overhangs in the market. There has been quite a lot of housebuilding going on.

Interest rates have risen and seem likely to rise further. A return to rapid population growth, from immigration, still seems some way off. The fiscal stimulus which has helped boost economic activity will be fading, and there are all those tax and access-to-credit restrictions. None of these address the longer-term problem of a rigged market that renders peripheral (developable) land incredibly expensive in a land-abundant country, but in combination they could be a recipe for a non-trivial fall at some point soon. Of course, prices ran up so much in the last year or so that even such a fall is unlikely to take prices back to real levels even two years ago, but…..falls of that sort would grab the headlines, and would probably lead some politicians to want to claim credit for having solved a problem they haven’t really even begun to address.

Without further indenting or block-quoting here is the full text of that article.

Lots of action, but none that will fix the housing market

Michael Reddell

(Published in Capital magazine, November 2021)

October 2021

Even before Covid, house prices in much of New Zealand were very high.  Over the last year or so they’ve again risen sharply almost everywhere, putting home ownership further beyond the reach of most, and underpinning rising rents.  This dreadful situation, transferring resources (wealth) from the relatively poor and young to the relatively rich and the risk-takers, is utterly unnecessary and deeply unjust. 

In a well-functioning market, times like these should be a renter’s dream.  Purchasing a house should never have been cheaper, and rents should be lower (in real terms) than ever.

That’s because interest rates are at record lows.  The New Zealand government’s 20-year inflation-indexed bond currently trades at about 0.8 per cent.  25 years ago the comparable rate was about 5 per cent.  Basic finance theory suggests that when rates of returns on one long-term asset fall so will those on other long-term assets. And in a well-functioning market, rents are the main source of return to the owner of the rental property.

But a well-functioning market is one in which it is easy to bring to market and develop new land and new houses. In that sort of market, developing the new land (building the new houses) would now be easier and cheaper than ever.   It takes time to develop a subdivision and build houses, and finance costs are one of the major costs those in that business face.   New Zealand has abundant land, that could readily be converted to urban uses. So, of course, does Wellington, and much of the land surrounding Wellington isn’t worth much in alternative uses.   But if regulations make land artificially scarce, then lower interest rates (or other sources of higher demand) can translate quite quickly into higher house/land prices.

The alternative isn’t just some theoretician’s dream.  When I wrote here six months ago, I highlighted Little Rock, Arkansas, as one example of the many growing, pleasant and highly-affordable US cities.  Real house prices in Little Rock hadn’t changed much in 40 years and median house prices appeared to be about NZ$300000.  Interest rates are at least as low as those here.  Check any website and you’ll easily find modern townhouses to rent in Little Rock for no more than NZ$1000 per month.   Try that in Wellington.

In a well-functioning market, when interest rates fall and prices look like beginning to rise, owners of land (whether existing sites in the city or new areas at the periphery) should be falling over themselves to get new land, and then new houses, to market, and owners of rental properties should be competing aggressively to get and keep tenants.  The alternatives would be a vacant property (earning nothing) or money in the bank (earning little more).

But this is New Zealand where, absent a well-functioning market, house/land prices have surged again, where rents have been rising, and where price to income ratios –  which should be less than 4 in well-functioning markets –  are now more like 10.

There has been all manner of policy announcements this year, some substantive and others little more than rhetorical.   The government has extended the “bright-line test”, so that investors selling properties within 10 years will pay a sort of capital gains tax, and – in one of the more bizarre moves – is legislating to stop businesses owning investment properties deducting their interest costs against taxable income.  A select committee is looked into new resource management legislation.    And, of course, some councils – including Wellington’s – are moving to allow some more intense development in some parts of the city.     Bureaucrats have got in on the act too, with renewed loan-to-value (LVR) restrictions from the Reserve Bank and the threat of more restrictions to come.  And the government has insisted that the Reserve Bank should talk more about house prices.

But there are two pointers that none of this amounts to much more than performative display. The first is that government ministers – from the Prime Minister down – refuse to express any interest in lower house prices.  Instead, they talk repeatedly about just lowering the rate of increase. Councillors, and Opposition parties, are rarely much better.

The second clue is that prices have kept on rising, and at best are perhaps expected to fall back just a few percentage points over the period ahead (despite the huge increases we’ve seen).   If people – smart people with lots of money at stake – really thought that the policy changes already made (tax rules, access to finance) or those in the works (such as the replacement for the RMA, or the National Policy Statement on urban development) were going to make an enduring difference, we’d see it in the prices of the assets already.  That is how asset markets work, whether stock markets, foreign exchange markets, or (a little more murkily) land markets.  But there are no signs or reports of substantial falls, whether for existing properties or potentially-developable land.

This year’s measures aren’t designed to fix the broken housing market, just to throw some sand in the wheels, be seen to be doing something, and perhaps to buy a bit of temporary relief.  Nothing done or promised is likely to make very much sustained difference at all, because none of it gets to the source of the problem.

Some put a lot of hope in provisions allowing for greater urban density – even as our cities are already quite densely populated by New World standards.  They are probably wrong to do so.   Increasing density has already been a feature of the last few decades – think of all the infill housing a decade or two back – and, of course, the physical footprint of our cities has also expanded.  But in the face of rapid population growth – likely to resume once Covid passes – these grudging changes have only been enough to avoid house prices rising sooner to even more outrageous levels.  

Without a radical freeing-up of land use at the periphery, creating aggressive competition between development options in cities and those at the margins, simply allowing a bit more densification will not bring land prices down. It may even bid up the prices of some sections, now able to be developed more intensively.  A lot of houses are being built right now, but there is no prospect of enduringly much lower prices unless or until owners of vacant land, on the peripheries of our city, are free to bring that land into housing and other urban uses.

New Zealanders should be able to count on a well-functioning housing/land market and ready access to finance.  Increasingly we have neither; just more complexity, more inefficiency, and more-unaffordable house/land prices.

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