Phil McDermott: Back to Basics: Planning, Housing Markets, and the Cost of Ignoring Economics

Acknowledging the impact of planning on housing

At last, economists, commentators and the media in New Zealand are recognising what has been evident in many countries since late in the 20^th century; that plans to contain city growth in urban boundaries betray the hopes of large and growing numbers of urban dwellers and job seekers.

In Auckland, an independent panel has modified the proposed Unitary Plan to allow more dwellings.  But it is too little, too late; so Auckland remains consigned to increasing social division fashioned around a new poverty, a poverty rooted in the failure of the housing market.

This post doesn’t deal with numbers, or with evidence of why the Auckland Unitary Plan remains a pig’s ear.  Plenty of others have picked up on that.  Instead, it aims to set out the basics of housing supply – the complexity of the market itself and the economic principles that regulators need to understand if the ground lost is going to be recovered.

The Conclusion

This is quite a longish post that concentrates on the basics of housing markets and economics.  If you don’t want to read it all, here is my conclusion.

There are no options if we want to make housing affordable again.  Without adequate supply, initiatives to dampen demand will be futile at best, destructive at worst.

Arbitrary restrictions on urban land development that cannot be justified on environmental or infrastructure grounds must be removed from the city’s plan.  Attempting to force people into small, high density dwellings by rationing land for inside or outside the metropolitan boundary penalises all new housing and large sections of the community.

Prescribing when, where, and how much  greenfield development can take place means that the price of brownfield land, infill, and remaining unbuilt lots within the urban boundary is inevitably pushed up to the point that virtually any dwellings in any location – whether apartments, terrace houses, or detached homes on tiny sites – will be unaffordable (and unfundable) for a very large share of the community.  Trying to make high density housing affordable will require small dwellings, cheaply fitted out, built to minimum specifications, little suited to most market segments.  They will be unattractive to developers and to the banks, and, if they can be delivered, are  likely to concentrate rather than alleviate the health and welfare consequences of inadequate housing. 

This is basic economics: generation rent, the millennials, the homeless, and families across the board will benefit only if land speculation is taken out of the housing equation by removing arbitrary restrictions on where, when, and how much urban development can occur in and around Auckland.

If you struggle with this conclusion perhaps you could read on.

What Happens When You Limit Land for Housing?

It’s simple, really: if supply is artificially restricted in a market with growing demand, that market will be distorted.  As a result, monetary and non-monetary costs will be higher than they need to be. 
If the market is at all complex, regulations aimed at managing demand to offset a supply failure (like investment or lending thresholds for house mortgages) will lead to further distortion. Distortion will show up in unexpected and inequitable outcomes, advantaging some groups and disadvantaging others.

A complex market

In a growing city the market for housing is continuously changing, which makes it difficult to predict.  It’s also complex, which makes it difficult to regulate. 

Complexity comes from the many ways housing demand is divided up; for example:

·  Across suburbs and sectors (e.g., inner, outer, north, south, east, and west);

·  According to where individuals or households stand on the housing “ladder”, which in simple terms distinguishes among people seeking a first home, households after a subsequent family home (or homes), empty nesters aiming to downsize, and those wanting a retirement home;

·  By demography which, while associated with progress on the housing ladder, will further influence the dwellings people need according to household size and type (non-family household, solo occupant, couple without children, couple with children, solo parent with children, extended family, and so forth);

·  By different lifestyle preferences among, for example: large and small dwellings, modest and indulgent scale or design; different types of locality (in or near the city centre, coastal, suburban, urban village, rural township, countryside); and, increasingly, whether or not in a planned or managed community;

·  By ability to pay, through which a household might exercise its preferences.

Together these divisions can be used to describe many market segments, each with distinctive housing needs and expectations.  Consequently, a trade-off between medium/high density and lower density development is meaningless: a differentiated housing market needs both, and options within each.

When housing supply is suppressed by regulations that reduce the availability of land, the impact is spread unevenly over dwelling types and therefore impacts unevenly on demand segments.  This is most obvious in the way in which new entrants are excluded from home ownership, along with low income earners, single income households, and young families with a preference for space; in fact, young people generally.  Social divisions that were once defined predominantly by income and socio-economic status are now also marked by a generational divide.

Housing and employment

The adverse impacts of limiting the land available to meet housing demand – by location, type, and price – are compounded by the link between housing markets and the labour market. Like the housing market, the labour market is organised geographically.  People want employment close to where they live; and businesses want to invest close to where the sorts of workers they need are likely to reside.  

Ideally, the catchments for certain types of labour will overlap with the areas in which those people live. This makes jobs readily accessible to households.  Accessibility can be maintained as cities grow with the development of transport connections that let people move easily between residence and work.  This is straightforward when a city is small enough and the city centre and inner suburbs account for a large share of employment.  But as cities grow and employment becomes more specialised, the role of the central city changes, and jobs and houses become dispersed, increasing the time and resources committed to commuting. 

Restricting land for housing and employment increases the costs of investment in both.  It makes houses less affordable and business expansion costlier.  The increased commuting times, costs, and congestion penalise both residents and businesses.  By lowering discretionary spending, increasing staff turnover, and inflating wages, the effect is to reduce productivity and competitiveness.

Fiscal pressures also increase, through the need to fund more roads, transit, and associated facilities. 

The social costs

There are costly social consequences. The impacts of substandard housing and overcrowded living conditions are well known.  They include poor health, difficulties securing and holding down jobs, erratic school attendance, limited educational achievement, and diminished employment prospects. 
Even for those who are housed, the high costs can create financial stress, contributing to domestic violence, and welfare and charity dependence.  The absence of starter homes, high rental commitments, and excessive mortgage repayments act to delay family formation and child-bearing, reducing fertility.  Ultimately, high housing costs will also suppress any offsetting demographic or economic gains that might come from immigration by making a city unaffordable to new arrivals.  It may well fuel outward migration, particularly among those with the skills and motivation to improve their situation elsewhere, robbing a city of some of its most socially mobile citizens.

The consequences of declining ownership

That fact that lower affordability reduces the opportunity to own a house is now well documented.  A prolonged period of renting becomes the only viable option for many if not most new households.  

This brings its own problems, especially in New Zealand where the institutional arrangements that might bring stability to renting are absent.  Lack of secure tenure is reflected in negative measures of school attendance, job retention, income growth, and social networking.  In contrast, home ownership has been a traditional path for saving and building equity, with the benefits of home improvement and appreciation accruing to the owner-occupiers.  Ownership provides households the stability required to underpin educational and career progression, savings, health, and social stability.

The opportunities to profit

The upsides of a housing shortage are confined to particular groups.  Home owners with significant equity may purchase one or more investment properties for rental purposes, boosting their incomes while bidding upprices. This favours older groups at the end of their careers and heading towards retirement, further highlighting the contrast in fortunes between retiring baby-boomers and the millennial generation

Then there are the speculators.  They may be small investors on-selling their rental properties for the capital gain.  Or, they may simply be owner-occupants who buy and sell regularly, sometimes improving their houses, but always seeking to exploit rapid price escalation by on-selling.

Large scale institutional investors, development companies and investment trusts, may accumulate green or brownfield land for development, and simply hold it in undeveloped form to farm the long-term gains from appreciation, writing holding costs off against investments elsewhere.  This slows the market – with less properties on sale than might otherwise be the case – and entrenches the shortage, compounding the distortion initiated by planning restrictions. 

Fixing it

Increasing housing supply alone will not solve the problem once the distortions initiated by inappropriate plans have become embedded in the behaviour of market participants, as is the case in Auckland with 15 years of compact city plans.  While boosting the supply of land for development is an essential first step on the path to normalcy in the housing market, reform to taxation laws will also be necessarily to remove the market manipulation evident in land banking and speculative investment. Imposing a modest capital gains tax across the board is the most obvious such measure, which would bring New Zealand into line with the rest of the world.

On the land use front, there are no options if we really do want to make housing affordable again.  Any attempt to force people into small, high density dwellings by limiting how much land will be made available for new housing penalises all categories. By prescribing when and where greenfield development can take place, the price of brownfield land, infill, and remaining unbuilt lots within the urban boundary is pushed up to the point that any dwellings built on it – whether apartments, terrace houses, or detached homes on tiny sites – will be highly priced and remain unaffordable to a very large share of the community.  Making high density housing affordable means small dwellings, cheaply fitted out, and built to a minimum specification, little suited to most market segments and difficult to finance. 

This is basic economics: generation rent, the millennials, the homeless, and families across the board will benefit from access to housing in whatever form they might seek only if land speculation is taken out of the equation.  This means removing arbitrary restrictions on where, when, and how much urban development can occur.  Until then, the Auckland Plan, even in its revised form, will remain the major impediment to creating a livable city which works for the majority of its residents.