How 'smart growth' and migration made Auckland housing unaffordable

By Rodney Dickens*

If your business or investments are impacted by the Auckland or national housing markets, be it by what goes on in the existing house market, residential building or the section market, you should want to know the answers to some, if not all of the following questions. See the full version of this Rodney's Raving here.

* Why are some housing market cycles brief affairs, while others are sustained and strong?

* How can we tell if a boom or a bust is lurking around the corner? * Why are the cycles in the Auckland housing market so highly correlated with national cycles?

* Why are Auckland house prices currently outperforming the national market while Auckland residential building is significantly underperforming, and will this situation continue?

* How do changes in the OCR impact on the housing market, and what game will the RBNZ?

* Why does Auckland and national population growth vary so much and how can we tell when population growth will next have a major impact on the housing market?

* Are the much talked about housing affordability and financial crisis issues really important and how are they likely to impact on the housing market in the future?

* How do economic cycles impact on the housing market and where is the economy heading?

* Is it a good time to invest in existing or new housing? What drives the cycles?

We'll be running two housing workshops in Auckland (details here) will show the primary roles interest rates and net migration/population growth play in driving housing cycles in the Auckland region and nationally.

This makes sense in the context of mortgage interest rates being set nationally, but also reflects a high correlation between population growth in Auckland and nationally. If significantly more or less people leave NZ for higher-paid jobs in Australia, they will leave in roughly equal proportions from Auckland as from the rest of the country. If there is a significant change in the number of people immigrating it will impact roughly the same on Auckland as nationally.

There have been times when Auckland gained a disproportionately large share of immigrants, which partly explains larger house price increases in Auckland in the mid-1990s, but even then the timing of changes in Auckland house prices largely coincided with national movements.

Housing affordability is a much more important issue now than has been the case historically and it is having a significant impact on the level of housing demand, especially because of the tightening of lending criteria by banks in the wake of the international financial crisis. Affordability is a challenge or problem all over the country, so this issue will be impacting on Auckland much as it is impacting nationally, although there are reasons to believe it is somewhat worse in the Auckland region, as reflected in the underperformance of residential building in Auckland.

Why is the Auckland region outperforming on the house price front but underperforming on the residential building front?

At a superficial level, the answer is straight forward. The demand-supply balance is more favourable in the Auckland existing house market than nationally and less favourable in the Auckland new housing market than nationally, but how can this be the case?

The link between the existing housing market on the one hand and the residential building and section markets on the other hand is the choice people have between buying an existing house and buying a section and building a new house. The relativity between existing house prices and the cost of buying sections and building houses will impact on demand for existing versus new houses.

In our assessment the single most important issue in this context is the “smart growth” policies vigorously pursued by the councils in the Auckland region that have limited increases in the supply of affordable sections (see here for a more detailed discussion).

Anyone vaguely familiar with economics will know that limiting supply will increase prices. Prior to the housing boom starting in 2003 the median North Shore section cost $50,000 more than the median national section. At the peak of the boom the median North Shore section cost $200,000 more than the median NZ section, and even now the gap is still almost $150,000.

This magnitude difference in section prices will drive people away. To put it in perspective, if someone has to borrow $150,000 more to buy a section on the North Shore, his/her annual interest cost will be $10,680 higher based on the current average mortgage interest rate charged by the major banks. This is big bickies!

If the supply of new sections is constrained too much, as is the case in the North Shore, not only will section prices increase but existing house prices will also increase. This is because an existing house is built on a section and the implicit price of that section will change roughly in line with changes in section prices.

A lack of supply of affordable sections in Auckland is helping local existing house prices outperform relative to the national average.

However, high section prices make new housing less attractive/affordable, which is why Auckland residential building activity can underperform at the same time existing house prices are outperforming.

However, this is only part of the story. Not only do relative prices have an impact on whether people buy an existing house versus a new house, some people also migrate around the country in response to relative house/section prices.

By limiting section supply increases the Auckland councils have played a major part in making Auckland housing unaffordable to a larger % of the population, which will weigh down future population growth.

A response is already evident with Auckland house building underperforming and house building in some parts of the country where section prices are affordably outperforming (e.g. New Plymouth and Napier).

Council polices are not entirely to blame for North Shore section prices increasing significantly relative to the national average. Part of the story is the general tendency for section prices to increase more in places with higher population growth, which has been relevant in the case of the North Shore.

However, with expensive section prices now playing a part in driving population away, it can’t be taken for granted that North Shore City (and the Auckland region) will continue to experience above national average population growth. Tauranga’s population growth has been strangled by the same policies.

* Rodney Dickens is the former chief economist for ASB and now runs Strategic Risk Analysis, an independent research operation based in Taupo. He will run two workshops in Auckland on the housing market. More details are available here.