NZ Initiative’s Jason Krupp says low interest rates and high population growth are not to blame for spiralling house prices - try red tape

By Jason Krupp*

Unlike broken clocks, bent rulers can still be very useful provided the same faulty instrument is used to measure differing items. That way comparison is still useful.

So it is with Demographia’s housing affordability methodology. Every year the group produces a report that compares the median house prices against the median household incomes across a host of cities to assess how affordable housing in these cities is.

This year Auckland made headlines because the ratio of incomes to house prices hit 10:1. In other words it now takes ten years of the median household income to pay off the median house in Auckland – a record high for the city.

A common critique of this approach is that it fails to take interest rates into account. Indeed, that is exactly what Harshal Chitale and David Norman of Auckland Council’s Economist Unit have done in their latest newsletter.

The pair argue that “House prices have surged in Auckland and similar cities because people want to live and invest here and because much lower interest rates have made it easier to service debt.” They support this position by noting that other coastal cities like Sydney, San Francisco and Vancouver have experienced similar house price inflation pressures.

In other words, excessive demand is the problem.

Unfortunately this only tells a portion of the story. Chitale and Norman have a point that Auckland has seen high levels of in-bound migration swell the city’s population, and interest rates are pinging around historical lows, allowing households to take on more debt.

This is where Demographia’s broken ruler tells the other side of the story in that it looks at cities around the world and ranks them. What it shows is that while some cities have seen housing affordability decline, for some it has improved or remained static.

If interest rates were a reliable predictor of housing affordability all cities would have seen affordability decline in 2016 because borrowing costs are low across the world. Also, low interest rates have not made the price of other goods that are usually acquired with borrowings shoot through the roof, such as cars. This suggests that there are other factors at work.

Another possible explanation is population growth. High rates of immigration have certainly increased demand for housing in Auckland. But if this is the true explanation for Auckland’s housing woes, then all cities that experienced high population increases would also have experienced significant house price increases.

But again, the Demographia ruler shows this is not the case. Houston and Dallas-Fort Worth, two cities in the state of Texas, were two of the fastest growing metros in the United States in 2015. And yet they remain some of the most affordable cities in the Demographia report, with median multiples of 3.5 and 3.7 respectively.

If low interest rates and high population growth were the true cause of spiralling house prices all the cities in the chart below would have seen housing affordability deteriorate in lock step with each other. Clearly that is not the case.

It is not the things that Houston and Dallas-Fort Worth have in common with these cities that is interesting, but rather where they differ. In the two Texan metros it is far easier for the housing market to respond to rising demand and greater ability to pay because there is so little red tape to prevent building.*

Meanwhile Auckland, Sydney, San Francisco, and Vancouver are drowning in regulations on home construction and land supply. The results are reflected in the state of their respective housing markets (see chart).

To use the car example again, when private vehicle sales rose in the December quarter, riding the tailwind of positive net migration, prices did not shoot up to record highs like in the housing market. That’s because dealers ramped up supply to meet demand.

With housing the market cannot do this because regulations have choked off the ability of business to respond quickly. The regulatory logjam is extensive. At a local level things like the Urban Design Council, Cultural Impact Assessments, height restrictions, and rural urban limits have severely limited the city’s build rate (admittedly things have been improving in some of these areas).

At a national level, the Resource Management Act, Building Act, Land Transport Management Act, and the Local Government Act have turned New Zealand’s planning framework into a byzantine nightmare.

To be clear, it is supply that is the problem. To suggest that demand is the root of all housing evil ignores the real lesson of the Demographia report.

In their note Chitale and Norman say the fix to Auckland’s housing problem will take “collective action from central government, the building industry, land owners, banks as well as the council.”

Again, they are only partly correct. The building industry, land owners and banks are merely operating within an existing framework that they do not control. That responsibility for the framework lies with central and local government.

Central government is currently working on its latest amendments to the RMA, which are a bit of a mixed bag. But as the NZ Council for Infrastructure Development previously noted, the reforms are pointless unless the other parts of the planning system are aligned. Work by the Productivity Commission on what a fit-for-purpose planning system would look like is also promising, albeit on the blue sky side of the policy spectrum.

For local government the focus needs to be on where councils can remove red tape from the system as so to free up building supply. More broadly, the focus on supply constraints needs to be redoubled. Dragging up the thoroughly debunked notion that demand is the problem is a step backwards. If there is any doubt on this, I suggest they consult Demographia’s useful ruler, even if it is a little bent.

(*Demographia does not cover cities in continental Europe, but the same housing affordability pattern is observable. In countries like Germany and Switzerland, with few restriction on residential building, house prices have remained flat after adjusting for inflation. Where building regulations are high, such as in Britain, housing tends to be unaffordable.)

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*Jason Krupp is a Research Fellow at The New Zealand Initiative, which provides a fortnightly column for interest.co.nz.