Escaping the High Price Trap
This post was expanded slightly on 24/10 for clarity
New Zealand went to the polls on 23 September, but only a few days ago did we finally arrange who would form the government. It’s a historic second in many ways: the second Labour - New Zealand First government, the second-youngest premier, and despite many misconceptions, the second time the largest party has not been in government.
But in another way it’s a first. For much of New Zealand’s history, the price of housing was not a major issue: the first Labour Government saw the quality of housing as the main issue, rather than tenure. Every government since has to some degree seen rises in house prices as a good thing, that allowed households to “build wealth”. But the flip side of those rising prices is for those who don’t already own: renters, and aspiring buyers. For them, rising house prices mean more expense putting a roof over their heads.
The outgoing government has seen prices rise more dramatically than ever: according to The Economist New Zealand’s housing is the most unaffordable in the world. But the new government is made of parties that campaigned heavily on making housing affordable, and this really is a first.
How the government can drop prices
Our unaffordable housing has many causes: financial (interest rates, lending conditions), speculative (expectations of future capital gains, overseas speculation), and regulatory rules and market pressures causing most new builds to be aimed at the top end of the market rather than more modest dwellings.
The chief cause, though, is the lack of supply. The construction industry doesn’t have the capacity to build, and when it does, planning restrictions have made it difficult or impossible to build in desirable locations - established suburbs in the main cities.
The new government has promised to tackle most or all of these. KiwiBuild will make the government far more involved in construction, by promising to directly build and sell 100,000 houses in ten years. Planning regulations will be liberalised for expansion both “up and out” in Auckland. Restrictions and taxes will be placed on speculation, foreign and domestic. These all promise to reverse the drop in prices.
That said, the main government party, Labour, has explicitly refused to say it wants house prices to drop. It’s worth looking at why.
What this will look like
Regardless of how it’s achieved, for new home buyers, falling prices are all good news. For renters, reduced capital values on houses should also lower rents.
But for a moment, spare a thought for those who do already own houses. Obviously, they are some of the people doing the best in society, especially anyone fortunate enough to own more than one dwelling. Why would a left-wing party care if their properties become less valuable? Indeed, unless you’re planning on selling, why would you care if the home you own and live in loses value on paper? It’s still the same house it was yesterday, and you still get all the same benefit from living in it.
But most people who own houses don’t really own them. The bank does. And when the value of the house goes down, the mortgage doesn’t go away. You still owe what you paid for the house, not what it’s now worth on paper. You could easily owe than what the house is now worth. Lose your job, or fail to keep up with mortgage payments, and you could well be bankrupt. A fall in house prices and a little bad luck could well send you from the middle class to the benefit. Our parties of the left are not quite left enough to shrug that off for hundreds of thousands of voters.
Worse: you might have borrowed against your house to fund a business. Suddenly, your business, too, is insolvent, with a flow-on to anyone you employ, and other businesses whose services you use. A fall in house prices can end up as a major very real shock to the economy.
The three ways out
So, we want house prices to drop for new buyers. But we also don’t want house prices to drop for existing owners. How can that possibly be done?
There are three ways, and only three ways, to achieve both of these at once.
This is what the outgoing National government pinned its hopes on. If people are paid more, houses are more affordable in terms of your income, without affecting anyone who already owns a house.
But it’s an impossible dream. Thanks in part to that very National government, wage growth is lower than the growth in house prices. Even if house prices stalled, it would take a generation for wages to catch up.
This is the means New Zealand has traditionally used. Prices and mortgages stay the same, the money is just worth less. Wages go up on paper, but buy the same amount. Essentially, prices drop in real terms, but the debt inflates away.
But governments have also long seen inflation as a bad to be avoided. New Zealand targets inflation of just 1-3%. Inflation wipes out debt, but it also wipes out savings: the savings of aspiring home buyers, and of those saving for retirement, among others. As people start to expect high inflation, it also drives up interest rates, undoing much of its own benefits. It’s also associated with a lack of certainty and reduced investment, stalling economic growth - and house-building.
Splitting the market
But do cheaper houses for new buyers automatically mean lower prices for existing owners? Incoming Prime Minister Jacinda Ardern has said “For homeowners, the ones who currently have their homes. We don’t want them to lose their value, but we want more affordable housing in the market as well, and that is what is missing.”
Is that possible? Right-wing commentator Hugh Pavletich says “You can’t have an affordable market and an unaffordable market sitting alongside of each other”, which is true enough if both markets are selling the same thing.
But what if they aren’t selling the same thing?
In an interview on The Nation, Jacinda Ardern suggested that the distinction would be about the size and quality of dwelling: existing houses were 200sqm or more, and new affordable houses would be 100sqm or less.
This is a valid point, but on its own, it’s not enough. There are plenty of modest dwellings out there, built in the 1980s and before. But they are still incredibly expensive, as well. Can new dwellings be more affordable than these?
What is a house worth, anyway?
The value of a house (or apartment) is made up of two parts: the improvements (the building itself), and the land. The building itself is normally worth about what it costs to build, or to replace. Rises in “house prices” are really increases in the price of land, and the price of the land is by far the larger component in severely unaffordable markets like ours.
But how much land a house needs is not a fixed amount, and here is our solution. Land has a value per square metre, not per house. If the price of land remains the same, an existing house keeps its value, as long as the amount of land it sits on does not change, which of course it does not: the land isn’t going anywhere1.
But building a new house, or apartment, requires as much or as little land as you choose to use for it, assuming you’re allowed to build it at all. A house can sit on a smaller section, and automatically become cheaper. An apartment can sit above another, and divide the cost of the land between more units. Both make a new dwelling available at a cheaper cost, without affecting the cost of existing units.
It makes sense: if you can knock down one existing house to build multiple new houses, the link in prices is broken. As long as the sum of the values of the new houses is worth more than the value of the one house you knocked down, the developer can make a profit (or for the government, through KiwiBuild, break even). But each individual new house is cheaper than the old one.
So we’ve done the impossible, and split the market: new affordable dwellings, and old ones keeping their value. Not because they are overvalued and scarce, as before, but because those existing houses sit on valuable, developable land. You’ve traded a value that only came from scarcity, and traded it for a value in something real: the ability to build multiple new houses.
Intensification: the magic bullet
Of our all the government’s many tools to lower the price of a place to live, only one can make a new dwelling cheaper without dropping the value of the homes people already own. You can tinker with taxes and regulations and interest rates, but only one lets the government have its cake and eat it too. Intensification: building more houses in the same space. So when the government decides between building “up” and “out”, there’s more at stake than environmental goals or planning fads. It’s also about whether you can deliver on the seemingly-conflicting promises you had to make: helping people put a roof over their heads, without wiping out those who already have one.
A true left-wing government might be tempted to say “the hell with it, let’s crash prices”. For a more pragmatic government that still wants to make a difference, intensification truly is magic.
Except for moving towards Australia at 4cm / year. There’s no accounting for taste. ↩