Inside the Gordian knot of Auckland’s housing supply
It seems wherever first home buyers, renters and the Government turn, they just cannot find a way to ramp up Auckland's housing supply to meet unquenched demand. Here are the twists and turns and loops of this Gordian knot of a problem for the New Zealand economy and society. This week’s revelations of bank funding restrictions is just the latest in a long list of roadblocks to house building.
Why won’t supply ramp up in response to higher prices?
The usual laws of economics say that when a price of something rises sharply in response to higher demand, the producers will increase their output to meet that demand. The recent swings in milk prices show how that works. Dairy farmers all around the world responded to record high prices in 2013 by increasing their cow numbers and feeding them extra. Milk powder prices more than halved by 2015 after farmers ramped up supply.
New Zealand and Auckland used to be much better at building houses quickly to meet the demand of a fast-rising population with plenty of jobs, high incomes and low interest rates. In the early 1970s New Zealand’s house building rate rose to 12 per 1,000 people. Last year New Zealand built just over 30,000 new homes at a rate of just over six homes per 1,000.
Yet there’s no shortage of market signals to build new houses. House prices in Auckland have more than trebled over the last 15 years and it’s clear there’s plenty of buyers. The official estimates are that Auckland needs to build 13,000 houses a year to keep up with population growth from migration and more births than deaths.
But last year just 10,000 consents were issued and fewer than 8,000 new homes were actually built and certified for occupation. Auckland’s housing shortage is estimated to be around 40,000 homes and rents in Auckland are now rising more than five percent per annum, which is twice as fast as wage growth.
Clearly supply is not responding to prices and strong demand. Auckland housing supply is incredibly inelastic, as economists say.
So what is making supply in Auckland inelastic?
This is the $500 billion question facing the Government and the economy. That’s because Auckland property is now worth well over $500 billion and is distorting the economy, society and politics in all sorts of perverse ways that is suppressing productivity, worsening child poverty and widening inequality. Rents are now rising faster than wages and employers are struggling to get skilled and unskilled people to work in Auckland because of the housing costs. The most vulnerable cannot get affordable housing, either to rent or buy. Children are bouncing from private rental to private rental and then from school to school. Many homes are not healthy, let alone affordable.
The basic problem is that developers struggle to find enough land at a low enough price to create a house and land package or an apartment at a price that a couple (let alone a single person) can reasonably afford.
There are plenty of reasons for the shortage of land available for housing, both on the fringes and in the centre of the city, and even more parties willing to blame each other for that shortage.
The Government in Wellington argues the combination of the Resource Management Act (RMA), Auckland Council’s attitudes and the Council’s tight balance sheet have prevented land from being made available. The RMA has extended the planning horizon for developers out to seven or eight years because of the multiple rights of appeal, which makes developments riskier and more expensive.
The Council has borrowed as much as it can without a credit rating downgrade that would push up rates by one percent per annum. That makes it resistant to expensive investments in the roads, pipes, footpaths and parks that are needed before a developer can start selling plots and/or building houses. The Council also has only a couple of revenue sources, including rates and charges on developers to help pay for roads and pipes. The benefits of economic growth in Auckland go largely to the central Government in the form of higher income taxes and GST.
So surely someone has tried to fix the RMA and remove those council funding restraints?
The combination of Auckland’s councils into the Super City was supposed to make it easier to grow, as was the passing of the one plan for them all -- the Unitary Plan – which extended the city’s boundaries for new suburbs and changed the rules to make it easier to build apartments, terrace houses and townhouses closer to the CBD.
The Government has also tweaked the RMA a few times and introduced a stop-gap measure called the Special Housing Areas (SHA) Act. It pushed through some developments in a faster timeframe than the RMA, but it expired late last year. The Government hopes the Unitary Plan and a new National Policy Statement on Urban Development will nudge councils to fund and approve the infrastructure needed to support new houses.
The Government has also offered $1 billion to help Councils fund the pipes and roads needed to bring forward housing development. It hasn’t approved any projects yet and Prime Minister Bill English has already pushed back at some of the proposals, saying they aren’t really bringing forward new projects, but are only funding projects already in the plan. Approvals are many months away, or even longer. There is still a debate to be had about the structure of the vehicles that build and own this infrastructure, so this funding is no quick fix.
Auckland Mayor Phil Goff has tried to get another tool to deal with a $4 billion shortfall in transport funding in coming years, but his idea of a regional fuel tax was rejected outright this month by Finance Minister Steven Joyce. Revenues from GPS-style congestion charging are still up to a decade away.
The short answer is the funding restraints for infrastructure development are not solved yet, with the biggest problem being the Council has few incentives to invest heavily for growth when the Government in Wellington gets most of the benefits and does not have to pay for local roads, some of the railways and none of the pipes.
But that’s it right?
No. Unfortunately, the RMA and infrastructure funding issues are not the only blockages to new houses being built. Risk of losses in any downturn, access to bank loans and land banking are also issues.
Most developers buying the land for a development, paying for the plans and contributing to the infrastructure need to borrow the money from a bank. To do that, they need to be confident they can sell the development to rental property investors, first home buyers and others, and then prove that to the bank.
The developer has to be confident they will not be left holding the parcel of land or a half-built apartment if the market suddenly cools and buyers can’t or won’t stump up the balance between their deposits and the sale price. They also have to be confident that construction or legal costs won’t blow out over the time it takes to get resource and building consents and funding.
Meanwhile, the banks have to be confident they’re not going to be left holding an unpaid loan to a developer if the market suddenly grinds to a halt and land prices start falling. The best example of what a property development loan looks like to a lender when the music stops is what happened from 2007 to 2012 when finance companies collapsed because they were stuck with empty holes in the ground all over Auckland and Queenstown. Finance company investors and a couple of overseas banks – Bank of Scotland in particular – had to book big losses.
Then there’s whether the banks are confident lending to the ultimate end buyers of these developments, particularly the rental property investors who are deemed higher risk than owner occupiers. The other issue for the banks is whether they have the funding to lend to developers and whether regulators will let them. As we discovered this week, bank regulators on both sides of the Tasman are wary of the big four Australian-owned banks becoming too exposed to riskier property developments, particularly given an apartment glut looming in Melbourne and Sydney.
And then there’s the risk to everyone of a rise in interest rates and some sort of economic downturn that causes a fall in house and land prices, which is what we saw from 2007 to 2010. Auckland house prices fell five to 10 percent through 2008 and 2009 after mortgage rates hit almost 11 percent and the Global Financial Crisis hit.
Mortgage rates started nudging higher late last year, despite the Reserve Bank saying it expects to keep the Official Cash Rate on hold for at least two years. Bank funding costs are rising and they’re also looking to increase their net interest margins.
The toughest of all the knots is the way developers and new home buyers feel about market risk when house prices have trebled in 15 years and house price to income multiples are well over 10 – three times what most international experts consider an affordable level. No one wants to buy if they think a market is peaking. It creates a Catch 22: very high prices both encourage and discourage development, depending on how close the cycle is to peaking.
So how can this knot be unpicked?
Very carefully and with a lot of nudges and tugs and scraping.
The Government and the Council will somehow have to find a way to fund the transport and water infrastructure needed for housing. The developers will need to see strong and reliable source of demand for home buyers that will not dry up in the instant of a financial crisis or economic downturn.
Land bankers will need to have their expectations of un-ending capital gains broken by a flood of new supply and assurances from Governments that enough land will be supplied – regardless of market conditions.
Construction companies will need to be confident enough about a big pipeline of house building demand that they create the economies of scale (potentially through house building factories) to bring house building costs down. They will also need the workers and building materials to build the 400,000 or so houses needed over the next 30 years.
And that’s just the supply side of the problem. The demand side is for another day.