On housing prices

This post is by PaulL, a regular commentor and occasional contributor. It is tangentially related to the series on effective marginal tax rates and incentives to work. The index to all posts in the series can be found here.

A slice of the effective marginal tax rate (EMTR) problem relates to the accommodation supplement. People who are not in receipt of accommodation supplement face lower EMTRs.

Accommodation supplement expenditure has increased substantially in recent years. In 2017 it cost $1.1 billion per annum, in 2021 it cost $2.3 billion.  Accommodation supplement applies to accommodation costs that are more than 25% of the base benefit. This is therefore even more striking given that benefit rates have increased substantially in recent years. Accommodation costs must have been rising faster than benefits have.

The accommodation supplement has an abatement rate of 27%, and that abatement is on top of any abatement already occurring for family tax credits.  This is a big driver of the high EMTRs for people at around 20-30 hours of work per week.

The best way to solve this problem would be to reduce housing costs. If people paid less for accommodation then fewer people would need accommodation supplement. In my opinion the increase in people receiving accommodation supplement is an important contributor to the higher EMTRs people face today than they did 5 years ago.

Any policy environment that seeks to improve incentives to work therefore ideally also would address high housing costs. 

Housing prices are currently falling in NZ. Auckland had an over ten percent housing price decline in the last year. Other regions appear similar. Remember also that inflation was over 7% in the last year, meaning that in real terms house prices have fallen 17% or more in the last year. A couple of years of this could make big inroads into the price of houses.

Rental costs are not falling at the same rate, and in fact increased by 4% in the past year (a decrease in real terms of 3%).  

Increasing interest rates heavily impact on housing affordability. Mortgages are more expensive to service, both for owner occupiers and for landlords. This increase flows into accommodation affordability. Whilst house prices are currently falling, housing affordability is not greatly improving.

What would a sensible policy on housing look like?

The outcome we want is similar to that we currently have – that housing prices are falling a little in nominal terms, but are also being further reduced by inflation. Using inflation to reduce house prices in real terms is politically much more palatable than nominal reductions in house prices, because it doesn’t result in home owners having negative equity. For this reason it may be politically wise to run slightly higher inflation in the medium term – perhaps 2-4%, instead of 1-3%.

We also need to make sure that house prices don’t immediately start increasing again after this current downturn.

House prices have a number of drivers. House prices are set by supply and demand, as are any prices in a (mostly) free market. However, that doesn’t mean prices can just float to any level.

Supply is constrained by the price of building new houses. If houses cost more to build than people are willing to pay, then supply will contract. In basic economic terms the supply curve shifts to the left when costs of building increase – the price that you need to pay for houses at a given level of supply increases.

Government (both local and national) impacts substantially on house prices on the supply side.  

Land use policies drive the raw cost of land. Protecting ostensibly high value farmland drives up land costs. Urban boundaries prevent building out, development restrictions prevent building up. Development contributions, planning rules and constraints on new infrastructure drive up the cost of subdivided land.

Consenting and inspection regulations add to the cost of every newly built or renovated/extended house, and delays in consenting add cost. Building regulations increase building costs. Government policy gives effective monopolies to building product suppliers – the combination of building regulations and liability rules makes it expensive and risky to specify products other than those commonly used, and stifles innovation in building systems.

The combination of all these government driven factors increases the price to build a house. That doesn’t mean we don’t need these things, but they should all be reviewed to see if the same outcomes can be achieved without increasing costs so much.

Supply is also constrained by workforce. The shrinking building workforce is at least partially impacted by incentives created for young people to go to university as opposed to an apprenticeship, and I understand that the current polytech/apprenticeship arrangements are a disincentive for many to enter the industry. We need a serious policy on moving people into skilled trades, and we need to make sure young people understand that as a valued and valuable career.

At the other end, demand is influenced by how many people want a house, and whether they can afford it. 

Net migration clearly increases demand – more people need more houses. Conversely, lack of migration will dampen demand.

Low interest rates encourage demand – more people will want a house when they can afford to service a mortgage. As interest rates rise the cost of owning a house increases, and people may choose to live in larger households rather than buying their own home (i.e. stay living at home).

So whilst supply and demand is setting prices, there are elements of government policy that impact upon both supply (and cost of supply) and demand.

The current drop in house prices is welcome from a welfare viewpoint, but it is also unlikely to be sustained without substantial policy change.

The cost of rental accommodation (likely to be a high proportion of lower income people) is influenced by underlying house prices, but also by other government policies. Removing mortgage tax deductibility for landlords makes rentals more expensive. Changes to housing standards and to renter v’s landlord rights also make rentals more expensive. 

Any action to alter the incentives to work and abatement rates needs to consider accommodation costs as a whole, and ways to bring these down.

To me, a sensible policy on core housing costs would:

• Free up land on the outskirts of cities for building
• Free up redevelopment of land inside the city to permit more dense housing, even where some people don’t like that densification
• Streamline the approvals process in council, and reduce the cost and bureaucracy associated with building
• Reduce the development contributions and general costs of development, and make more infrastructure available to allow subdivision
• Where development contributions are taken, require that they are actually spent in the vicinity of the development, not syphoned off to some other region entirely
• Allow more flexibility in building products and building systems, in part by reforming the liability rules that holds councils joint and severally responsible when they approve anything new, in part by allowing easier substitution where brand name products have been specified in building plans
• Leverage government building programmes (Kianga Ora and Kiwibuild) to create a pipeline of new building workforce – perhaps through requirements for apprenticeships baked into long term contracts
• Leverage government building programmes to approve new building approaches that reduce cost – akin to the acres and acres of weatherboard state houses that we have around NZ, all built in a similar way to a similar standard
• In general allow more personal choice in housing. Instead of regulating everything, let developers build houses/apartments that we think people won’t buy. Not poor building quality, but maybe small or with no parking. And then if it turns out nobody buys them, then the developer loses money, their problem. At the moment we appear to have urban planners pre-emptively deciding what the market will want

Further, a sensible policy on rental costs would:

• Avoid loading costs on landlords
• Restore interest deductability on mortgages, returning the tax system to the same as experienced by basically every other business
• I’m not as fussed by the brightline rule, as I don’t think there’ll be much capital gain in the next 5-10 years. I will note that the brightline rule will mostly be taxing inflation in the near term, and taxing inflation is wrong
• Restore sensible rights for landlords to remove non-paying tenants. When there’s a shortage of rental accommodation and it’s hard to evict tenants, then landlords are very selective in who gets to rent. The literature on this is pretty clear. Guess which sorts of tenants are the ones who can’t get a rental?

I also personally think most of NZs rental management companies suck majorly. I’m pretty sure there’s a market opening there, I’m not sure that government regulation is the way to solve it though. I don’t understand why people who don’t want to do their own property management invest in property – it seems that if you wanted a handsoff investment the share market would suit you better.