February Newsletter

I don’t know if you’ve noticed yet but starting just three or four years ago a New Zealand property developer has begun an international campaign that’s having quite an impact – and it’s something that you need to know about whether you just own your own home or you’re a property investor.

I ran into Hugh Paveletich – the New Zealand property developer in question – in my role as an economic consultant.  After I expressed interest in a website he helped establish he put me on his ‘drip’, which is to say his e-mailing list.  Rarely a day goes by without being ‘bcc’ed into an e-mail intended for the media and anyone else he can influence pretty much anywhere in the English speaking world – but particularly in the antipodes. I’ve since lunched with Hugh and his wife on one of his trips to Australia and he’s a nice fellow. 

As Hugh looked at the New Zealand property market he thought how ridiculous it was that land cost so much when New Zealand had so much of it – per person that is (per sheep it’s a different story – but I digress!).  Hugh got thinking about all those policies that go under the name of ‘smart growth’.  They sound pretty well and good.  Contain cities to certain limits so they don’t gobble up all the farms in the area in a massive urban sprawl.  Increase density, limit spending on roads and increase spending on public transport so that it’s more viable.  In fact when you look closely at these policies they come with heavy costs.  I won’t go into detail on all of them here, but suffice it to say that I think Demographia has done us a service pointing to many of them.

Hugh and his partner in the US – Wendell Cox – produce figures on all the major cities in the English speaking world on their Demographia website and they recently released their third annual report into housing availability (and prices!) in the USA, the UK, Australia, New Zealand and Canada. 

They argue that where house prices are high – like they are in our capital cities, they’re high not primarily because of increased demand for them, but because regulation – particularly the inadequate release of land for housing on our urban fringes – has starved the market of supply.

Australians might be surprised to learn that Sydney , Adelaide , Hobart . Perth and Melbourne made it onto Demographia’s list of least affordable cities.  The report found that on average Australian houses cost 6.6 times annual household incomes. According to Demographia, anything more than 5.1 is ‘severely unaffordable.’

What lends striking credence to the Demographia view of the world is that cities of similar sizes  have very different price levels and this is particularly where they regulate land differently. Take Austin Texas and Perth WA . Both cities are rapidly growing, and both have populations of 1.5 million. But whereas Perth ’s multiple median has sharply risen over the past five years from 3.7 to 8.0, Austin ’s multiple has actually fallen over past ten years from 3.3 to 3.1. This means houses in Austin are more affordable today than they were ten years ago. 

The difference, Demographia contends, lies in Perth ’s stringent land zoning regulations that monitor and restrain growth on the fringe. And the same conclusion is drawn for all 159 cities surveyed: ‘Where there is constraints on the supply of land for residential development housing inflation has occurred…Where there are no such constraints housing cost inflation has not occurred.’ Demographia’s answer to the crisis in housing affordability is to free up the regulations governing land release. When supply is balanced with demand, they argue, prices will fall.

Now if Demographia is correct, then all those first home buyers have something to get angry about – it’s politicians that are making that first home so difficult to buy – or at least its what politicians do which is regulate the release of land. And investors – well the Demographia message for them can be boiled down into one word – risk!  If Demographia are right and they get their way and politicians ease up on land release on the outer fringe then maybe our house prices will start to fall from over 6 times average earnings back to around 3 where Demographia says they should be. But the consequences are scary: investors home owners will lose their shirt.  Red ink from property investors will be running in the streets.

So what’s all this mean for your property investments – existing and future?  Well like lots of other inputs into your thinking, this is just something to be kept in mind.  The implications could be huge.  But I doubt they’ll be all that great.  I have little doubt that if Sydney or any of our capitals converted to Texas ’s style of land tenure house prices would fall – perhaps a fair way.  They don’t regulate land release on the fringe like we do.  And they have fewer restrictions on redeveloping your block – about which more in a moment.

At least one right leaning think tank – the Institute of Public Affairs – has geared up for a campaign for greater deregulation of land use. They and the Housing Industry Association are sponsoring the Great Australian Dream campaign to secure greater land release. John Howard is jumping on the bandwagon but it’s not his area – it’s the states (strange how he never misses an opportunity to pass the buck to the states). 

I expect all this activity will have some impact – indeed it already has in Victoria which has looked at ways of releasing more land notwithstanding its own previously announced plans to lock more of it up.  But somehow I doubt that there’ll be a torrent of new land released. And Melbourne ’s house prices are slowly heading up, not down.

Rory Robertson of Macquarie Bank thinks Demographia’s work is too one dimensional.  He argues that Dermographia fails to factor in the significant and interactive roles played by low interest rates, negative gearing, the halving of the Capital Gains Tax, and immigration: ‘Record levels of immigration and population growth have been a key factor in putting upwards pressure on house prices’. In the past twenty years has seen immigration grow at a steady rate of 100, 0000, a year. That’s another million people who need houses.

Robertson points out that in its list of affordable cities all are North American cities, all were inland, and most had comparatively low populations.  It is not news that most people would prefer to live in New York or Sydney rather than in Buffalo or Dubbo. The choice for Robertson is between ‘dull’ or ‘sexy’. Still I found Demographia’s comparisons between Austin and Perth and Houston and Sydney more pertinent.  Yes, Perth and Sydney are on the water and so can’t expand as efficiently as inland cities – which can do it around all 360 degrees from the city centre.  But can that really explain why Houston ’s houses cost around 3 times annual earnings while Sydney ’s are around three times that?

But will the release of land brings about a fall in inner city housing prices? Robertson doesn’t think so: ‘Releasing new housing land and building homes faster on our outer fringe is unlikely to produce significantly lower city average house process, ’  For ‘those who want to live in the inner city but can’t afford it shouldn’t hold their breath,’ land release is unlikely to be the quick fix they are waiting for.

And Demographia is pretty silent on what those real estate agents will tell you it’s all about – location location location.  The divide is not just between desirable and less desirable cities, but within cities themselves.  The desire to live closer to the centre is based on infrastructure as well as life style choices, but inner city aspirations, the lure of location, is also responsible for driving up prices. First home buyers often buy on the fringe and then when they became wealthier and/or become ‘empty nesters’, often ‘trade up’ to be nearer to the city.  And as Robertson points out, any survey of median prices fails to distinguish between the value of inner city property and that on the fringe.

The American literature tells us that an important driving force of property prices is the difficulty of getting redevelopment permissions in inner city areas.  This is an Achilles heel for Demographia.  Because it is a political campaign as much as a research outfit, Demographia is keen to acquire allies in its fight.  It seems supportive of the suburban lobby groups campaigning against redevelopment.  Groups like Save-our-Suburbs often argue that they are resisting ‘forced densification,’ which occurs in the inner suburbs as part and parcel of the ‘smart growth’ philosophy.  But a major force for densification (I’d guess it’s more important than any policy of ‘smart growth’) is increased demand for housing in inner city locations.  The Save-our-Suburbs crew seem to me to be almost the antithesis of Demographia’s free market philosophy. 

And they’ll be supporting all those restrictions on redeveloping your block if you own a house in Hamilton , or Double Bay or Toorak. So my expectation is that property prices of well located and serviced suburbs will continue to rise, and indeed that now is not a bad time to buy.  But do keep an eye out for the issues that Demographia raises – both as a citizen and as someone who owns or is interested in real property.  And watch out for land on the urban fringe.  If you buy in, remember that some of it’s value comes from an ‘artificial scarcity’ which could be undermined with the onward march of free market ideas (where they’re convenient for their advocates that is).

In the meantime, let me (belatedly) wish you a happy new year and suggest that you have a hunt around Demographia for lots of interesting facts, opinions and food (for thought!).  And if you want to read Rory’s critique shoot this e-mail back and I’ll send you a copy of his paper.

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