crazy reduce house prices

Would it be Crazy to Reduce House Prices by 40%?

Geoff SimmonsEconomics24 Comments

Economist Arthur Grimes yesterday suggested building 150,000 new homes to reduce Auckland house prices by 40%. This idea was described as ‘just crazy’ by the Prime Minister. Is it?

Affordability

We know that in Auckland the median house price is more than 9 times the median household income. The standard international definition of ‘affordable’ is 3 times, so it is pretty safe to say that Auckland’s house prices are a long way from being affordable.

The maths of restoring affordability are fairly simple; we need to reduce house prices relative to incomes. To achieve that we either need to reduce house prices, increase incomes, or both; slow the growth in house prices so that it is less than the growth in incomes.

In contrast, the Government’s target is to return house price growth to ‘single digits’. That is no guarantee of house prices becoming more affordable. Instead, if the Government achieves their target it could just as likely mean that already unaffordable housing gets slowly more unaffordable. As an aside, returning house price growth to single digits seems inevitable – the current rate of growth cannot be sustained indefinitely – at some price level people would stop buying.

From an affordability perspective Grimes’ plan seems comparatively sane.

Financial Risk

The concern the Prime Minister raised was that people would lose their equity and banks would be put in trouble. 

As Grimes pointed out, housing is an investment like any other so why can’t prices come down? Most investments are by their nature a risky business. Values may rise or fall; just ask any Kiwi who piled into the sharemarket back in 1987. The law of investments is the more return you get, the greater the risk is that you could lose it all. Why shouldn’t that apply to housing? Indeed, we have seen price falls in some parts of the country in recent years.

As for the risk to banks, in Grimes’ view (and he is a former Reserve Bank chair) our banks could handle that kind of shock; in fact they could handle up to a 55% drop in Auckland house prices.

The Prime Minister shouldn’t fret about this one, it is the job of the Reserve Bank to ensure that banks are prepared to deal with a fall in house prices. The Morgan Foundation has for many years pointed out that the lending rules around mortgages have helped fuel the speculation in the housing market. The Reserve Bank has argued that housing is a lower area of investment, which justifies higher leverage without increased risk to the economy. However this has become a self fulfilling prophecy – allowing for higher leverage simply means that investors pile in until housing does eventually become a risk. The Reserve Bank seems to be realising this increased risk, they have already implemented loan to value ratios (which look set to be tightened further) and perhaps the use of debt to income ratios in the future. So the risk to banks is low and assuming the Reserve Bank continues to act, looks set to remain that way.

Developers

Finally the Prime Minister argued that developers could be hit by any drop in house prices, which would work against Grimes’ plan for 150,000 new homes.

However, Grimes’ suggestion wasn’t for business as usual. His was a bold plan to build up and out. Allowing increased density in the inner suburbs would provide a strong incentive to stop land banking and start building, otherwise developers could see their land values start to fall. Similarly on the fringes Grimes was suggesting using the Public Works Act to acquire land, and using the profits from that to fund the development of infrastructure.

While a fall in house prices could hurt certain developers who own a lot of land and were slow off the mark to develop it, it is hard to see how it would hurt development.

Are there enough builders to build the houses in Grimes’ plan? We found the builders to build in Christchurch – we got them in from overseas where necessary. The Christchurch rebuild will be winding down soon, so there will be plenty of spare capacity if the jobs are there.

Radical?

Is Grimes’ plan really that radical? The most extreme part of his proposal is compulsory land acquisition; effectively forcing owners to sell their land. However, the Government is already looking at this idea as a way to reduce land banking, so it is hardly radical. As we have pointed out, closing the loopholes around the taxation of assets would be a far less invasive incentive against land banking.

The only really radical part of the plan is the sheer scale, particularly for intensive development in the city. This is the part of the plan that scares politicians because it means standing up to residents that oppose development in their back yard. The problem is that these NIMBYs vote, and have a much louder voice than the future tenants of those inner city apartments.

However, intensification is essential for restoring affordability. As we have discussed previously, sprawl may deliver cheaper housing, but once the private and public costs of transport are taken into account it often ends up more expensive overall. Intensification is the thorn that must be grasped for sake of the future of Auckland.

Would it be Crazy to Reduce House Prices by 40%? was last modified: July 5th, 2016 by Geoff Simmons
About the Author

Geoff Simmons

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Geoff Simmons is an economist working for the Morgan Foundation. Geoff has an Honours degree from Auckland University and over ten years experience working for NZ Treasury and as a manager in the UK civil service. Geoff has co-authored three books alongside Gareth.

24 Comments on “Would it be Crazy to Reduce House Prices by 40%?”

  1. Banks know their risk better than the Prime Minister. Banks run regular risk analysis. As for his unhappiness over reducing house prices the biggest risk is political. Main reason why the Govt doesn’t want to act on housing is that the investors & developers in that area are National Voters. As far as politicians can stay in power they would even sell their mother

  2. challenger, don’t forget that the majority of National politicians are heavily invested in property, they are protecting their own interests as much as their ‘core’ parasitic constituents happy to profit at the rest of NZ’s expense.

  3. In the event of creating a housing price crash, why would it not be possible to protect the vulnerable, i.e. NZ citizens with just one house and negative equity? I cannot see how we can achieve a reasonable measure of affordability but still avoid a crash, so perhaps protection such as this should be on the drawing boards now. That is if the government is serious about wanting to reduce house prices, and I suspect their polls are indicating they need to be.

  4. I think the first thing to do is to hit speculative investment… that would slowly bring prices down wouldnt it ?

  5. One other thing to try is making the sale of land/houses/property only to NZ born or citizens. Grandfather clause those who have bought up to date, with the proviso that properties etc purchased prior to this can only be sold when applicable to NZ citizens.
    Many of the countries that have their citizens purchasing land etc here have restrictions on the sale of anything to foreigners, why not here as well

    1. Nonsense. That’s a pretty extreme nationalist/xenophobic comment – with perhaps racist or anti-immigrant undertones. We came to NZ as immigrants four years ago. It’ll be another year before we can become citizens. The first thing we did – before we even got on the plane – was buy a house so we would have *somewhere to live*.

      Why should we be ‘forced’ to rent for five years minimum before we’re ‘allowed’ to buy a house? If that was the law we would assuredly have got around it; using a corporate or trust vehicle to buy our house.

  6. As an economist, I am surprised he (and you) are suggesting developers build so many properties that supply is greater than demand. That’s a Tui ad.

    Auckland city says today they have 7-8 years of section supplies, over 110,000. There goes another plank of the idea.

  7. I must be missing something here – can someone please explain why developers would want to build houses to the point that they were reducing house prices and thus, most likely, reducing their profits?

    1. Because profits are profits regardless, would you turn down $50k profit just because you can’t make $100k? The majority of house-building isn’t done by speculative developers anyway, it’s done by people building a home to live in or to rent out. In those cases they’re all more interested in long-term valuations rather than what they can flip it for immediately.

  8. Capital gains tax on second house and more. None on your first “home” but tax investment “houses”. That would help the situation a lot

    1. One also needs to block people using trusts to hide investments. Otherwise this only affects the investors who dont have access to quality lawyers/ accountants.

  9. A correction via inflation will hurt the banks more than a crash. Absolutely nobody out there is going to be nice and stop making money from flipping properties while the market balloons and since Banks are effectively in control of inflation and they’re not a fan of the money they’ve lent becoming devalued, you can expect the bubble to become a pressure cooker that will go off with a bang of mortgagee sales and personal bankruptcies. No politician is going to step up and be the one to take the blame for heralding the inevitable so they’re all playing a game of hot potato while they wait for it to happen.

  10. NZ incomes are quite low overall and you can’t blame middle NZ who own houses to want to keep the increased equity or look to release some so they have no other debt. When a correction comes from the global financial domino falling on us as part of the interconnected system the local housing market will likely fall back to a more realistic level. Government needs to help by slowing down the rate of incoming people to ease the stress on housing demand. (Schools and infrastructure also affected).

    Auckland has grown at a rate of 800 people per week over the past year.
    Which equates to about 344 homes a week.
    That is 40,000 people in one year approx.
    Prediction is that Auckland will have over 740,000 more people by 2043.
    That is more than the whole of Canterbury the 2nd biggest region.

    Until the pressure valve of incoming people is slowed the new housing wont be able to catch up with demand for several years.

  11. 1. Effects of Migration: A solution – Reduce numbers and introduce first 2 years in the provinces policy. 2. Monopolized Cost of Building: A Solution – Start 3 d printing $40,000 2 bdrm dwellings, (also investigate a range of state of the art manufacturing innovations, make it a ‘under $40k dwelling’ design competition and build the models all on a site as a visitor attraction) 3. Money creation by printing through housing: – this is the biggest part of the problem intrinsic to our modern economic ponzi scheme – trillions and trillions of dollars of inflated value based on the power of private banks to print money as debt out of thin air, unrelated to any real productivity, great for those who have real estate but inflationaryily devastating to the have-nots, Solution – move on mass from singular monetary system to multiple alternative and real value based trading systems or just wait for staus quo to implode sometime soon and wish you had moved to the alternatives ahead of time.

    1. here here.
      the future problem of renters trying to rent on super-ann will result in a bubble of elderly-poverty.

    2. I suppose we could find the money but what are all the new worker houses for? Near where I live the state houses were for people working at the railways Workshops. Presumably low paid service industries?

  12. This is an Auckland issue – here in Southland a house is worth barely more (sometimes less) than the materials and labour to build it

    The problem is NOT too few houses in Auckland it is too many people in one large city
    (compared to the size of the country)

    The solution is not to build lots of houses in Auckland but to encourage some of those people to move to the “provinces”

  13. Has anyone got any ideas on the Unoccupied dwellings in Auckland? Google the 2013 Census data and there is a report on Unoccupied dwellings which says that 66% of the 33,000 unoccupied homes in Auckland were genuinely unoccupied during the time of the 2013 census. That’s around 21,000 houses.
    Now even if only a portion of these homes are liveable ie, they could be renovating, derelict etc, we have an already built supply of homes to inject into the market. How do we get them onto the market? Make it too expensive for people just to speculate on them, charge an annual 2-3% surtax on the current CV for being empty. It’d be money in the pocket for the govt and if they didn’t want to pay then they will either sell or rent the home out. Even if you got 5,000 homes out of it, what a massive difference that would make to help get ahead of the game. Appreciate any thoughts on that.

  14. As Grimes pointed out, housing is an investment like any other so why can’t prices come down?

    “China is so big it has cities larger than London that nobody has ever heard about”?
    I was just listening to RNZ Country Life where (it seems) behives have gone from 300,000 to 700,000 with “big players overseas money” and there is theft and conflict, Isn’t this just pure competition for scarce resources?

  15. This is the part of the plan that scares politicians because it means standing up to residents that oppose development in their back yard. The problem is that these NIMBYs vote, and have a much louder voice than the future tenants of those inner city apartments.

    …..
    Go the NIMBYS! The public didn’t vote for the massive increase in migration.

    New Zealand: The Politicization of Immigration
    January 1, 2003
    By Richard Bedford

    Notwithstanding this ambivalence, there seems to be clear recognition and acceptance that New Zealand society is going to become more diverse in terms of ethnic and cultural groups over the next 20 years. Immigration will play a major part in this diversification of communities, especially
    immigration from countries in Asia. Fortunately, there seems to be a broad consensus among the main political parties as well as many of the minor ones that this is not something to be feared or resisted at all costs. In this regard, there appears to be some consensus of party view (excluding the position adopted by New Zealand First) that continued immigration at or above present levels will produce positive outcomes for the country’s economy and society.
    ..

    Based on a large body of new research evidence and practical experience, the consensus
    among policymakers now is that other factors are more important for per capita growth and
    productivity than migration and population growth. CGE modelling exercises for Australia
    and New Zealand have been influential in reshaping expectations.
    Treasury Working Paper 14-10

  16. Would it just be better to stop the massive increase in house prices, give time for incomes to catch up. Or perhaps a smaller steady decline as opposed to a massive crash. Remember politicians (local and national), banking, real estate industries and all those who own their own homes have a vested interest in keeping the status quo. It would take quite a shift on thinking to change this. The change does need to be palitable to have any chance of being successfully implemented. So freeing up land, more building of high quality AND affordable community / human focused housing (ie not souless inner city blocks or suburban sprawl), would seem to be part of the solution. And realising that this country is so much more than just Auckland and Christchurch. Regional development needs also to be part of the picture.

  17. Intensification of Auckland house prices is a no-brainer in terms of being what is best for the city. The biggest stumbling block to this happening as Geoff has pointed out is the existing residents vocal opposition to it. The Auckland Plan was trying to get this obvious fix to Auckland’s sprawl, congestion and housing affordability through but hit the brick wall with the NIMBY’s. My question is, what can the Auckland council do about this? Are they able to enforce the right policy for the city and the country, or will be the NIMBYs win out and the massive crises remain? We know the National government won’t back the city council – they are all in favour of more sprawl, more congestion and the last century Kiwi dream of the quarter acre block.

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