Wednesday, August 19, 2020

Will removing planning controls crash the housing market?

Recent Twitter exchanges have helped me to understand a couple of additional confusions in the housing supply debates. Let me take them one at a time.

The housing supply mechanism


This Twitter statement contains some hidden assumptions and two main points; 1) that land is worth different market value depending on the rights attached to it, and 2) that massive amounts homebuilding will affect prices.

Points 1) and 2) are correct. But the hidden assumption that because land has a different value with a planning permit (or with different zoning) that overall homebuilding rates will rise if a plot is rezoned. This part of the mechanism is wrong, in my opinion.

It is not obvious to me that changing planning will greatly affect the rate of market supply. If you assume that planning is the reason new housing supply is not higher, then you are assuming the outcome. I don’t think it would do much at all.

This challenge was put to me.


I responded that not much would change.

Let us be clear. Many cities effectively have this type of planning system. Sydney councils, for example, allow tall towers in vast areas of the city and had record new housing construction for nearly a decade. That doesn’t stop people from saying these new apartments should be taller, or that supply isn’t a problem.

Sure a large scale planning change would be a shock to an equilibrium. It will probably stimulate a flurry of activity—site trades, new types of development proposed, and maybe extra buying of these new dwelling types. During this adjustment period, prices would probably rise rather than fall, as is usually the case. But this would quickly calm down until there is no sustained change to the rate of supply.

The effect will be like any other small shock to a dynamic system.




Developers slow their sales when prices fall, and increase them when prices rise. They build to order. I do not see what mechanism there it so sustain faster supply and falling prices with these economic dynamics at play. Would it make sense for any developer to sell out their apartments at lower and lower prices to sustain a faster sales rate?

The zoning and land value issue

Additionally, the fact that changing zoning, or permitting development, affects the price of a property seems to be evidence about supply constraints for many people.


This exact argument was the second paragraph of a recent RBA paper about housing supply. 

There is a hidden assumption at play to make the leap from “different property rights have different values” to a supply shortage. Unless you want to argue that property rights should have no value, then this is a weird argument. 

No one would think it unreasonable that if you gave a landowner the rights to use adjacent public space to build extra housing that their property rights would have a higher value. Yet when we change the orientation of neighbouring rights from “beside” to “above” apparently these rights should be worth zero.



We know rights to airspace and higher density are valuable because they can be traded in some markets. They are a distinct property right. Planning is a tool to allocate them. 

There are no "true" property rights to land that go from earth to the heavens. With property rights, you get what you are given. 

Strangely Ed Glaeser’s approach to housing implies that property rights to land should be worth zero. He says, in essence, housing supply would be effectively unconstrained without planning and land values would fall to zero.

He is careful not to say it this way because it sounds stupid. He instead says that the cost of housing will be pushed down to construction cost. Hence, the land component of home prices will be zero.



This is unusual, to say the least. It implies that if you removed all planning controls (build anything anywhere) that land would become valueless. If this were true, announcing such as policy would crush land value to zero immediately as expectations get factored in. Who would want to own an asset whose value is rapidly trending towards zero?

How you can affect housing prices with “supply”



The physical number of homes does not change prices much. It was, therefore, confusing to some when I said we could flood the market with supply to reduce prices. If we think about property price crashes, we can see what flooding the supply-side of the housing asset trading market can do. This effect has nothing to do with the total quantity of dwellings. In fact, such price declines are usually accompanied by crashing housing construction.

I also do not claim that developers artificially drip-feed new supply. There is nothing artificial about it. This is the normal market outcome. Another way of saying it is that there is a rate at which they must sell to maximise the value from their land. If the sold faster, they would undermine their own profitability, which would happen because these faster sales had an effect on price. When I looked at developer landbanks and sales data it was common for large approved (<200 lot) subdivisions to go a full year without a single sale. If they wanted to sell, say, 10 lots that year instead of zero, they would have had to drop the price substantially. 

"Flooding the market" can be thought of as mimicking the asset-trading dynamics that happen during a house price crash by adding many desperate sellers to the market. A public housing supplier could do this. The scale would have to be very large, but this is exactly the large scale change in supply many expect to happen automatically from rezoning. So why not guarantee that it happens with a public competitor to these private housing suppliers?

An improvement on this "flood the market" idea is to copy how the price of money, the interest rate, is regulated by central banks. They promise to supply reserves (and demand back reserves) at narrow price range around their target rate. Their promise to back these guard-rail prices with a supply of reserves is enough for private market participants to adopt that price. In effect, monetary policy is implemented by announcement. They rarely have to use the guard-rails because they are credible.

Imagine a Central Housing Bank (CHB) with a promise to buy any dwelling at a $300,000 price and sell as many dwellings as desired at $310,000. Obviously, it would be more sophisticated than this with price schedules for different locations and dwelling types. But regardless, it sets a price corridor with a price promise backed up with an ability to supply housing.

If this institution demonstrated its ability to back up its sales with new housing, this credibility would lead the market to accept that price and operate within the corridor. It would realign market expectations on prices and capital gains.

How many new dwellings would need to be built to back up that promise and demonstrate its credibility? Probably not as many as you would think. Yes, there would be waiting lists at first as home production ramped up to back up those sales. But even then there would still be an effect. Pay $500,000 or wait a while on the waiting list and pay $310,000?

I would guess that building about 30,000 thousand dwellings per year for the first few years in Australia would make the CHB credible. Maybe 60,000 per year in the UK.

Now, I do not think this is the best “solution” to high housing prices. I think the best affordable housing system is Singapore's proven model.

What thinking about this option does is show that we do intervene in important asset markets, like money, when we think a different price would be socially more desirable. It also shows how difficult it would be to get prices down via supply-side interventions. 

It also puzzles me that those who want low home prices and think homebuilding will get us there usually do not advocate for such systems. Why not advocate to copy Singapore’s model to build every citizen a new home at construction cost? Why not propose to flood the market via a non-market housing developer who will meet their supply targets regardless of how low they have to drop prices? 

This report, entitled Help to Build, is apparently a plan to support housing supply, yet it proposes only demand-side interventions. In effect, it concedes that housing supply responds to demand and that we just need more demand to get the supply. If this is true, then it cannot be true that planning changes will result in voluntarily faster supply at the same level of demand.

Likewise, suppliers are unwilling to ramp up output unless they think there will be a prolonged period of high demand since they do not want to start up only to have to switch off shortly after.

This is a long post, so I will stop. Post your questions in the comments.
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Sunday, August 16, 2020

Sam Bowman's 9-points on housing supply

Sam Bowman thinks that a lack of supply is the primary reason for high home prices. I just released a podcast with Ian Mulheirn going into detail about why I think this is not the case.

Sam is right about some things but wrong on most. So let’s try and pin down our disagreements.

Let me first disclose my professional background. I have worked for listed and private residential and industrial developers and worked for the state regulator on infrastructure charging regimes. My first degree was in what was a then niche area of property economics, covering a range of topics involving construction management, design, town planning, feasibility methods. My PhD included extensive analysis of planning decisions, and I have published many academic papers on housing, planning, and supply dynamics. I have also been an expert witness in corruption cases involving town planning decisions.

I can assure you that if there were an issue with the planning system constraining the rate of new housing supply, at least in Australia, then I would be spending my days arguing that case.

Let me also say that I am not anti-supply. I do think the planning system is more cumbersome and costly than it needs to be, even in most jurisdictions in Australia. But I don’t think that changing the planning system is going to do anything about the overall price level of housing. I support public housing supply programs that have clear objectives and penalties for missing targets.

I like to preface any housing supply discussion with a thought experiment to help disentangle whether housing issues are mainly about distribution or supply. If every mortgage was written off, and every renter was given the home they currently live in for free, so that 100% of households lived rent- and mortgage-free in their current homes, would there be a housing affordability crisis?

I’ll leave that with you.

Sam makes nine arguments against certain claims of "shortage deniers". Please go and read them in full.
  1. “House prices are high because of interest rates, not a lack of supply.” 
  2. “Rents haven’t been rising as a share of income, so there is no shortage.” 
  3. “The elasticity of house prices to new supply is low, so building more houses won’t do much to lower prices.” 
  4. “Nine out of ten planning applications are granted, so the problem isn’t the planning system.” 
  5. “Land banking is the cause of housing shortages.” 
  6. “Empty properties make the housing shortage worse.” 
  7. “The private sector cannot build enough houses to meet demand.” 
  8. “It is impossible to make housing “affordable” without council housing / affordable housing.” 
  9. “We risk speculative development after building booms which leaves us with ghost towns.” 
These are my responses. 

Low interest rates

On this issue, I think we mostly agree. Low interest rates increase the price of assets by reducing the capitalisation rate. 

We differ on this part of Sam’s explanation. 

"Falling interest rates do not increase the price of other durable goods like airplanes or ships, or of housing in places where there is not a supply constraint, like in the North of England or Houston (which has a liberalised planning system)."

The missing distinction here is that housing is a durable good attached to a property right to a piece of the three-dimensional space that has been carved up with a land titles system. Home construction has not inflated in price, just like other durable goods. But the cost of buying a share of the property rights system from the system’s existing owners has inflated. Without that, you have nowhere to put your dwelling.

We can, therefore, agree that the problem has something to do with property rights having perverse effects. Sam thinks it is the permitting part of the property rights system. I think it is the property titles system itself.

We also disagree on this point.

“If interest rates were the only factor, we would expect to see houses everywhere rise and fall in line with them.”

No. We would expect to see the interest rate effect on the capitalisation of rents the same everywhere, but with prices still diverging due to non-interest rate factors. Different cities have housing price booms at different times for different reasons. Houston’s 1980s price boom is a classic example of a price boom that far exceeded that scale of price growth in other cities at the time. There were other factors at play, including plain old expectations and speculation. 

Sam's own chart seems to show that most variation in prices is common between London and the rest of England. 



Rents as a share of income

I think we agree here that rent is the appropriate measure of the economic price of housing, which is good.

Sam’s view here mainly deals with UK rental statistics. I would defer to Ian Mulheirn who has two detailed pieces about that issue (one and two). 

But we differ on this point.

“Suppose everything we spent money on changed in the same way, rising in real-terms as we got richer – groceries, electricity, clothes – without getting any better in quality. Economic growth would be meaningless, because any overall income growth we experienced would simply be eaten up by these rising costs.”

Remember my earlier point. Housing products have not increased in value in line with incomes. The combined cost of renting houses and that location in the property titles system has grown in line with incomes. Remember also that this location rental is also someone’s income.

What makes property different? When you rent a dwelling you also rent the location, essentially buying out your transport costs by paying the owner of a better location. If we had an equilibrium where people spent 5% of their income on rent, some people might start deciding to spend 7% of income on rent (40% more rent) to live in better locations rather than spending that money and time on commuting. Those with higher incomes will find that the time-cost of commuting is relatively higher, with the equilibrium process sorting the location of households by income or wealth at their maximum willingness to pay (taking into account the cost of transport).

Compared with tradable and transportable consumer goods, it is the finite nature of locations and their relative advantages that ensure we end up in a fixed-share-of-income equilibrium.

The way to use rent-to-income as a supply metric is to see whether the number of people per dwelling is increasing compared to the average size of dwellings. A shortage would be indicated by more people in smaller dwellings paying the same share of income on rent.

It may be the case that this exists in some locations but not others. The question would then arise, how does this situation persist if there are alternatives in different locations — just pay the lower rent plus higher transport costs and get more space.

These are the types of questions and the evidence we should be looking about when talking about the adequacy of housing supply.

Elasticity

It is also good that we agree that the price elasticity of housing supply is low.

Sam says the following

“Imagine a similar argument being made during a famine where the price of food was very high: if an additional food shipment did not make a big dent in overall prices, would we conclude that the solution wasn’t more food?”

Yes. That’s right. This evidence would force you to conclude that although more food would be beneficial, the distribution of food is mainly causing the famine because adding more total food to the system is not helping much. This very point is the subject of many debates about famines and food prices. It is also why I prefaced this piece with a thought experiment about the distribution of dwellings.

Regardless, saying that more dwellings won’t decrease prices is wrong. What Ian Mulheirn and I are saying is that because housing supply matched population growth, and in many places far exceeded it, that supply is not the cause of the price growth observed. Adding more supply will decrease prices, (putting aside whether changing planning rules actually will change the rate of supply). But it happens in a slow and expensive way. 

In Australia, around 8% of the labour force and 6% of GDP is spent on building new homes. When someone says “let’s double housing construction” from 1-2% of the stock per year to 2-4% of the stock, they are really saying “let’s take 8% of the workforce away from what they are doing to build more housing for a 1% rental price decline each year”. Maybe that trade-off is worth it (assuming supply would increase this much by removing planning regulations). Maybe not. But this is where you should end up when talking about elasticity and the size of the price effect of the investment in new housing.

High approvals rates

I agree that this metric cannot show the effect of deterred planning applications.

But does that make it meaningless? I don’t think so.

In a radical supply shortage situation, with so much profit to be made from getting into the housing game, even low probability applications would be made. People buy lottery tickets all the time. Large organisations often invest billions in activities with low probability outcomes when there is a large potential payoff.

Shouldn’t we see the planning system swamped with low probability applications and observe them being rejected? 

Then there is the issue of one million excess planning permissions granted in the past decade. Very hard to explain this as a planning constraint.    

I also have a gripe about planning applications and their apparent slowness. While the situation is different in the UK and Australia, slow approvals usually happen because the applicant has sought approval for a development that is far outside the scope of the plan. They bought land that was not designated for what they wanted to build, then chose a slower route through the planning system rather than a faster one. I'm surprised that these developers have the confidence to blame someone else for their self-inflicted problems!

Land banking

Sam writes that land banks are an inventory necessary to smooth out supply and ensure workers are not idle after selling stock.

I agree that land banking smooths out supply.

I disagree that land banks are inventories. I even have an academic paper on this topic where I looked at the annual reports of listed housing developers to see what they say to investors about planning when they are obliged to be honest (here's a free working paper version). Australian developers never seem to tell investors that planning is delaying them.

We are now getting to a key issue on housing supply. How does a developer choose the rate per period to sell their subdivision?

They need to be careful not to sell too fast. Faster sales might require lower prices, or raising them more slowly, reducing the present value of the return from that project. But if they wait too long, they might also miss out. As I often say, what kind of crazy property developer floods the market because they can?

I also don’t see how land banking is a symptom of a shortage. In any other product market, even large durable goods like ships or trains, large inventories don’t happen when there is a shortage. Do these firms “buffer” and keep large inventories to smooth out their production? Most large capital goods production is on a “build to order” model where the process schedules buyer orders, matching supply to demand.

Empty properties

I have no idea how many empty homes there are in London. Sam seems to have the data. I can attest to the fact that Australia has more empty homes as a proportion of total dwellings now than at any point in history, along with larger homes and fewer people in each one.

The private sector cannot build enough / need council housing

I agree with Sam that the private sector can build enough homes. I disagree that they would just because they could. 
 

I am quite often puzzled that using the power of government to flood the market with housing is never proposed. We just cross our fingers and hope that the private sector will crush the price of their assets. 

Sam has stumbled across the “absorption rate question”. How fast should developers build to maximise the present value of the flow of their economic returns from development?

Clearly, it is not so fast that the final sales of a subdivision are at a far lower price than the first sales. This would also see problems with buyers pulling out of contracts and purchasing at the lower later price. 

If we look historically, periods of rising homeownership and rapidly expanding supply are usually associated with government programs—housing for returned soldiers, giving public housing to tenants, Singapore's subsidised housing model, and so forth. My view is that we should expand these programs just in case the private market doesn't deliver what it promised. Think of it as insurance.

We risk ghost towns

I don’t think already large cities are going to risk this, so I agree with Sam that this is a silly argument.

I would only note that this happens in places like mining towns where they really do see rapid demand growth—expressed in rents—along with high and unconstrained rates of new home building. Of course, despite the lack of supply constraints, mining towns always seem to still get a boom and bust rent and price cycle. I wonder how Sam would explain this.
2 comments:

Sunday, August 9, 2020

Are NIMBYs financially motivated or are property developers?

A puzzle came via twitter following the crazy story of RBA research claiming that if you remove planning controls, apartment prices will fall 42%.

I argued that it would be weird for property developers to lobby for policies that eroded the value of their products and sent their housing projects broke.

Andrew responded as follows:


So we have two groups who apparently stand to benefit from tight planning controls if they do in fact increase prices, yet they are arguing opposite cases.

This is a genuine problem. How do I make sense of it?

The first thing I would do is break it down further. Homeowners are an investor-renter hybrid—landlord and tenant of the same property. Maybe we can break out renters and landlords separately and see if they lobby for different planning outcomes. The position of homeowners would then reflect them acting as their “renter” or “landlord” selves.

Survey research has shown that renters are just as likely to oppose rapid development in their neighbourhood as homeowners, perhaps even more so if we believe this survey.
“If a similar ban were proposed for your neighborhood, how would you vote?”

Given the consistent NIMBYism found among homeowners nationally, I expected homeowners to show stronger support for a ban on new development within their own neighborhood. Instead, only 40 percent of homeowners chose to support this ban compared to 62 percent of renters. In other words, 30 percent more renters supported the NIMBY ban than homeowners.
This gels with my experience in community groups. Renters play a large role. Investors/landlords not at all.

If tight planning controls increase prices, renters will be the worst off, having to pay higher rents. Yet they lobby in favour of these tight controls.

Landlords will be better off, but they do not lobby in favour of tight controls.

So if homeowner NIMBYism matches the behaviour of renters, not landlords, then we can say that NIMBYism is not financially motivated by homeowners looking to increase the value of their homes.

This goes against the conventional wisdom [1]
NIMBYism is part of what drives property prices so high. When opposition to local development means that homes can’t be built in useful areas, the remaining homes become scarce and extremely valuable.
So what’s the deal?

One way to reconcile this behaviour is to question whether in fact tight planning controls increase local rents and prices. My experience as a property developer is that areas undergoing rapid densification become more attractive and, if anything, increasing in value.

Some have argued that it is the risk, or variation of the outcomes, from densification that homeowners don’t like, hence their conservative status quo bias. Will the benefit of more local retail services outweigh the cost of extra traffic or not? This risk issue could certainly be part of the story.

Another resolution to the puzzle recognises that densification typically does increase local rents and prices but, unlike investor landlords, homeowners can’t realise any financial gains without selling and relocating.

Since they chose to buy and live in their suburb rather than an alternative area, they have a preference for the current density/amenity. Had they known they were buying into a high-density area that was not yet built, they may have chosen to buy elsewhere instead. The same logic applies to renters.

It would be a bit like someone coming along and offering to paint your car pink. Sure, maybe pink cars sell for more, but if I wanted a pink car, I would have bought one in the first place. 

If NIMBY psychology is more like this, we would expect that development that complies with zoning codes to see little push back, as homeowners have reasonable expectations about what sort of development is planned for their area. But we would expect a lot of push back against development proposals that fall far outside planning codes. This is consistent with my experience. 

In the end, I don’t think I am fully satisfied with any of these ways to reconcile the NIMBY and developer puzzle.

What is clear is that the story is not a simple one of NIMBYs preventing some local developments in order to increase the value of their home.

What are your thoughts?

fn. [1] The conventional wisdom is often wrong when it comes to property markets and planning.
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