Why I am anti-anti-zoning

I have fairly unique views on zoning, housing supply and prices. Here they are. Presentation slides covering similar issues can be downloaded from here. A video of the presentation is here.

Is zoning good?

The principle of zoning and land use regulation is very good and something I support. In practice, a lot of zoning and planning controls generally are designed poorly. I'm a big fan of simple rules.

For example, in Queensland, Australia, the developer charge (impact fee) on new housing was required to be set using a complex forecast of future population growth and infrastructure needs, with the fee per dwelling calculated in a big spreadsheet and published alongside various maps. I know it well. It was my job to help councils follow the required procedure and approve these modelled fees.

Then in 2011, the government announced a fixed cap on developer charges across the State. All councils quickly adopted this maximum charge. This system has been in place now for a decade, and it functions well enough. Its simplicity is a huge advantage, and across the planning system, there are similar gains from simplicity. (This surprise policy change also allowed me to demonstrate that these charges do not add to the price of housing)

I am a fan of the following process for managing land use.

• Periodic reviews (each decade) of local planning schemes. 
• Extensive community input into these schemes, perhaps with a citizen jury having the final say. 
• Reviews to require some minimum zoned capacity unless there are strong reasons not to (not every area needs to accommodate housing growth).
• Strict adherence to the scheme between reviews. 
• Few zones with simple controls (e.g. height, floor area ratio, setbacks, and use types).
• A simple, fast and cheap way for applications that meet the code. 
• A longer assessment for applications that do not meet the code, which allows for community input into the decision. 
• A mechanism for capturing value from changes of use (adopt the ACT betterment tax).

Across most of Australia, planning schemes generally follow this basic structure, though with limited value capture. Debates happen because buying land already zoned for what you want to build requires you to compete with other buyers and pay a higher price, reducing your potential profits. The big economic gains come from buying unzoned land then arguing about the planning scheme to get your site rezoned. Many developers choose to make planning applications with designs that do not meet zoning codes. By doing so, they choose the longer, slower, more expensive path. Doing so usually pays off for them if it results in more saleable building space on the site.

There is bad zoning and planning. I do not like systems where applications that comply with the zoning codes can be stopped. Yes, some bad designs will get through. But the whole point of creating the code is to "set and forget" the rules and not argue on a case-by-case basis.

I have no issues with detached house (single-family) zoning. I have no issues with car park requirements. Whether these are desirable should be debated during the review of the local planning scheme. In general, removing car park requirements should be accompanied by local transit investment and on-street parking management to address any issues. I'm not anti-car. I think cars are a good, flexible, way to move about in low-density areas. But they can be troublesome in high-density areas.

Generally, the transformation of detached housing into "missing middle" housing faces economic constraints. The rezoning jump should probably be to 4-5 storey buildings. Alternatively, allowing townhouse/ancillary dwellings that can fit in yard spaces will work to slowly increase density. New suburbs, even on the city fringe, should be allowed to have townhouse density housing, and the zoning decisions of these areas should fit with transport plans. I am not anti-suburbia. There is no problem with even large areas being zoned for low-density housing, especially if they are not planned to get transport upgrades.

Nothing is going to be perfect. While I think the planning profession overthinks things and tries to micro-manage more than it should, some coordination is necessary. Whichever way cities evolve, there are going to be arguments and conflicts. Planning can improve these non-planned outcomes and avoid conflicts if the system is kept simple and done well.

To summarise, I like good, simple zoning that includes plenty of zoned capacity and complements transport plans. I dislike complex micro-managed zoning systems. Unfortunately, most of the economic analysis of zoning never actually assesses planning rules, nor the zoned capacity in the system. Planning rules are usually just assumed to be a binding constraint on the total stock of housing. This type of detailed analysis is hard to do on a large scale because local rules vary. My recent study is one of the few that do.

I also do not think that shifting a city from a "bad" planning system to a "good" planning system has much of an effect on either the rate of new housing supply overall or on housing prices. 

I like more new housing supply. But the property market does not. To supply more than the market we need a non-market supplier. More on that later. 

Housing is an asset. It is priced like one.

Rent is the consumer price of housing. Only the rent is affected by the number of dwellings relative to the demand to occupy them. Rents rise with wages, not other consumer prices.

For the economists out there, think of consumers with Cobb-Douglas preferences in the utility function. This utility function generates fixed budget share results, where consumers spend the same share of their budget on each consumption alternative (on average across the distribution). This means that households will optimally spend roughly 20% of their income on housing, regardless of supply, and that the market gets to this equilibrium mostly through price adjustments, with higher-income households outbidding for relatively superior locations.

Here is what the private rental cost share of income is in Australia over a 20 year period. Yes, there are cycles, but in 2017-18 it was the same 20% income share that it was in 1997-98.

Most of the housing price adjustment over the past two decades has been yield compression—prices have risen while rents have been flat relative to household incomes. The housing asset, rather than earning a 5%+ yield when purchased at the old price, now earns a 2.5% yield. Prices double relative to incomes, but the consumer price of housing remains as expected, tracking wages.

There is no mechanism by which planning or zoning can affect housing asset pricing except via rents. This is why I do not take seriously the claims that Houston and Tokyo are good examples of how planning has constrained housing prices. Rents in those places reflect incomes, just like elsewhere, and both have had historically enormous price bubbles. In fact, Houston home prices increased the exact same 65% that Sydney prices did from 2010 to 2020. 

Density and supply are different concepts

A major confusion in the housing supply and zoning debate is that density, or dwellings per area of land, is assumed to be equivalent to supply, or new dwellings per period of time. This is wrong.

Developers choose the housing density at a site to maximise the site's residual land value. They also choose the rate at which they sell, developing to meet market demand in a "build to order" type of approach. This rate is known as the absorption rate. They also choose this rate of sales, and hence their rate of supply, to maximise the site's residual land value.

Many people seem to assume a contradictory idea that housing developers choose the density that maximises their land value but a rate of sales that minimises their land value.

I don't.

I've outlined how the optimal density and rate of sales work together in my paper entitled A Housing Supply Absorption Rate Equation. I take the logic of optimal density but include time in the model (yes, time is usually absent from models of new housing supply) to show how the two decisions relate. Here's a free version of the paper. Here's the published version. Notably, the main result is that the optimal rate of supply is independent of the density of dwellings. If it is optimal to make five sales per month when you are building 100 dwellings on a site, it is also optimal to sell five per month are building 1,000 dwellings on a site.

Rules on density do determine the location of different types of new dwellings. But the overall market rate of supply is determined by demand. There is no independent supply curve.

Undeveloped land is an asset

Undeveloped and zoned land is an asset that earns a return via capital growth. Owners of undeveloped land do not have to develop to earn an economic return. They manage ownership of these sites like any other capital asset that sits on their balance sheet.

The image below is from the annual report of one of Australia's largest housing developers. They own sites that can produce 56,000 apartments and 47,000 detached housing lots. But they aim only to produce 4,000-6,000 per year because that's what they expect the market will absorb.

I have a paper showing how undeveloped land is managed as an asset by housing developers rather than treated as inventory.

In fact, flexible zoning makes the value of undeveloped land grow faster before it is developed, incentivising development delay. This has been known since the 1980s when Sheridan Titman published a real options model of housing in a little journal called the American Economic Review. Titman's model relies on the idea that development timing choice will be delayed if density can be adjusted. If the optimal density increases with price, then sites with density limits will be developed first because the return to delay is lower. In density-constrained areas, the payoff to delay comes from higher prices, but in density-unconstrained areas, the payoff to delay includes both higher prices and higher density. A higher payoff to delay means a longer delay.

He writes

It is shown that the initiation of height restrictions, perhaps for the purpose of limiting growth in an area, may lead to an increase in building activity in the area because of the consequent decrease in uncertainty regarding the optimal height of the buildings, and thus has the immediate affect of increase in the number of building units in an area.

Vacant housing is also an asset—a more liquid but lower-return version of an occupied home. We can look to China for a good example of vacant housing stored as a balance sheet asset. Over 22% of dwellings there are vacant and housing supply has been astronomically high for decades, yet prices are still extremely high. Those high prices are due to the asset portfolio decisions of the Chinese people, which has compressed gross rental yields down to about 1.6%. Rents, as they do everywhere, reflect household incomes.

I recommend this video on Chinese housing. 

This is why I ask https://t.co/VY7C11iFbb pic.twitter.com/vHrBn38Sr8

— Cameron Murray (@DrCameronMurray) April 3, 2021

A problem with the standard economic approach to housing is that by disregarding the time dimension, the picture of the housing stock and its geographical distribution leaves no room for undeveloped land. All land is always developed to its highest and best use, and the only way the housing stock changes is via a complete demolition and rebuilding of the city at the new optimum. It is a model of the optimal density (economic frontier) not the actual stock or rate of supply of housing. 

The political economy

The political economy implied by anti-zoning advocates implies that well-connected property owners and developers are the weak ones, whereas the un-resourced Grandma who complains about development is the politically powerful one. Maybe that is true in some places. Not in Australia.

I did a study on rezoning and found that politically connected landowners are very likely to get their land rezoned and capture millions in windfall gains. Even our Prime Minister is a former property lobbyist. In these circumstances, are we really pretending that developers cannot build housing because of political barriers?

People also argue that when one site gets rezoned, the effect is mostly to increase the value of their land. But if a whole city got rezoned, then the value of all land decreases. Developers are playing a risky game by lobbying for city-wide rezoning when they actually want only their site rezoned. It is puzzling then that development lobby groups that call for large scale rezoning are so powerful. They should not exist in a world where large scale rezoning decreases land values, because no individual developer would be incentivised to support that collective lobbying effort.

If a whole city adopted a no-zoning rule, with no restriction on the density of housing or uses, what would happen? There would be quite a few sales as the asset market adjusted. Some landowners would sell up, others would buy in. Development in new areas where it was previously not allowed would happen. But after a short adjustment period, there would not be a noticeable change in the rate of new housing being built.

Auckland, New Zealand, a city of around 1.5 million people (about 600,000 dwellings) adopted a new plan that increased zoned capacity for dwellings by one million. There was no effect on the rate of supply. Can you spot when this happened in the below chart?

My view

Zoning is a useful tool for ensuring that different types of land uses happen in different areas. That's what it does. Just like lane markings on the road regulate where vehicles can go if they travel in different directions, zoning regulates where different types of stationary objects can go.

Zoning is not a good tool for slowing down, or speeding up, the rate of development. It is private landowners who make decisions about when and how quickly to develop.

If we want to build faster than the market absorption rate, we need a non-market housing supplier to do that. It is simply not optimal—either individually or jointly—for private landowners to sell new dwellings faster.

In fact, the recent low-interest-rate environment has made it optimal for private landowners to develop slower than otherwise. The logic is that developing housing is swapping a land asset for a cash asset. Since cash has such a low relative return, landowners are less in a hurry to do that. Higher interest rates would increase the equilibrium market absorption rate, but only after a short-term downwards price adjustment that will reduce the rate of new housing supply.

Lastly, I am suspicious of a political movement (e.g. YIMBYs) that argues that the market is not supplying enough housing but does not suggest any public intervention to build more housing. All the post-war success of boosting homeownership and housing supply was the result of heavy-handed government involvement in the housing market—rent controls, public finance of new construction, public land subdivisions, public housing, and more. All the problems we now face in a fully private housing market existed for centuries prior to the invention of zoning. 

As I like to say, the private property system is the original exclusionary zoning. All the problems I have seen blamed on zoning are merely problems of the private property system and will only be resolved by providing access to land and housing through non-market means. 

I would like to know what the people arguing for zoning reform as the secret to cheap housing and high homeownership think about how we historically achieved these outcomes?

1/4

— Cameron Murray (@DrCameronMurray) March 17, 2021