Land and house prices

Over at Club Troppo, Nicholas Gruen has a nice piece on what is driving the growth in house prices. He’s correctly sceptical of the view that restrictions on land releases on the urban fringe are to blame.

The crucial economic test here is the location-price gradient, measuring the rate at which prices increase as you move from the rural fringe to the inner city. I haven’t got numbers but it’s pretty clear that this gradient has become steeper over time. This is most obvious in Sydney where the Southwest was the last area to boom and the first to bust.

Sticking with supply constraints, Nicholas goes on to mention resistance to urban consolidation, an effect which works in the right direction. Still, it seems to me that this resistance has been much less effective recently than in the past.

It seems clear that the primary motive for the boom is increased demand. Of course, if the supply of land, skilled building workers, materials and so on were perfectly elastic, higher demand would not increase prices. But supply is never perfectly elastic.

Looking at policy, the obvious thing to change, if you want to make it easier for people to buyer houses is to remove taxes on entrants, like stamp duty, and replace them with taxes on incumbents, by removing the owner-occupier exemption from land tax. The fury with which this suggestion is invariably rejected makes it clear that, as a community, we don’t really mind high house prices.

43 thoughts on “Land and house prices

  1. “as a community, we don’t really mind high house prices”. “community” is the problematical term here (as al loomis already pointed out).

  2. The problem with removing stamp duty is that supply in the short-run is almost perfectly inelastic. As a result, the decrease in stamp duty that once went to the government would now be 100% captured by the seller in increased prices.

    I think we are looking at the whole debate in a bit of a wrong-headed way. We shouldn’t be thinking about supply of land (people can’t live just on land). We should be thinking in terms of supply of bedrooms/houses. If we look at things in this way, then things like urban consolidation AND new land release become equally important. One of the major problems with anti-urban infill campaigners is that they are probably the most likely beneficiaries of the ongoing high migration intake (ie there’s a good chance that anti-urban infillers live in the leafy suburbs and own or work in businesses that directly benefit from a larger population) is that you can’t have it both ways. Increasing population means demand will continue to grow for housing. And you can’t just build new houses overnight.

    I am not sure if what we’re seeing now is an aberration – supply will come on line to match the demand. The problem is everyone stopped building in around 2003-04 when people thought the market was going to burst. Well it didn’t! Will the market correct itself? I think it probably will. Will it correct itself before the upcoming election? Not a chance.


  3. Recently Ross Gittins’ suggested public housing at affordable prices (which I interpret to mean people on minimum wages can afford the rents) to help those who are on low incomes and those who want to save a bit more to buy a house.

    I think this is a good idea because it provides the supply in the market segment where it is needed most.

  4. If home ownership is unattainable for many people today, at least allow renters to claim a deduction against income for rent. This would at least neutralise the tax bias in favour of home ownership.

    Why bias the tax system in favour of home ownership anyway? (Note that this is equivalent to disadvantaging renters.) It encourages individuals to hold a significant proportion of their wealth in a single asset, rather than hold a diversified portfolio.

  5. Looking at policy, the obvious thing to change, if you want to make it easier for people to buyer houses is to remove taxes on entrants, like stamp duty, and replace them with taxes on incumbents, by removing the owner-occupier exemption from land tax.

    I think that such a reform would be beneficial and fair if done right. I would suggest the following caviats:-

    1. The land tax should be based on purchase price not current estimated market value. The purchaser can control and hence predict the former but not the latter.
    2. Properties purchased before the abolition of stamp duty should be exempt from the land tax.
    3. The rate of land tax should be low an in line with the stamp duty that it replaced.

  6. Within a generation, there has been a quantum leap in housing expectations. Long gone are the typical outer suburban development of my parents. They moved into modest 2-3br houses with one bathroom and toilet and were lucky if the road had been bitumised. Certainly there were no kerbs or footpaths and they had no floor coverings, or light fittings and old sheets or taped newspaper went up on the windows for privacy and to hide the spartan borrowed or secondhand furniture. (many asked for the painting to be left for them to do) As for instant lawn and landscaping, such profligacy was unthinkable. These families would have to fight tooth and nail, as well as attend many a working bee to gradually get the full range of facilities and services of the established inner ring. They paid for things like road sealing, kerbing and footpaths as the Councils could fit them in their budgets and extract the costs.

    Fast forward to today and that ethos seems positively quaint by comparison, but it is not without its costs. Firstly their offspring want 4 br houses with family rooms and ensuites, umr garaging, complete with landscaping, floor coverings, light fittings and drapes. As well their new suburb will have its bitumised streets fully drained and sewered, with kerbing and footpaths, and most of the basic community facilities and amenities. Basically, the land developers have had to marginally cost in all these mandated requisites that older suburbs have paid for, spread over many years and those costs are rising. For example, the utilities no longer cross subsidise the costs of new infrastructure from established consumers. It’s full user pays and add it on to the house and land package. Well meaning govts increasingly demand more and more stringent requirements that don’t impact on existing owners. Think of a few- hard wired smoke alarms, residual current devices, water tanks and storm water reticulation, as well as requiring developers(really the homebuyer) to contribute toward public land for housing. Compliance with Greensmart housing code and solar or heat pump water heaters, which have to go in if cheaper gas is not available, which it often isn’t in new suburbs. On and on it goes, impacting on the price of replacement housing and driving up the established prices.

    I’ll give you an example of how marginal pricing affects decisionmaking. A mate of mine wanted to expand his machining business as he was bursting at the seams in his existing industrial premises. He was prepared to wear the burden of moving and stamp duty, etc, until the killer blow. $65000 to ETSA utility to upgrade the power in the new premises to match his existing 3 phase power supply. ETSA are a regulated private poles and wires company nowadays and fully marginal price the cost of upgrade including a new transformer. They can’t slug other power consumers because they don’t sell power nowadays. They sell poles and wires transmission only and it’s ‘new user’ pays. Same for suburban developers. It’s all in the marginal costs of things nowadays. You have the well meaning Ruddernomists adding to the burdens with uneconomic, mandatory rainwater tanks and the like, all the while bemoaning the housing affordability crisis, whilst wanting to pay more public servants to monitor the price of bananas and wanting to sign the battlers up to Kyoto and no doubt impose some more globally warm housing costs. Welcome to more of the same battlers. Meanwhile, I can replace my J tarriff (6c/kwhour) electric storage hotwater system for a grand, but you’ll need a three and a half grand solar hot water system, or a 3 grand heat pump in your new house in Adelaide. No J tarriff for you guys then.

  7. Observa,

    Landscaping is pretty much compulsory these days. Even if you are happy to live with the bare earth after effect of house construction the council in many areas generally won’t let you. Typically these days you can’t live in a caravan at the back of the block whilst you build. You can’t move in and finish the details later like my parent did. You can’t leave out insulation and put it in later when wages rise and the budget permits. The entire construction enterprise is today regulated in every detail. Builders and contractors are now all licenced where once were not. My father built houses for many years and I remember when they brought in licencing and he cynically showed off his gold builders licence.


  8. Spot on, observa. Gone are the days when first home expectations would probably have included a dunny out the back and no laundry!

    Another point I want to make is about how terrible it is that we’re saying that first home buyers should be happy to move out further and further from the city centre. Well, less and less people work in the CBDs of the capitals these days. Sydney, for instance, has a plummeting proportion of people who commute daily to the CBD – now people commute to suburban jobs in service centres and industrial parks, which of course are likely to be on the urban fringes. So cheaper housing is in fact likely to be close to where jobs are!

  9. Actually the sis and bro-in-law ran into precisely the marginal socialism problem a few years back after they’d bought a block of land in the Adelaide Hills, with views of Adelaide, to build a new home. Bushfire country in an established street and while they remained in their more modest first home in a less fashionable burb on the Adelaide Plains, saving to build, the bushfire regs changed for Development Approval. Welcome to the cost of a 22000litre tank(concrete not poly or galv silly billies) and stand alone petrol driven pump for firefighting. They bought the established place next door, complete with pool for a helluva saving and will sell the block eventually for a fat profit. Notice that although every other homeowner in the street gets the benefit of such a firefighting storage and equipment, not one of them contributes except the new chum on the block. That’s the problem with marginal socialism. The nanny staters never have the political guts to impose the costs on the general population and hence their marginal socialism approach. It’s happening all over the building and development game, much to their mock horror at the final outcomes for the battlers.

  10. My parents owned a block of land and for many years and they had to pay for town sewage in spite of:-

    1. There being no dwelling on the property.
    2. There being no town sewage in the street.

    After they did build a dwelling (which they rented out) they had to pay town sewage plus the cost of a regular pump out service.

    At the same time there was a referendum in the locality to decide whether to upgrade the local sewage treatment plant to tertiary treatment and to use the expanded capacity to provide town sewage to all the regions that were already paying for it. The referendum easily got majority support but then the vocal minority petitioned the newly elected state government (Bob Carr) to halt development. For years after that the area was stuck with secondary sewage treatment and pump out services (with frequent spillage into the stormwater system).

  11. would reducing population help?

    would eliminating all taxation except a flat tax on any transaction help?

    would active decentralization help?

    would free public transport help?

  12. abolish negative gearing.

    i have never figured out why our income tax system should deliberately assist property investors over owner-occupiers. in america it is owner-occupiers who can claim an income tax deduction, whereas investors cannot (which seems to be a bad idea also but at least, politically, you can understand how that situation might have arisen and persisted).

  13. Whilst I think marginal socialism has been responsible for a large part of the housing affordability problem on the supply side, clearly demand has been a significant part of the problem. You ask about reducing population al, but there are plenty of growing population centres around the world that don’t share the affordability problems of a Sydney. To what extent foreign investors are responsible for Sydney’s problem, we really couldn’t tell in a globalised economy with free capital flows. However that balance of payments shortfall must be being corrected by capital flows somehow, given the high value of our dollar. You’d have to suspect it’s going into real estate. The question rightly might be what sort of tax policy and incentives started the flows and maintain it. Negative gearing and generous capital gain treatment for owner occupiers are the logical culprits. As well you only cop capital gain when you sell, unlike other income flow streams, which are taxed annually. My conclusion about all this distortion? I’ts another nail in the coffin for a dinosaur income tax system, which would be easily overcome with abandonment of income tax altogether and a reliance on resource and carbon taxing. That would remove any distortions in the market for assets, particularly the unhealthy distortion in favour of tuscan boxes at present.

  14. Good to see some reasoned argument that does not blame the federal government, whose fault this is not.
    It is just simple economics – housing stock only slowly growing in places that people want to live, rising wages and low interest rates.
    The only solution – beyond dropping wages or raising interest rates sky-high – is to increase supply. Changing the tax mix will just change the way that the purchase price is allocated, not the final price. People want to live in houses and will gear themselves to get the best one they can afford, particularly if they are optimistic about the future.

  15. “Nicholas goes on to mention resistance to urban consolidation, an effect which works in the right direction. Still, it seems to me that this resistance has been much less effective recently than in the past.”

    Living in an area where there has been and continues to be substantial urban consolidation (former City of South Sydney), I see no obvious disadvantages stemming from it. On the other hand there are a number of advantages, not the least being rejuvenation of local shops and other businesses, plenty of people on the streets at all hours (crime reduction factor?), interesting night life, frequent public transport etc.

    Over the years South Sydney and now Sydney city councils have done their bit with more parks, streets blocked to through traffic (much better pedestrian precincts than the typical leafy quarter-acre suburb) and recent planting of street trees.

    I really don’t know why urban consolidation has such a bad name if it is done properly. People should stop for a moment and think about its benefits.

  16. I should think that the federal government policy on education and health (promoting publicly subsidised private organisations) affects housing affordability for many individuals because it affects individuals’ debt capacity constraint (even at an interest rate close to zero).

  17. The biggest disadvantage of rising property prices around where I live is that it is squeezing out students (UTS and Sydney Uni are just down the road), low income workers, pensioners, artists, musicians and the like.

    I’d rather see substantially less appreciation in the price of my own property and greater opportunity for maintaining a good mix of people.

  18. Ernestine,
    I think that link is tenuous at best.
    If that is the case the only real solution is to go for higher-density – more flats, dividing some of the terraces and houses into two etc. Short of the intrusiveness, inefficiency and outright errors of government allocation it is the only way (IMHO).

  19. Thanks observa – that site gave my firefox adblocker a really good workout.
    On the broader point, the piece is quite sensible. Government investing in markets makes little sense as it has to be formula driven. Not the market’s fault but the regulations’ fault.
    The US sub-prime market has little relevance to our own though – the sort of re-sets and extreme leverage without mortgage insurance we saw there simply did not happen here on any scale.

  20. No, Andrew R., it follows from plugging numbers into an equation that describes a budget constraint for individuals who want to act as prescribed, namely that ‘choice is good’.

  21. On the other hand, the NSW State Government and its ‘new public sector management’ bureaucracy (Carr) in conjunction with local government bureaucracies which intersect with private certifying agents (such that nobody knows, at non-trivial information acquisition costs, who is doing what) do add to the construction costs of houses on environmental grounds which do not seem to be absolutely necessary.

    For example, there is a cost for water tanks. True. But the costs differ significantly for project A where say 10 000 lt rain water are stored in plastic tanks on a residential side in a Sydney suburb at a place judged suitable by the builder (assuming appropriate qualifications) and the owner and project B where it is mandatory to have 40 000 lt tanks stored under ground at a place on the property determined by people sitting behind a desk and this thus determined place happens to require digging 3x3x8m into rock (generating CO2 emissions and noise pollution).

    I suppose all of these observations are but observations of ‘teething problems’ which happen to translate into non-negligible adjustment costs. Frank Hahn’s insights on the notion of an equilibrium in a monetary economy make more sense to me than ever before.

  22. I think you’re right JQ – as a community we really don’t mind high house prices. I certainly pity the younger folk trying to enter the property market after a 10 year boom – but these things cycle….. opportunities to enter the market will no doubt arise again in the future.

    In the meantime – I see no end to the dinner table conversations about the amazing rise in house prices and how great it is – particularly in the leafy suburbs. Yes debt levels are high – but what’s wrong with debt? Provided debt can be serviced and it’s more than covered by equity then debt is a great thing.

  23. An interesting question is whether there will be an increase in the supply of houses in the inner leafy suburbs as the baby boomers start to downsize or die. If so, there may be a long period of subdued house prices and the Gen X and Y people, who are currently the main complainers, could eventually be the main beneficiaries.

  24. Ernestine,
    Moving the debt capacity constraint would not, in the longer run, affect the ability to afford houses – it would merely move the general level of house prices to match the increased or reduced ability to afford housing, with some short term substitution effects. Increase or reduce the amount of debt people can take on (in whatever way that is done) and the ability to afford housing at a given price does improve / reduce – but the level of house prices will increase or reduce to match with no net gain but possibly with some increased uncertainty amongst prospective purchasers.
    The only way, in the long run, is to change either supply of or demand for housing at given price levels. At the moment, people generally want larger houses with fewer people in them than our parents made do with (in this I am guilty), so somewhere there needs to be more housing or we need t ogive up this dream.
    Either we do infill housing or we build on the periphery, or, more probably, both. Infill is generally opposed by current residents as noted up the thread. What’s left?

  25. observa, and others trotting out the line that (essentially) ‘people these days just want more’. This line gets a lot of support, especially amongst those 40 and up, but it too simplistic.

    Firstly, let me just acknowledge that there is certainly some truth to the claim that many first home buyers want bigger, better homes that previous generations of first home buyers. But this is not the cause of high house prices.

    To show this, one only need look at the increase in price of established houses. A concrete example — I grew up in a unit (sharing a room with a sibling), and my parents bought that unit on a single labourers income (my fathers). The unit is in essentially the same condition now than when they bought it. And yet the average (median) household income in Sydney could not hope to purchase this unit now. This is true in general of established houses.

    Easy credit, a limited supply of good ‘locations’ (not land), and increase in double income families are more likely explanations.

  26. For Sydney at lelast, where lend release has to be far from, well, everything, Increasing supply in good locations is the only real way to tackle the problem. This means urban consolidation. But people dont want this, do what gives?

    In Sydney, either we accept urban consolidation, or non home-owners pack up and move somewhere cheaper. Brisbane has benefitted from such an exodus (from Sydney) for some time, but if Brisbane gets expensive, they’ll just move elsewhere instead.

  27. Andrew, thank you for your comparative statics example.

    Please note you compare only “equilibrium” prices without bankruptcy and you leave out borrowings for education and you leave the time frame of ‘adjustment’ undefined with respect to the life span of individuals. You recognise ‘increased uncertainty’ and hence recognise incomplete markets.

    If you were to start of modelling the decision problem of two people on minimum wages with 2 children, using actual price data for private schools, food, housing, clothing, I should think you will see the problem very quickly.

  28. Ernestine,
    Expecting, as you seem to, an article ready for peer review through a blog comment is a bit unrealistic – but I am familiar with this.
    The “incomplete markets” I am implicitly recognising here is the uncertainty due to future, inconstant, government policy – I am happy to concede that irrationality happens when government gets involved. Such interference is a common source of error.
    I would be interested to see your estimate of the reality of the scenario you have presented – how many families are on minimum wages and have two children going to private school? I would not want to waste my time modelling a trivial scenario.

  29. I think we actually have two separate problems here. The one is rising expectations amongst some people. As mentioned above you have a group of people who now won’t tolerate the modest 2-3 bedroom homes of yesteryear and think they’re being priced out of the market when they actually could afford a house if their expectations had not shot up.

    However, a different problem is the people who really do need to live in the inner city or close to public transport. Uni students are the most obvious example. In the days when people looked down their nose at the inner suburbs (or at least some of them) these people could occupy rundown houses close to the places they need to attend for study or low paid work.

    Now that there is no cheap housing in these areas students are forced to either pay exorbitant rates, or to live long distances away creating huge travel costs, as well as loss of time. The places they are living in are nicer (few outdoor toilets these days in inner city Melbourne) but many of these uni students/low paid workers would be happy with lower standards of accommodation if only they could afford somewhere close.

    The problem in the second case is that a benign irrationality (prejudice against certain suburbs) has been removed and the true situation of starck income inequality has been exposed. Previously those with really low incomes had an effective subsidy from the irrationality of the housing market. Now they don’t and they’re hurting.

  30. Well, after many months, and with the special incentive of some arrant nonsense to refute, I have finally overcome the barriers to entry that JQ put up. It remains to be seen if I can only do this using a Microsoft platform like this one at the library. The barriers might still be there if I try to use my Linux platform at home – I couldn’t get in last night.

    Anyhow, the arrant nonsense is the “…and…” in: “Looking at policy, the obvious thing to change, if you want to make it easier for people to buyer [sic] houses is to remove taxes on entrants, like stamp duty, and replace them with taxes on incumbents, by removing the owner-occupier exemption from land tax.”

    It’s a non sequitur, completely ignoring the unhypothecated nature of these revenues. When people reject the suggestion, they are not rejecting the “…remove taxes on entrants…” part but the rigged bargain, either/or, that they are being offered; in other words the “…replace them with taxes on incumbents, by removing the owner-occupier exemption from land tax” part. That part is a terrible suggestion and would outweigh any benefits from the first part for a number of reasons even if there were a nexus. I could go into great detail demonstrating that, but happily I don’t need to; the nexus is spurious, and the arrant nonsense is presenting it like that, pig in poke fashion. A true debate would consider a wider range of options, including but not limited to replacing the revenue decline in yet other ways, or even … wait for it, you dyed in the wool social democrats … reducing government services (in cost terms – I readily acknowledge that real needs would still have to be met, but there is a similar spurious nexus in suggesting that that intrinsically requires government provision, let alone that it requires government provision of the same sort as now).

  31. What’s so great about the capital cities? There is still a modicum of affordable housing in Gosford and Wyong (although admittedly even these prices have shot up, but at least a bit more commensurate with the rise in real wages). You can either pay for better housing upfront (ie in a higher purchase price) or through loss of time (ie in spending time commuting). Rational agents can do the sums!

    And then there’s the whole question of decentralisation. As we move to a services/knowledge-based economy, people can escape to nicer places than Sydney, like Hawks Nest and Tea Gardens. On a more general note, where are the new towns? Businesses face high costs of being in capital cities too (including for commercial land). Surely there’s a people -> industry -> business -> model somewhere in the regional economics textbook? Encouraging people not to live in the capitals would surely limit the need to expand supply in the capitals!

    One of the root causes (as I see it) for higher house prices is the vicious circle that was established by two-income households. These households had the money to bid the price of housing that they wanted to live in up. This meant that in order to buy a normal house, other households also had to become two-income households. Now a single-income household struggles where before they did not. The whole demand curve has shifted outwards because more quantity can be demanded at every price point. However, at the same time, society has benefited greatly from the participation of women in the workforce. In a number of respects, society has made its choice on the trade-off; I think that society’s choice is by far the correct one.

  32. Ernestine Gross: “If you were to start of modelling the decision problem of two people on minimum wages with 2 children, using actual price data for private schools, food, housing, clothing, I should think you will see the problem very quickly.”

    People in this situation have never been able to contemplate buying a house, now nor in any other era.

  33. Luxury Yacht, is you conclusion due to private school fees or is it due to location and size of house?

  34. Andrew Reynolds, its not always that simple. For one thing some university courses are not offered at outer suburban universities. Others are, but in substantially lower quality.

    On top of this, most students start off going to university while still living with their parents. When they move out there are significant adjustment costs in changing universities because they can’t afford to live within cooee of the one they were going to. Of course they could stay with their parents, but that can be pretty sub-optimal for a range of reasons.

    Finally, part time work is often not available close to outer suburban universities, leaving part-time students with the choice of living where they can get to their work, or where they can get to their university, but without being able to access both without major costs of one sort or another.

    I don’t know how much of the population is being genuinely squeezed by this situation, rather than just whinging about everything not being perfect for them, but it is certainly more than was the case 20 years ago.

  35. In Perth it is a straight forward demand and supply problem. Current annual demand for new houses is 30,000. Current supply of new land is less than 20,000. Jerking around with first owners grants and stamp duty isn’t going to improve the shortfall. State and local governments are responsible for placing restrictions on the number of new lots being released. This is NOT a Federal Government problem.

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