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. 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’.

  2. 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.

  3. 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.

  4. 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.

  5. 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?

  6. 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.

  7. 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.

  8. 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.

  9. 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.

  10. 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.

  11. 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).

  12. 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.

  13. 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.

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

  15. 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.

  16. 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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