Supply, not tax, the answer

Jason Krupp
23 May, 2016

Amid the rancorous debate about whether a land tax should be imposed on non-resident property buyers it is vital to remember what caused New Zealand’s housing crisis in the first place: a sustained lack of land supply.

Far too often in the discussion on how to cool Auckland’s white-hot housing market the focus strays from this fundamental fact, and falls on demand-side factors. The most recent of which is a land tax, put forward by Prime Minister John Key as a means of stemming the deluge of cheap money into the Auckland housing market.

The problem with this tax is that it will do little to stall the momentum of the city’s housing affordability crisis. That is because a tax is ineffective, and worse, targets the wrong problem.

Consider that if you are a property speculator, the optimal time to sell up and realise your gain is when the return from your investment is equal to the costs of capital. Until that point you may as well sit back and watch your asset values grow. Now factor in that median house prices in Auckland rose 14% in the year ending March 2016 according to REINZ data, while floating mortgage rates were pinging around the 5.5% mark (and offshore borrowing can be even cheaper than this).

A tax would have to be set so high that it disincentivised foreign speculators altogether. This is of course possible, but in all likelihood it would only swap foreign investors for domestic ones. After all, who can ignore an 8.5% net increase in the value of their investment when five year term deposits only return 3.8%?

Most importantly, a land tax would not build any new houses in a city currently experiencing rapid population growth. That is the root cause of Auckland’s housing crisis and the reason why property speculation is possible in the first place. Amid a severely constrained supply, each new person moving to Auckland drives up the returns on housing investment relative to the costs of capital.

If we want to tackle this problem the answer is to release so much land that there is little incentive to speculate. Speak to central or local government officials and they will tell you they are doing exactly that. The Auckland Unitary Plan, for example, has capacity for around 60,000 dwellings on greenfield land, two-thirds of which are within the old urban growth boundary. That is a significant amount of land that could potentially make a huge difference to housing affordability if it were to be released onto the market in one go.

Only it will not happen. That is because Auckland Council cannot afford to provide the necessary infrastructure due to balance sheet constraints. One such constraint is the binding rule that limits borrowings to 15% of revenue, a threshold that Auckland Council has almost reached.

As such, land is drip fed onto the market, the supply constrained status quo holds amid a booming population, and the incentive to speculate increases. This is particularly so in the case of land bankers, who can see the value of their agriculture land shoot up from $50,000 a hectare to $5 million dollars a hectare once it is up-zoned for residential use.

Of course this vicious cycle cannot last forever, and when it stops the consequences for the country will be disastrous.

If policymakers are serious about tackling housing affordability before this happens they need to accept some uncomfortable truths. The first, to quote economist Arthur Grimes, is that you can have cities that are either cheap-and-big, or small-and-expensive. That means accepting that Auckland must grow beyond its current boundaries. Small-and-cheap is not an option.

The second is that if councils are to solely provide the infrastructure needed to open the land supply spigot, housing affordability will only worsen. Financial constraints such as rates burdens and debt limits mean that new land will only be dribbled onto the market, doing little to address the factors that make speculation possible.

Instead private developers should be allowed to provide their own infrastructure for housing development at the edge of cities. In Houston, the use of Municipal Utility Districts has allowed the city to rapidly expand its residential capacity as its population boomed without relying on the public purse. It should be noted that housing in Houston is now cheaper than it was in the 1980s when adjusting for inflation. And it take three times the median wage to buy the median house there, while in Auckland the median multiple is 10 and rising.

Whatever your views on foreign investors, the bare fact is that the cure to New Zealand’s housing crisis is supply. It is a damning indictment on all of us that in a country the size of the United Kingdom, and a population 14 times smaller, New Zealand’s stability is threatened by housing crisis.

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