BEFORE THE AUCKLAND UNITARY PLAN INDEPENDENT HEARINGS PANEL

IN THE MATTER of the Resource Management

Act 1991 (RMA) and the Local

Government (Auckland

Transitional Provisions) Act

2010

AND

IN THE MATTER of the Proposed Auckland

Unitary Plan – Topic 081 –

Rezoning and Precincts

Hearing Statement by Adam Thompson for the NZIA and UDF

Economics and Property Market Analysis

14 MARCH 2016

1. I address three key topics in my summary statement. The first is an outline

of the two key principles of housing economics that I believe are crucial for

understanding the housing market. The second is a brief overview of some

of the proposed changes in the Resource Legislation Amendment Bill which

I believe is important context for the issue of the supply of housing under

district plans. The third is a brief response to Dr Fairgray’s 081a evidence

on housing capacity, which is outlined in more detail in evidence I presented

under 081 on behalf of the Property Council of NZ.

Key Principles of Housing Economics

2. The two main concepts that I rely upon to understand the housing market

are the ‘fundamental cost of production’ (supply) and the ‘price elasticity of

demand for housing’ (demand). There are of course many other principles;

however, these are in my opinion the two key principles.

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3. I have reviewed all of Dr Fairgray’s evidence on housing under the PAUP,

and do not believe he has addressed the economic principles I outline below,

in his 081a evidence, or previous evidence on the housing market.

Fundamental Cost of Production (Supply)

4. The principle is that the price of new housing should reflect its fundamental

cost of production in an efficient market. In other words, the price a

consumer should pay for housing should reflect the cost of construction,

technical consultation, consenting fees, finance, raw land purchase price and

a normal market profit. This principle can be broadly understood as the

supply side of the equation (i.e. at what quantity and price can dwellings be

supplied).

5. If there is insufficient capacity for housing in a District Plan, to keep pace

with demand, the ‘raw land price’ will increase, resulting in a windfall profit

for the land owner. It should be noted that this windfall profit does not just

fall to developers that are land banker: it also falls to farmers, and perhaps

to the greatest extent, it falls to owners of existing small urban properties

that have untapped development potential, such as for an additional rear lot

and dwelling.

6. At present the raw price paid for a development lot is in the order of

$150,000 - $200,000. This means that once the ‘land developer’ undertakes

the development of the lot itself, the end price of the lot is in the order of

$250,000 - $400,000, and much higher in the higher end of the market. To

put this in perspective, the value of one hectare of raw development land in

Auckland is now in the order of $2 million to $4 million, and it is this high

land price that flows through and underpins the high price for new dwellings.

By comparison, one hectare of raw development land is in the order of

$500,000 to $700,000 in Hamilton, Tauranga and Christchurch, which are

the other main growth areas in New Zealand, and these cities are able to

deliver relatively affordable dwellings, with new three bedroom dwellings

available for around $400,000. As a benchmark, the value of land for

agricultural production is generally less than $430,000 per hectare, so in

theory, raw development land could be acquired at a very low cost in an

efficient housing market.

7. The concept of the fundamental cost of production for housing is outlined in

detail by a Professor of Urban Economics at Harvard, Edward Glaeser, such

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as in his book entitled “Rethinking Federal Housing Policy: How to Make

Housing Plentiful and Affordable” (2008). Professor Glaeser goes on to

conclude that the quantification of the fundamental cost of production is

more useful than an assessment of the household income to dwelling price

ratio, as the latter can be inaccurate for a number of reasons, such as

household wealth (equity) or local interest rates; however, the former is a

measure of the ‘degree of monopoly’ that may exist in a housing market as

a result of insufficient supply. I would highlight that having a degree of

monopoly is a market failure, or more accurately a government failure, and

this undermines economic efficiency, so is contrary to the RMA.

8. When evaluating the results of the ACDC15 model, Dr Fairgray does not

consider the issues the cost of production, and although he identifies that

there will be a shortage of dwellings for less than $500,000 in the urban

area, he ultimately concludes that the housing market will work efficiently

under the PAUP. Therefore, Dr Fairgray does not acknowledge the significant

economic benefits of a housing market that can produce dwellings at a

marginal price that reflects the cost of production.

9. In my opinion, it is not possible to conclude that a market would be

economically efficient if each additional unit is produced at a price that

exceeds the cost of production. This is a fundamental economic principle that

has not been considered by Dr Fairgray in his evaluation of the results of the

ACDC15 model.

10. The following is Dr Fairgray’s conclusion regarding housing under the PAUP,

presented in his 018a evidence, dated 2nd March 2016:

“8. CONCLUSION

8.1 My overall conclusion is that the currently available information

shows that feasible dwelling capacity is likely to be considerably in

excess of demand for additional dwellings in the period to 2026,

(and beyond to 2041).” (emphasis added)

11. For the reasons outlined I do not believe that this conclusion can be reached

because it is contrary to the economic principle that the price of housing

should reflect its fundamental cost of production in an efficient market, and

Dr Fairgray has previously established in his evidence that the price of

housing would substantially exceed its fundamental cost of production, in

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that no new dwellings are possible for less than $500,000 in terms of the

highest percentage profit criterion.

Price Elasticity of Demand for Housing (Demand)

12. The principle is that as dwelling prices increase there will be a corresponding

decrease in demand. This does not mean that households do not want new

dwellings; rather that some households are simply not able to afford to

purchase or rent a dwelling as prices become too high, and consequently

they resort to overcrowding or simply move to another city. Both of these

issues appear to be evident in Auckland. The principle of the ‘price elasticity

of demand’ can be broadly understood as the demand side of the equation

(i.e. at what quantity and price will dwellings be demanded).

13. It is generally accepted that the ‘price elasticity of demand’ for housing is in

the order of -0.7%. The price elasticity of the demand for housing services

in North America is estimated as -0.7 by Polinsky and Ellwood (1979), and

as -0.9 by Maisel, Burnham, and Austin (1971).1

14. This means that a 7% annual increase in the average dwelling price, as

estimated by Dr Fairgray in his 018a evidence, and described by him to

reflect “general market conditions”, would result in a decline in demand of -

5%. This means that every year, as prices increase by $90,000, there would

be a corresponding decrease in demand of 600 dwellings. I would re-

emphasise that this is not because households do not want their own

dwellings; rather it is because they choose to overcrowd or leave the City as

a result of the high prices.

15. I would note that Dr Fairgray has put forward the opinion that an increase

in the average price of dwellings would lead to a higher rate of construction.

This is contrary to the literature on the price elasticity of demand for housing.

16. I would also highlight that Dr Fairgray has not considered the ‘price elasticity

of demand’ principle in any of his evidence, and in my opinion, if he did

consider this principle it would not be possible for him to reach the conclusion

that “…feasible dwelling capacity is likely to be considerably in excess of

demand”. This is because of the principle that rising prices lead to lower

1 Polinsky A. M. and Ellwood D.T. (1979) An empirical reconciliation of micro and group estimates of the demand for housing, Review of Economics and Statistics, vol. 61, pp. 199–

205, Maisel S.J., Burnham J.B., and Austin J.S. (1971) The demand for housing, Review of Economics and Statistics, Vol. 53, pp. 410–413.

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demand (due to high prices) and therefore fewer dwellings are built, with

the implication being that if dwellings are not able to be built by the market,

they cannot be considered to be capacity.

17. A similar situation is evident in the United Kingdom. Cheshire, Nathan and

Overman (2014) explain that requirements for local authorities to supply a

given amount of development capacity were futile. The authorities in the UK

met the requirements by providing a large amount of notional housing

capacity that the authors allege did not relate to their incomes in terms of

affordability, or their other locational and typology preferences. The authors

conclude that as a consequence the overall supply of homes was not

improved2.

Resource Legislation Amendment Bill – Implications for Housing

Markets

18. A key purpose of the Resource Legislation Amendment Bill is to improve the

quality of research and analysis undertaken for the residential and business

land markets when preparing new District Plans. The Resource Legislation

Amendment Bill proposes the following addition to section 30 of the RMA:

“the establishment, implementation, and review of objectives,

policies, and methods to ensure that there is sufficient development

capacity in relation to residential and business land to meet the

expected long-term demands of the region”.

19. This provision would in effect require the development of models such as the

ACDC15 models. I would highlight that there appears to be a general

acknowledgement of the need for a proper understanding of the impact of

District Plans on land markets and in particular whether they enable the

efficient supply of dwellings and business premises.

Dr Fairgray’s 081a evidence

20. I have reviewed Dr Fairgray’s evidence which is based on the results of

version 3.7 of the ACDC15 model. There are a number of issues that I have

with this evidence. The main technical issue I have is that Dr Fairgray has

relied on a version of the model that has not been peer reviewed by either

2 Cheshire, Paul, Nathan, Max, and Overman, Henry (2014) Urban Economics and Urban Policy: Challenging Conventional Policy Wisdom, Edward Elgar Publishing Ltd, Cheltenham

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the 013 Expert Group (”013EG”) or the Property Development Expert Group

(“PDEG”). Dr Fairgray has therefore effectively developed his own version

of the ACDC15 model and relied upon this for his evidence.

21. I have communicated with the PDEG members and all of these members that

have responded have confirmed that they are not comfortable with the use

of the ACDC15 model version 3.7 results because they have not been peer

reviewed by the PDEG, which was the agreed process.

22. Within Dr Fairgray’s version 3.7 model, he estimates house prices will reach

$2.0 million by 2026 and $2.6 million by 2030, under what he refers to as

the “general market conditions”, or in other words a ‘business as usual’

housing market. This is an increase of $90,000 each year over the next

decade. Dr Fairgray’s estimates of capacity can only be achieved if this rate

of price growth occurs. In other words, if a lower rate of annual growth was

built into the model, substantially fewer new dwellings would be feasible.

Such an outcome would have unprecedented adverse economic and social

effects, the nature of which are largely unknown.

23. Auckland Council’s ‘income to dwelling price’ goal of “five by 2030”

(Resolution Number AUC/2015/196) which is to be included in the 2016

Auckland Plan, will not be achieved. Based on Dr Fairgray’s expectation, the

ratio will instead be “26 by 2030”. This will make Auckland the most

expensive City in the World relative to income. It is difficult to understand

how Dr Fairgray concludes that the housing market will meet the needs of

the community under the PAUP given this level of price increase and absence

of affordability.

24. Perhaps of most concern, Dr Fairgray estimates that no dwellings can be

built for less than $500,000 under the PAUP and that only 400 dwellings can

be built for less than $600,000 when the highest percentage profit factor is

considered. This is the most likely outcome in the market, as developers will

in most cases seek the highest percentage profit (notwithstanding their

capabilities and ability to access development finance). Dr Fairgray

consequently concedes that first home buyers will need to rely on the

existing housing stock for affordable dwellings.

25. Dr Fairgray estimates that around 23% of the City’s housing stock is sold for

less than $500,000 (although I would note that the percentage of the total

stock would be a lot less because lower priced dwellings tend to sell more

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frequently). Given his expected annual average price increase of $90,000,

the majority of these dwellings will however be priced above $500,000 in 1-

2 years. Dr Fairgray’s conclusions about the housing market therefore

predict a future in which dwellings for less than $500,000 will be extremely

scarce or generally not available by 2018.

26. Dr Fairgray makes an error in his assessment of his version 3.7 model

results. He does not account for the fact that some developers will not

choose the most profitable development due to constraints on their access

to development finance or limited expertise. For example, a land owner may

build one dwelling on a rear lot and retain the existing dwelling, rather than

demolish the existing house and build five new terrace houses or ten

apartments. In my opinion, the commercially feasible capacity estimates

that Dr Fairgray presents should be discounted to reflect this market reality.

27. In my opinion Dr Fairgray’s 081a evidence demonstrates that the housing

market under the PAUP would be in a state of extreme market failure. This

is contrary to the RMA.

013EG Report

28. Dr Fairgray and Mr Balderston have prepared a summary report on behalf of

the work of the 013EG, dated 4th March 20163. I have reviewed this report

and raised concerns with the 013EG that this was not in my opinion a

balanced representation of the 013EG work. In particular, the report:

Included a large amount of demographic and other analysis

undertaken by Dr Fairgray that was not discussed in detail by the

group, and was not the main focus of the work the group undertook;

Contained a detailed assessment of the implications of the model

for planning in general that was not discussed by the 013EG, and

Did not sufficiently emphasise the concerns raised by many

members, in particular issues with the ACDC15 model and wider

issues such as the shortfall of lower-priced dwellings.

3 Residential Capacity Results, Methodology and Assumptions Produced by Topic 013 Urban Growth Expert Conferencing Group, At the request of the Auckland Unitary Plan Independent Hearings Panel

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Auckland Council’s consulting economist Peter Nunns’ view on the

housing market under the PAUP

29. Auckland Council’s consulting economist Peter Nunns concludes that:

“[t]he most likely outcome of this is that Auckland will continue to

build too few homes [under the PAUP] and prices will continue

rising…The social ills caused by that dynamic – poverty and

unhealthy housing, crimped opportunities for young people,

unsustainable levels of car-dependent sprawl, and high rates of

outward migration among the young – will also continue.”

Conclusions & Recommendations

30. In my opinion Dr Fairgray’s evidence should not be relied upon to support

decisions regarding housing under the PAUP. The main reasons for this are:

Dr Fairgray has relied on his own version of the ACDC15 model that

has not been peer reviewed or accepted by the 013EG or the PDEG.

The ACDc15 model is a property development simulation model and

should be built and interpreted by property development experts.

Dr Fairgray has not considered the key economic principles for

housing in his 018a evidence. These are the fundamental cost of

production and the price elasticity of demand for housing.

31. I agree with Peter Nunns’ conclusions. The main reason Auckland will build

too few homes is because it is not able to build lower-priced dwellings in the

lower end of the market under the PAUP as concluded by Dr Fairgray.

32. I believe that the most important issue for the PAUP to address is the supply

of lower-priced residential dwellings, particularly in the sub-$500,000 price

range. Dr Fairgray has concluded that this issue will not be addressed in the

form of new housing, and relies exclusively on the existing housing stock to

provide lower-priced housing. Given Dr Fairgray’s estimated dwelling price

growth of 7% per annum, which equates to $90,000 per annum, it is

reasonable to conclude that all existing dwellings will be priced above

$500,000 within 1-2 years. If Dr Fairgray’s prediction does occur, it will

mean that the City’s housing crisis will be exacerbated and the risks to social

and economic wellbeing will reach a level that is probably unprecedented for

any city.

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______________________________

Adam Jeffrey Thompson

14 March 2016