Estudio económico 

Rapid house price escalations, and house price volatility more generally, are particularly concerning if prices deviate from long-run fundamentals for significant periods of time. In this case, investment decisions in the economy may not reflect underlying resource costs, with negative implications for productivity and incomes. Of course, unpicking the drivers of the New Zealand housing market and the extent of any imbalance between supply and demand is not straightforward. Notwithstanding this caveat, this section sketches out a framework for assessing the key drivers of house price dynamics from a New Zealand perspective.

5 _{Of course, as discussed in Chapter 3, these factors also contributed to real house price inflation over this period, highlighting the complex}

Demand side

On the demand side, it is useful to distinguish between underlying and effective demand for housing:

 Underlying demand is driven by household formation, which reflects population growth and changes in household size. In turn, population growth is a function of natural increases (births minus deaths) and net migration. Household size is essentially determined by demographic factors.

 Effective housing demand reflects the combined effect of consumer and investor aspirations to rent or buy a dwelling and their financial ability to do so. As such, it is influenced by the prevailing set of economic factors, including incomes, availability of finance and the economic situation more generally. Previous empirical work indicates that both underlying and effective demand-side drivers have, to varying degrees, played a role in the New Zealand housing market.6 _{In particular, the evidence outlined in Chapter}

5 indicates that population and demographic influences have been important drivers of household formation, with implications for the quantity and type of dwelling required in the New Zealand market. Population growth has been relatively strong in international comparison and migration flows have been volatile and mostly focused on Auckland. Further, demographic changes – such as population ageing, cultural and ethnic diversification and a radical transformation in family structures – have also been pronounced over recent years. Although there is some debate in the New Zealand literature on the significance of migration for house prices (discussed in Chapter 5), across OECD countries, higher population growth is associated with real house price appreciation (Sánchez and Johansson, 2011). Changes in effective demand have also been significant in the New Zealand housing market. Although income growth has been relatively weak in international comparison, as outlined in Chapter 3, it has still led to some upward demand pressures in the housing market as households seek to ‘trade up’ and improve the quality of their living environment. However, perhaps more importantly over the course of the recent house price boom, increased access to credit, low interest rates and innovations in financial instruments have increased the ‘borrowing capacity’ of households and have been a key source of increased effective

demand for housing (Figure 2.6 above). As mentioned above, these changes in financial markets, which have occurred across most OECD countries, are commonly cited as a predominant reason why the last house price boom was so synchronised across countries (for example, André, 2010).

Supply side

The extent to which new housing construction responds to changes in demand is perhaps the most important factor for the effective functioning of the housing market. This reflects a collection of determinants, including the time taken to acquire land and complete construction. As such, the

responsiveness of housing supply depends not only on geographic and urban characteristics, but also on policies – such as land use and planning regulations – that directly impact on housing supply.

The supply responsiveness of the housing market influences the extent to which an increase in housing demand leads to more housing construction or to higher house prices. As such, it is a key determinant of housing affordability. The international evidence indicates that if the supply of housing is constrained in some way, then increased demand will tend to feed into higher house prices, rather than an expansion in housing supply (Glaser, Gyourko and Saiz, 2008; Gyourko, 2009). Conversely, if housing supply is relatively responsive, then the impact of demand shocks will tend to show up as changes in housing investment. The empirical evidence for New Zealand suggests that the responsiveness of housing supply to changes in demand is around average across the countries for which data is available, but almost half as effective as in a number of the better-performing OECD countries (Figure 2.7). With a long-run supply elasticity that is less than one, an increase in the demand for houses in New Zealand is estimated to lead to a proportionately larger increase in house prices than in new house construction. In some of the better-performing countries, with supply responsiveness that is more than twice as vigorous as in New Zealand, much less of the

adjustment to a positive demand shock ends up coming through as higher house prices.

Figure 2.7 Price responsiveness of housing supply, selected countries1

Estimates of the long-run price elasticity of new housing

Source: Sánchez and Johansson (2011) Notes:

1. Estimates of the long-run price-elasticity of new housing supply are derived from a stock-flow model of the housing market that is estimated with an error correction framework. The estimation period is from the early 1980s to the mid-2000s.

Supply responsiveness at the local level

Some of the regulations that influence the supply side of the housing market are set and/or administered by local councils. As such, the extent to which housing supply responds to changes in demand, and the

associated price dynamics, may vary across the country to some extent. In areas where council policies and practices allow for rapid expansions in new house construction, house prices should be less volatile than in areas where new supply is more constrained. This type of dynamic has been detected across cities in the United States. For instance, Green et al. (2005) find that housing supply is highly-responsive to demand pressures in cities with ‘pro-development’ regulatory environments and readily available land. In contrast, supply responsiveness is low in cities with high regulatory barriers to expansion and cities with declining populations.7

Empirical work by Grimes and Aitken (2010) indicates that the responsiveness of housing supply does indeed differ across TAs. This indicates that the construction and land development sectors are more responsive to changes in housing demand in some parts of the country compared to others. There is also evidence that in areas of the country where housing supply is more responsive, an increase in housing demand results in relatively more houses and smaller increases in real house prices, with potentially

beneficial implications for housing affordability. In technical terms, there is a negative correlation across TAs between the extent of supply responsiveness and the speed with which house prices adjust to their new equilibrium.

Although difficult to show conclusively, differences in supply responsiveness at the TA level may, in part, reflect the efficiency with which local councils implement and enforce regulations governing the land development and building sectors.

Land availability and the Metropolitan Urban Limit

Supply-side rigidities in New Zealand’s housing market are apparent in relative price pressures for the various inputs into the house building process. Section prices have grown more quickly than house prices over the last 20 years, indicating that land supply has become less responsive to increases in housing demand (Figure 2.8). Steadily increasing section prices as a share of the cost of new dwellings indicates a shortage of residential land in places where people want to live. Land price pressures have been particularly acute in Auckland where section prices have increased by significantly more than in the rest of New

7 _{Arguments about the role of regulatory and geographical constraints have subsequently been strengthened Gyourko, Saiz and Summers (2008) and Saiz}

Zealand. Land now accounts for around 60% and 40% of the cost of a new dwelling in Auckland and the rest of New Zealand respectively. As a result, appreciating land prices have been a key driver of house price inflation in New Zealand over recent years.8

Figure 2.8 Land prices as a share of house values

Source: Productivity Commission calculations using QV data

In Auckland, the Metropolitan Urban Limit (MUL) is a key zoning restriction that defines “the boundary of the urban area with the rural part of the region” (Auckland Regional Growth Forum, 1999). The Commission has estimated a model of land values in the greater Auckland region to assess the impact of the MUL. The results from estimating this model indicate that the MUL is a binding constraint on the supply of land. The value of this land price differential has increased since the late-1990s, suggesting that the MUL has become increasingly binding as housing demand pressures have intensified within Auckland city.

Much of New Zealand’s land area is unsuitable for residential development. However, a very low population density suggests that raw land is potentially relatively abundant. Although data on the quantity of land at various points of the development process is not collected in New Zealand (House Prices Unit, 2008), this suggests that policy and planning practices are constraining the supply of residential land. For example, strong land price pressures in Auckland raises questions about the impact of policies aimed at increasing density – such as the Metropolitan Urban Limit and other planning restrictions – on housing affordability. As discussed in Chapter 7, the challenge is to improve land release and planning approval processes so that affordability considerations are taken into consideration.

Construction costs

As outlined in Chapter 10, construction materials are more expensive in New Zealand than in Australia. This reflects a number of factors including the small size of the New Zealand market, and corresponding small scale of New Zealand material manufacturers, and high domestic transport costs. Also, there are only two major materials manufacturers in New Zealand and some inquiry participants raised questions about the extent of competition in the market. From 2002 to 2011, the cost of building materials increased by almost 20% in real terms, although about one third of that reflects the introduction of new materials (such as double-glazed windows).

More generally, the costs of all the major inputs into housing construction have typically increased more quickly than both generalised inflation and the costs for other forms of construction (Briggs and Ng, 2009). The available evidence suggests that the construction industry is populated by a large number of small businesses that predominantly operate on a cost-plus basis. As such, productivity growth in the sector has, at best, been flat over recent years and lower than in the economy in general. This indicates limited scope for the sector to respond to demand increases without upward pressure on relative prices.

8 _{Work by Grimes and Aitken (2010) indicates that increases in the price of land may actually lessen supply responses in the housing market and}

Reflecting these issues, total construction costs have increased by 30% in real terms in the nine years to 2011, with large increases recorded over the 2000s house price boom. The cost of residential construction in New Zealand is significantly higher than in Australia, with negative implications for housing affordability. For example, per square metre building costs are estimated to be around 15% to 25% lower in various Australian cities than they are in Auckland.

Lowering construction costs to improve affordability calls for productivity improvements driven by a range of factors, including improvements in government procurement and technological and regulatory changes that allow a greater use of internationally traded house components and building supplies.

Charging for infrastructure and the cost of building regulation

Infrastructure charges vary across the TAs and can be significant – a survey conducted across ten regions found that development contributions account for between about 1% and 10% of median section prices and can influence housing affordability (Chapter 8). There is no reliable data available on the impact of building regulations on construction costs.

It is clear that regulations governing residential building construction increase the cost of building a house. However, the benefits of these regulations, which include increased safety and amenity, also need to be taken into consideration. The challenge is to develop, administer and enforce regulation in the sector so as to maximise its net benefits. The impact of land release policies, infrastructure charges and building regulations are discussed in Chapters 7, 8 and 9 respectively.