Labour on Housing, RBNZ on LVR

There appears little plausible economic justification for Labour's proposed ban on foreigners' buying houses.

Let's take Seamus's logic from yesterday one step further. Recall Seamus's simple model:

Consider a very simple model of the New Zealand housing market in which there is a fixed supply of identical houses that will not change over time, and an unchanging demand. Let there be no on-going maintenance or other costs to owning a house, just the one-off capital costs. Finally, let there be a risk-free interest rate of 5%, let demanders be risk-neutral and indifferent between renting and owning for a given cost, and let rental income to a landlord be exempt from tax so that there is no tax advantage to owner-occupied housing. In this world, there would be an unchanging equilibrium rental price for housing over time, and an unchanging price of houses that would be equal to this rental price times 20.

Following on from Seamus's later tweaks to the base model, let us also change the model a bit. Imagine that demand in one year's time will double and then stay constant from then on, and that everyone knows that as of tomorrow. The process is identical to the one Seamus lays out for the case where only foreigners know that equilibrium demand doubles in a year's time given that the stock of foreign capital is large relative to the domestic market:

In this version of the model, the rental rate would continue to remain constant for a year before doubling, but foreigners would bid up the price of houses now to the point where the capital gain between now and in one-year’s time was sufficient to exactly offset the fact that current rentals are insufficient to cover the capital cost of the house.

We can get a disconnect between current rental prices and current house prices where the market expects a future increase in demand relative to supply. That rental rates have not gone up lock-step with Auckland housing prices simply isn't automatically evidence of a bubble or anything irrational. Rational, forward-looking investors could easily be looking at the current Auckland market, the current plans for expanding housing supply in Auckland, and concluding that there's no way that supply will increase quickly enough to keep up with increases in demand. We can't guarantee that this is what's happening, but we cannot simply look at the purported disconnect between rental costs and property prices and conclude BUBBLE.

Now, consider the RBNZ's proposed LVR policy. The policy restricts banks against allowing more than some percentage of new home mortgage loans to have "small" deposits. I am not sure if RBNZ has yet indicated what the thresholds for the different speed limits will be, but it's sounded like it's designed to be binding most of the time. Under what scenarios does this rule make sense?

Start with a world like Seamus's: perfectly inelastic supply, prices 20 times rental rates under his conditions. Further, there is zero chance of bank bailouts in case of property market collapse; everything would be handled under OBR where depositors might take a small(ish) haircut. Individual investors form expectations about future demand; banks form estimates of the future price paths of housing. They're both identical in this simple case. Now, suppose that a cohort of buyers knows that demand will double next year and so start bidding up the price of housing today. The banks from whom they're borrowing money check to make sure that the buyers will be able to cover the mortgage costs and that the buyers' expectations around future rental earnings aren't crazy.

In this world, LVR restrictions only make sense where bank exposure to highly leveraged property loans impose systemic unpriced risk. Even if RBNZ knows no better than do individual banks, they might want to set speed limits where loans risk pushing into leverage levels consistent with prior cascading bank failures. I'd expect that RBNZ has run plenty of stress tests and has some idea of what level of leverage could yield cascading failures for varying levels of property leverage and plausible ranges of housing market drops.

But, in this world, you only set the speed limit to bind in exceptional cases, not in normal cases. To get a rule that binds more strictly, I think you have to assume that RBNZ knows more about the future path of relative demand (either shifts in demand, or potential moves in the supply curve) than do either the banks or investors.

I wonder whether Labour's "dey turk er houses" ban-the-foreigners housing policy shares some common assumptions with RBNZ's LVR regs. Tweak Seamus's model a little bit such that these foreign investors are all just systematically wrong about the future demand path and that there are enough of them that they can manage to affect prices at the margin. Then banning them from bidding up housing where we know that they are causing a bubble by definition avoids a bubble. I do think this requires some pretty heroic assumptions about knowledge asymmetries. But they might not be all that far from the knowledge assumptions required to make sensible an LVR policy that binds in the normal rather than only in the exceptional case.

Christchurch Housing

I'd missed the Ministry of Business, Innovation and Employment's summary report on Christchurch housing when it came out a couple of months ago.*

The highlights:

• Total housing stock dropped by a net 11,500, or 6.2% of the ex ante housing stock, from 2010Q4 to 2012Q4.


• The number of private rentals as measured by tenancy bond remained constant at 39,000 during 2011 and 2012; the prior trend had increases of 1500 per year prior to 2010. 
  Demand for rentals would have increased sharply with destruction of owner-occupied homes, temporary moves by those getting repairs, and incoming construction workers. The largest drops were in tenancies of 2 to 3 bedroom homes.


• House prices in Christchurch are well above their prior 2007 peak, though Auckland's prices have ramped up by even more. But Christchurch rental prices have increased by more than Auckland. From August 2010 through February 2013, the average Christchurch weekly rent measured by new bonds lodged** increased by 31%, from $293 to $384. Auckland rental prices increased by 13% over the same period. 
• While average weekly rents remain higher in Auckland and in Wellington, the 2012 Household Income Survey has household income in Auckland at $94k, Wellington at $93k, and Canterbury at $82k.


• Rental accommodation at the bottom end of the market have been particularly hit. MBIE notes that MSD reckons $180/week about what beneficiaries can pay in rent; the proportion of private new bonds lodged in that range has halved since the quake. 
• I'm following up with MBIE for a bit more data on the overall distribution.


• Social housing units, whether provided privately as bedsits and boarding houses or publicly as Council housing or Housing NZ units, have also dropped substantially. Housing NZ was down 6% as of December 2012; I understand that the government pushed pretty hard to get the Housing NZ units sorted despite some thorny insurance issues. Christchurch Council is down 17%. The low-income tenants here served would not have an easy time finding alternative accommodation. They're being outbid for private rentals by incoming construction workers and by people seeking temporary accommodation during earthquake repairs. 
• I note that measures that could increase supply at the lower end of the market, like making it legal for private homeowners to build secondary flats into their homes, would result in fewer vulnerable tenants being displaced. 


• Holiday parks, which sometimes provide overflow temporary accommodation rather than just catering to tourists, are also overflowing. 
• I note that Council staff came close to shutting down the South Brighton holiday park when its toilet block failed an engineering code assessment; they backed down when it hit the press and instead are letting it be strengthened.  

The report also warns of a huge increase in accommodation demand set to come in 2014-2016 when an estimated 15,000-25,000 construction workers will be looking for housing at the same time as tens of thousands of home repairs create demand for short-term accommodation.

There's no way that allowing secondary flats within peoples' houses would come close to meeting the demand that's yet to come. But neither is there any reasonable reason to continue banning one of the easiest ways of getting quick temporary accommodation to market.

It will be interesting to see what will happen in 2014-2016.

* I'd linked the report here, but hadn't gone through it in depth.

 ** This will provide a better indicator of current market prices than would a measure of all existing rents: it shows what prices are faced by those coming to market.

The rent is too darned high: Auckland edition

Matt Yglesias, author of "The Rent is Too Damned High", points to work damning America's blue states. The map shows that it takes far more hours of work at the state minimum wage to afford a two bedroom apartment in California, Maryland, DC, New Jersey, New York and the like as compared to North Dakota, Montana, and Oklahoma. While the minimum wage is higher in the blue states, land-use restrictions keep housing pretty expensive.

Now there are some potential problems in the measure. They set an affordability line at 30% of income assuming a single earner household, but they don't seem to have accounted for the raft of other benefits that those low-income workers receive, most notably via EITC. So when they say that it would take a wage of $27.15 per hour to be able to afford a two-bedroom apartment in DC, that's just the number you get when you take the HUD Fair Market Rent measure, divide it by 0.3 to get the monthly wage necessary to afford that rent, then turn that into an hourly wage rate. Add in a second earner and the household wage of $27/hour is much easier to achieve. And EITC tops up wages at the lower end of the distribution, especially for those with kids.

But it's nevertheless fun to see where New Zealand's main cities might rank in this kind of comparison. There are 380 2-bedroom apartments for rent in the whole Auckland region on TradeMe. Sorted by rent, the 190th apartment is going to be about the median rent. $520 per week. You'd need to earn $1733 per week to "afford it", or $43 per hour. There are 1137 2-bedroom properties of any kind (apartments, houses, townhouses...); the 568th listing is $400 per week. You'd need to earn $1333 per week to "afford it", or $33 per hour. [Updated to get the proper median property and to provide a stable link]

Maybe the median price isn't a good indicator. Let's take the median overall price as the maximum in our search and get the 25th percentile. The median 2-bedroom property in the "under $400" set is $350: $29 per hour. Maybe that's too nice a place too. The median price on the first page of the low-to-high price-sorted search is $260: $21.67 per hour. On a 40-hour week at minimum wage, you'd be paying half your income in rent to afford it.

If the HUD FMR approximates the median market price for a 2-bedroom place, then Auckland ranks above the most expensive US state. If it approximates the market price for property at the 25th percentile, then Auckland ranks below Hawaii, but above everybody else. If it approximates the market price for the median rental property on the first page of a rental search sorted low-to-high, then Auckland is 9th: cheaper than Connecticut, but more expensive than Alaska.

The same process for Christchurch gives a median price of $365 per week and a 25th percentile price of $300 per week.

If you run the country as a whole, you get 3388 listings for 2-bedroom properties. The median, number 1694, is $340 per week. 25th percentile: $260 per week.

I'm not arguing we should set policy so that a single earner on the minimum wage can get a two-bedroom apartment on 30% of his salary. But that we fare poorly on a "number of minimum-wage hours necessary to rent a two-bedroom apartment" measure against the US, when the minimum wage here is much higher as a fraction of median the median wage than it is in the States, does suggest something about NZ land use policy.

The dollar is a price

Matt Nolan's bemoaned that nobody quite seems to understand that exchange rates are just a price. He would love this particular example.

The story here is bad enough: the Greens calling again for bans on foreigners buying houses in New Zealand. They say it isn't racist, but when pretty much every complaint is around Chinese buyers, I call it a dog whistle.* It's particularly galling when it's smart-growth style, Green-supported policies that have forced the property supply curve to be near-vertical and have made it possible for increased demand to be met primarily by price increases rather than by supply increases. And kudos to Prime Minister Key for batting this one down, despite its populist appeal.

But here's one vox pop understanding of exchange rates. It's always a bad idea to read the comments section of anything (except Worthwhile Canadian Initiative and maybe sometimes this blog). But here's Veda's view on exchange rates, hoisted from the 3 News comments:

The wannabe property speculators are in full swing on this thread... All those who benefit from rising prices keep pushing the emotional spin about racism...

The reality is that foreign countries are manipulating their currencies lower (which pushes our higher) using whatever brute force necessary (low interest rates and massive currency sell offs) and the result is favorable terms for buying NZ property (as our high dollar makes land in NZ cheap when earning money overseas). This is driving NZ property prices well beyond fundamentals (what working kiwis can afford) and precipitates more NZ money flowing offshore (as more and more rentals are now being held by overseas interests). [rest truncated]

Where to begin. It's likely that one country's currency would be bid up relative to others' if others pursue devaluation policies. We can argue about whether it consequently means that New Zealand should follow suit, and I can't see how we can do it in any substantial way while staying withing the Policy Targets Agreement's inflation bounds, but at least that first part isn't completely mad.

But the point of devaluing your currency is to make other countries' products relatively more expensive. You discourage imports and encourage exports by effectively dropping your country's real wages: people from your country can't afford as much when the value of the currency drops. Because real wages drop, nominal wage rigidity doesn't matter as much and employment goes up. At least in the first order. It also makes intermediate imported industrial inputs more expensive and messes up a bunch of other stuff, but we'll take that as read.**

So here's a pop quiz. If we devalued to the point where $1 NZ = $0.01 US, would it become:
a) more expensive, or;
b) less expensive
for somebody earning US dollars to buy a house in Auckland?

Hint: every dollar earned by the American would count for $100 NZD when bidding at auction.

Veda wants to devalue the New Zealand Dollar so that foreigners will have a harder time buying Auckland real estate. And, obviously, rental income being sent abroad to foreigners is entirely offset ex-ante by those foreigners buying New Zealand Dollars to purchase the property in the first place.

Why oh Why does every vote count with weight of one?

* Dogs can hear dog whistles while people can't. Kiwis who hate the Chinese hear the Greens' dog whistle; those who don't, don't notice.

** Devaluation that's consequent to proper application of inflation-targeting policies I don't have a problem with. Monetary easing to keep inflation from being too low will have the consequence of devaluing the currency, but the devaluation isn't the point of the policy. And maybe devaluation is best policy if you've a massive foreign currency debt you can't otherwise repay. Otherwise, read Nolan, linked above.

Consent constraint

From the Christchurch Press.

Item the first: there's a boom in building consent applications.

With the rebuild ramping up, the Christchurch City Council is struggling to find enough qualified people to process the hundreds of building consent applications it receives each month.

Building activity in the city has jumped markedly in the past four months, with the number of consent applications now at levels unseen since the peak of the 2007 building boom.

Many applications then were for minor building work that is now exempt from building consent requirements.

The council is dealing with a similar volume of applications, but the work is complex residential earthquake repairs and rebuilds.

Wow, they're busy. Ok. Item the second:

Of the 281 new homes approved in November [for the Canterbury region as a whole], 96 were in Christchurch and 185 in other Canterbury districts, figures show.

So Christchurch Council in December 2012 approved the construction of ninety-six new houses. 96.*

The Canterbury region as a whole had 4037 new dwelling consents approved in 2012.

If you go to the StatsNZ underlying data, you'll find Christchurch City approved 1,506 new dwellings in 2012.

Auckland as a whole had 4,581 new dwelling approvals. Auckland has a lot more people than Christchurch: roughly four times as many. And they only had three times as many new dwelling consents as Christchurch did.

So Christchurch Council approved a few more new dwellings than Auckland did, relative to population.

But more than 6000 homes in Christchurch were set for demolition because they sat in the Red Zone. And there are non-red-zoned houses that have to be demolished.

Some low income families in Christchurch live in tents and garages.

None of the low-income cohort that feature in the all-too-frequent Press exposes of Christchurch housing problems would ever be able to afford any of the stuff now being built, nor could they even if consenting were eased such that land prices could drop. They benefit instead when richer people move into new houses,  freeing up space in existing housing stock.

If approving new dwellings is too complicated and hard, Council could ease its burden by making it legal for owners of existing dwellings to build a rental flat into the existing house. A couple interior walls, a kitchen, and a bit of plumbing - pretty simple. Shame it's banned.** And, again, even if the people currently living in tents and garages couldn't afford those new units, they might be able to afford the places vacated by those moving into the new units. Or the places vacated by those moving into the places vacated by those moving into the new units.

Sometimes, allowing that more steps be built at the top or the middle of the ladder isn't a bad way of letting the folks at the bottom climb up a rung.

* In January, Christchurch Council also closed 31 social housing units because they no longer met earthquake spec.

** And see here.

Exchange rates

Michael Berry looks at New Zealand's exchange rate in this weekend's Christchurch Press. I provided a few comments; he's quoted me accurately. I'm copying below what I'd sent Michael, not because he's gotten anything wrong, but rather because it seems a waste to lose the bits Michael didn't use. The paragraphs answer questions about which he'd asked me to comment.

“The exchange rate reflects a complicated mix of foreign demand for New Zealand assets and exports, domestic demand for foreign goods and assets, domestic savings rates, and trader expectations about what will be happening with real asset returns in New Zealand relative to other countries. Trying to push it around without thinking hard about the reasons that it’s currently high isn’t without risk. If there are structural problems in the economy that, if fixed, would reduce the exchange rate, that would be a good thing – but mostly because those problems are worth addressing regardless of the exchange rate. For example, we rely on capital imported from abroad because a reasonable proportion of domestic savings are invested in housing. Fixing land use policy to reduce the cost of housing would free up some capital for domestic investment, reduce demand for foreign capital, and help push down the dollar.”

“A lower dollar could help some exporters in the short to medium term, but we have to remember the mechanism by which this works. A low dollar helps exporters by reducing the real wage they pay to their employees. At the same time, it increases the cost of machines and equipment that manufacturers import – our manufacturers losing access to those goods hurts us. In the medium to longer term, wages, in New Zealand Dollar terms, are bid up. And then exporters suffer again the next time that the exchange rate rises and they’re stuck with a wage bill that’s high compared to their export earnings.”

“There is absolutely no good reason for New Zealand to be considering quantitative easing. Quantitative easing is a policy that you try when you’ve reduced nominal interest rates to zero, have indicated that long term rates will remain at zero until inflation expectations come back up, and still have inflation outcomes that are at or below the bottom of the Reserve Bank’s target band. We are not in that world. If we tried it now, with so many other options still available to RBNZ if needed, our central bank’s international credibility would be completely shot. It would be like cutting off your hand because you had a hangnail.”

“A pegged currency also is a last-resort kind of policy. If different countries are affected by different economic shocks, independent currencies give economies ways of easing those shocks. A pegged exchange rate effectively means that you’ve given up having an independent monetary policy. That’s not a bad idea if you have a terrible central bank and you’ve not otherwise been able to establish central bank credibility, but it’s a particularly bad idea for a small open economy subject to idiosyncratic resource-price shocks and with a decent central bank.”

“The Tobin Tax is another of those ideas that sound good on paper – stick it to the speculators! – but risk being pretty awful in practice. The transactions tax is meant to reduce currency volatility by requiring that the expected returns from any trade be higher before anyone make the trade. But, there is reasonable argument that this kind of tax instead can work to increase volatility – it opens up the bid-ask spread on a currency and thins out trading markets. Further, New Zealand Dollar exchange rate movements seem to be on longer cycles than we might expect would be smoothed by a transactions tax. Even if this kind of tax reduced volatility, it would seem likely to do more to reduce intraday volatility than the longer term increases and decreases in the dollar that New Zealand experiences. Those persistent swings seem more likely to reflect fundamentals.”

“Fundamentally, New Zealand has a high exchange rate because we’re an attractive place for foreign investors to put their money. Our relative lack of domestic savings in things other than housing means that the returns on other kinds of investment here are relatively high. Because we have decided to impose very tight limits on urban growth, preventing our cities from either increasing in density or expanding at the fringes, property prices have been something of a one-way bet. So it isn’t surprising that Kiwis choose to put a lot of their savings into housing. Changing land use policy so that households could choose to put a bigger portion of their savings into the real economy would reduce our need for foreign capital and would help reduce pressure on the dollar. It’s a policy worth doing for its own sake, and if you want a lower dollar, it would help to work to that end.”

“The most important thing that the government can do in the next year is start fixing land use policy. Current policy hurts young people trying to get into their first homes and consequently helps encourage them to move overseas; it also embeds a lot of fragility into our cities in case of disaster. Imagine what Christchurch would be like today if, after the earthquake, developers had quickly been able to get a pile of new subdivisions up on the edges of town. Instead, we’re only now seeing consents issued for developers to start building. Christchurch home owners are not even allowed to build a secondary flat with a kitchen into existing homes except under regulations that make it uneconomical to do so; letting them do that would have been one of the quickest ways of getting new housing supply into the market after the earthquakes. Instead, it was forbidden.”

Increasing the burden

This is why we can't have nice things.

Imagine that there's something you like. You have the power of government at your disposal to help you get more of the nice thing you like. Should you:

1. Pay people a subsidy for providing the nice thing;
2. Make it more expensive for people to own the nice thing.

When it comes to heritage buildings, which are very nice things indeed, we're increasingly doing the second. The National Business Review reports that the Heritage New Zealand Pouhere Taonga Bill will make it more difficult for owners of pre-1900 buildings to make any kind of alteration. In addition to requiring a building consent and, for buildings listed in district plans, a resource consent, you'll now also need an archaeological permit. 

NBR points to the Law Society's submission on the bill. They write:

The practical implications of this definitional change, however, are wide-ranging for New Zealand’s older settlements.  In some of these (for example, Nelson and Dunedin) there is still a substantial housing and commercial building stock comprising pre-1900 structures. A literal application of the definition of “archaeological site”, together with its companion definition of “harm”, means that there will be many thousands of private dwellings around New Zealand that will require an archaeological authority to be obtained for the most minor maintenance work, such as the replacement of spouting or the hanging of new wallpaper.  It is not clear whether this level of intervention with private ownership rights is intended by the Bill.  If that is not intended, then revisiting the definition of “harm” or “archaeological site” is warranted.  The Law Society does not believe that this difficulty can be addressed by Heritage New Zealand simply applying the legislation in a pragmatic way, since the failure to obtain an archaeological authority is a criminal offence of strict liability.

Who would want to own a heritage home if they had to seek archaeological approval if they wanted to change the wallpaper? If the value of heritage buildings is bid down because of the regulatory encumbrances, investments in maintenance and strengthening are attenuated too.

Previously:

• Heritage Preservation
• Liability and building risk
• See also ISCR, pages 14-15 at the linked PDF.

Anchor Projects

It always made a kind of sense that some parts of the downtown Christchurch rebuild were being help up while property owners waited to see where the "anchor projects" might land: hotels would want to wait to see where the Convention Centre might sit before deciding where and whether to rebuild. Bars might want to know whether there'd be a downtown sports venue.

But I hadn't caught this angle: expropriation risk. From this weekend's Press:

So the CCDU [Central City Development Unit] was set up as a development agency to do it the other way around - begin with the project and then design it to achieve the masterplan's objectives. Let the building heights, parking access and other details flow from the logic of the intended outcome.

Elder says this is what surprised him - the boldness of the new approach.

The CCDU design consortium, led by planning consultant Boffa Miskell, has been told to forget about land ownership, road grids and other restrictions, and simply put anchor projects, such as a new conference centre or sports stadium, where they make most sense, he says.

The city's problem is that property is split into thousands of individual titles, so any rebuild was always likely to be a disjointed, piecemeal affair.

However, the CCDU, backed by the power of Cera, can now come in over the top. Land can be amalgamated, by force if necessary. Owners are even being warned that new buildings that get in the way may get knocked down.

Elder says there is a clear determination to develop areas of the city as a coherent package.

"Getting the right result is more important than being constrained. We will fail through being timid."

It is the only way to bring in the corporate-scale investment needed - the offshore money from Australia and Asia, he says.

"They're saying we will put out a proposal call on two city blocks for this type of development in there - whether it's a health precinct, residential, business, a convention centre and hotels - and get people to come and bid.

"And if we have to get rid of a landowner or two, or close streets to do that, then we will if the quality is good enough and the business case is good enough."

There will be property owners who will complain, says Elder, but for most it will be a better deal. They will end up with shares in a larger land-owning company. [Emphasis added]

How much work would you put into planning what to do with your property if, on top of the insurance and regulatory hassles, this kind of thing loomed?

You don't need compulsory acquisition to amalgamate lots of small titles. Just buy options on the properties you think might be needed for any project. Any of the option contracts can specify a schedule of compensation prices that rise with how far any owner's gotten through redevelopment when the government wishes to exercise the option. Do it right, and there's no incentive to sit around waiting to see if you'll be expropriated.

There's a great case for buying out landowners to make way for big projects so long as those projects are worthwhile. But I'd be awfully nervous about this kind of language if I were a downtown land-owner and wondering whether I should bother rebuilding.