The Reserve Bank of Australia (RBA) last night released a speech (below) Christopher Kent, Assistant Governor (Economic), entitled Recent Developments in the Australian Housing Market.
The speech contains some useful data and analysis of current trends affecting the housing market, including rising prices on low transaction volumes, the recent pick-up in dwelling approvals, and the collapse of first home buyer mortgage demand (and the growth of investor demand).
My main issue with the speech is its discussion on the supply-side, which seems to insinuate that Australia’s planning system is not particularly restrictive and housing supply has been fairly responsive to increases in demand:
Factors affecting the supply of land for development will obviously have an important bearing on the cost of new housing, and the speed with which any increase in demand for housing can be accommodated by a rise in construction… whatever these supply-side constraints might be, they don’t seem to have prevented an increase in construction across much of the country in 2009 and 2010. At that time, a general increase in incentives for first home buyers (for both new and existing dwellings), and the support provided for a time by lower interest rates, led to a sharp run-up in construction in New South Wales, Queensland, Victoria and Western Australia (Graph 10).
Further evidence that the supply of land is not the whole story can be found by looking across different regions within the states. If supply has been the critical constraint, we might have expected construction trends to have been very different across inner and outer parts of cities and the regional areas beyond the cities. For example, development in the outer suburbs tends to be on greenfield land, while development in the inner suburbs tends to be higher-density dwellings on brownfield land. However, for Victoria at least, the pick-up in building activity in 2009 and 2010 was relatively broad based across these different areas (Graph 11). For New South Wales, it does appear that there was a larger and more sustained pick-up in approvals in the inner and middle regions of Sydney, than in outer Sydney and the rest of the state. This may have reflected some limitations in access to land on Sydney’s fringes, but nonetheless, there was a relatively rapid pick-up in approvals in 2009.
Even so, this doesn’t mean that supply-side issues have not had an important bearing on the housing sector. This point was made in research published in one of the Bank’s Bulletin articles last year. Many public reports and the Bank’s own liaison with industry participants pointed to a range of supply-side impediments in the Australian housing market. These included the length and complexity of the planning process, the provision and funding of infrastructure, land ownership and geographical constraints, as well as the challenges for development within those city regions that are already well developed. While these factors may impose some constraints on the cost and responsiveness of new supply, it is less clear that they have been restraining the level of new construction more so now than in the past.
My concerns with the RBA’s analysis are two-fold. First, an examination of dwelling approvals, commencements, and completions data against population growth shows that housing construction has shown zero pick-up, despite the huge surge in house prices since the mid-1990s and the boom in population growth since the mid-2000s (see next chart). Therefore, it is wrong for the RBA to suggest that housing supply has been somewhat responsive to increasing demand – it hasn’t.
More importantly, the RBA speech does not mention the huge escalation in fringe vacant land costs over the past decade, which are bonafide proof of impediments to land supply. A 2008 speech by the RBA’s Anthony Richards explained these dynamics well:
…supply-side factors should have a much greater influence on prices towards the fringes of cities, where land is less scarce and accounts for a smaller proportion of the total dwelling price. In principle, the price of housing there should be close to its marginal cost, determined as the sum of the cost of new housing construction, land development costs, and the cost of raw land. And in the absence of any restrictions on supply, the price of raw land on the fringes should be tied reasonably closely to its value in alternative uses, such as agriculture. So unless there has been a marked increase in the value of this land when used for other purposes, the availability of additional land towards the edges of our cities should have limited increases in the cost of housing there…
So if we are looking for explanations why housing is not as affordable as we might like, it may be necessary to look at factors on the supply side as well. One obvious place to start is the cost of land for building new houses near the edges of our cities…
There are no doubt a number of factors that could be contributing to the observed level of land prices… One factor that has been widely mentioned is the existence of various constraints on land development, including growth corridors and boundaries. Another factor that has been mentioned is the existence of a range of government charges, including developer levies or infrastructure charges. More broadly, concerns have also been expressed that zoning policies and building approval processes have hampered in-fill development closer to the city centres.
Both economic theory and international evidence suggest that housing prices can be boosted by land usage policies (which can create artificial scarcity of residential-zoned land), problems with the complexity of the development process (which creates rents), and the fees and charges imposed on development. Accordingly, the fact that higher prices for housing have not resulted in a more significant supply response could be a reflection of various supply-side costs that have represented a wedge in the cost of bringing new housing to market.
So what has happened to vacant land costs on the fringes of Australia’s cities? They have literally skyrocketed over the past decade as plot sizes have shrunk (see below charts).
If the above isn’t evidence of increasing supply-side rigidities, I don’t know what is. Anthony Richards recognised these dynamics in 2008. It’s shame that Christopher Kent has not displayed the same level of understanding.