Potato houses and model assumptions

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In the long debate over housing supply, I have been on the lonely side of the argument. Many readers would not know that my past career involved assessing site acquisitions and development feasibilities for residential and industrial developments. I was quite intimately involved in planning applications and housing supply decisions.

I took away an important lesson about housing supply from this experience. That lesson is that the rate of sales of new homes is what holds back housing supply, and the incentives are stacked in favour of not selling or developing rather than reducing prices.

So why do I need to reveal all this?

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Because Matt Cowgill’s recent post on potatoes and housing supply, while internally correct and useful in to many real life situations, is the same model so often misapplied to the housing market to reveal the price impacts of town planning regulations.

Matt’s argument is straightforward. He uses the potato market as an analogy to housing. If there are many types of potato, and you reduce the supply of one type of potato, you reduce the supply of potatoes in total. And if potatoes are a staple with no substitutes (except between types), you have a price impact from the shortage.

So why doesn’t this logic apply to housing supply? It could, but you need to explain how town planning rules, which have become, if anything, far more lenient in the past decade in terms of allowable residential densities, can act like a quota restriction on the supply of housing as a whole. What makes town planning regulations equivalent to a sudden potato shortage?

To build a more appropriate potato analogy, imagine a shopping centre with many stores offering potatoes – a Coles, Woollies, a couple of fruit and veggie stores, and maybe even an ADLI. Now the shopping centre ‘town plan’ says that the potato density at Coles will be capped because the shops neighbouring Coles are sick of potato shoppers crowding outside their stores. Coles can sell no more potatoes each day than it currently does. Demand for potatoes is increasing. Does this Coles potato density restriction, perhaps called a potato-greenbelt, impact that total supply of potatoes to the shopping centre?

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I argue it doesn’t.

So what is my evidence that the other potato sellers remain unrestricted? In the housing world, we have the evidence on many hundreds of thousands of approved new dwellings, many more potential new dwelling in areas already zoned, and many millions of new dwelling through infill and increased density of existing residential lots.

Even in Hong Kong, a place where the supply of land for housing seems obviously more critical than Australia, studies show government sales to land developers do not increase the supply of new homes.

Further, price fluctuations during housing booms tend to be larger in city fringe areas where the potential supply of new dwellings is highest. If the supply side was a factor in the past decade’s pattern of housing prices, these outer-urban fringe areas should have had the smallest price changes.

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I don’t want to dismiss completely the possibility that housing supply can be altered by regulatory arrangements. However, to argue this is the case, you would need evidence that rents have been increasing in proportion to household incomes, that the square meters of housing per capita is falling, and that the quality of homes is diminishing. None of these factors exist as far as I can tell.

My observations have been that we had a speculative price boom in the early 2000s, then a short rental squeeze around 2009 as population growth spiked, and now both prices and rents are receding. During that whole period, the quality of homes and the area per person increased.

Tips, suggestions, comments and requests to [email protected] + follow me on Twitter @rumplestatskin

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