Last week I took a look at the economics underlying Demographia’s “International Housing Affordability Survey” and found them severely lacking. As it turns out, Demographia’s data isn’t much good as a measure of the costs of poor planning rules – but it does seem to provide some information about people’s “revealed preference” for urban amenity.
To recap: urban economics suggests that differences in the level of the median house price to median household income ratio between cities can be interpreted as differences in livability. All else equal, people should be willing to pay more to live in cities that offer better quality of life.
But how should we interpret changes to the median multiple from year to year? If a city’s median multiple rises from 5 to 5.5, does that mean that the city suddenly got 10% more livable? Or did something else happen?
Demographia is very certain that higher median multiples are the product of one thing, and one thing only: limits on sprawl into greenfield areas. Here’s Don Brash, former Governor of the Reserve Bank of New Zealand and former head of several right-wing political parties, laying out that view in Demographia’s 2008 report:
Once again, the Demographia survey leads inevitably to one clear conclusion: the affordability of housing is overwhelmingly a function of just one thing, the extent to which governments place artificial restrictions on the supply of residential land.
With that in mind, Demographia’s data seems to indicate that housing in Los Angeles and Las Vegas (as well as many other US cities) suddenly became a lot more affordable in the late 2000s. It’s obvious that they must have removed their Metropolitan Urban Limits – how else to explain such a big drop? Oh, wait…
(It’s slightly disturbing that our Reserve Bank used to be run by a man who doesn’t believe that interest rates and credit conditions can affect house prices. But I digress.)
Here’s a graph of changes in Demographia’s median multiple estimate for Auckland since 2004. We haven’t seen the same drastic swings as in the US, where the housing bubble and bust was pronounced, but house prices have risen relative to incomes. (Although, as Stu found in his analysis of different measures of housing costs, this hasn’t flowed through to rents or mortgage payments, due in part to changes in interest rates.)
This change has been especially pronounced in the last few years. Since 2012, Auckland’s median multiple has risen roughly 22%. Does this mean that we’ve become 22% more “livable” during that time?
With all due respect to the good work done by Auckland Council and Auckland Transport since their inception, probably not. So we need to look for alternative explanations, of which there are several. I’ll focus on three in particular.
The first potential explanation is that there has been a market failure. Residential construction slumped massively during the Global Financial Crisis, with the most significant reductions occurring in the supply of apartments and attached dwellings. Here’s a graph that John Polkinghorne put together illustrating that trend:
Incomes and employment have mostly come back from the recession, but construction has been a bit slow to respond. I suspect this reflects technical constraints within the development sector, as it takes a while to organise finance, find sites, and hire the cranes, bulldozers, and blokes/blokesses in hardhats. Until they get into gear, there may be a bit of an undersupply – but one that will tend to sort itself out.
The second potential explanation is that the introduction of Auckland’s Unitary Plan has caused people to expect housing supply to be more constrained in the future. While the Unitary Plan envisages the gradual expansion of the city’s Metropolitan Urban Limit to meet new demand for greenfield suburbs, it maintains extensive controls on the supply of new dwellings in accessible, high amenity areas. Moreover, the plan actually got significantly more restrictive following the consultation process.
Transportblog has highlighted this issue a number of times before. To recap, here’s a map (from Koordinates) that shows where the Unitary Plan got more restrictive as a result of consultation. The areas in red have been down-zoned to restrict development, while areas in green have been up-zoned. The large orange areas show future greenfield land. As you can see, there are not a lot of opportunities to develop new dwellings in the isthmus and lower North Shore, while West Auckland has been happy to facilitate growth:
Timing is important here. Demographia’s figures suggest that there was a jump in house prices relative to incomes between the end of 2012 and the end of 2013. This coincides with the notification of the Unitary Plan in September 2013, which, as described above, will ease greenfield land supply while limiting development opportunities in the inner suburbs.
However, there is also a third potential explanation: that our rising house prices reflect increasing awareness of Auckland’s great quality of life. For most of the last decade, our city has been near the top in Mercer’s Quality of Living Survey. It’s been ranked third for five years running.
So maybe the story is that potential migrants and investors have observed that, by international standards, Auckland offers high quality of life at an affordable price. And they are in the process of arbitraging that away.
I’ve illustrated that process in the following graph, which shows the relationship between Demographia’s median multiple (X axis) and Mercer’s Quality of Living Survey (Y axis). The trend-line is estimated based on 2012 data. I’ve also plotted Auckland’s median multiple and Mercer index in 2015.
The red dot that represents Auckland is moving towards the trend-line, suggest that its prices are catching up with its livability.
Previous studies have found that growth in New Zealand house prices is strongly correlated with net migration – i.e. migrants tend to bid up house prices. Net migration to New Zealand did, in fact, start picking up in 2013 – around the time that Demographia’s estimate of the price to income ratio began to rise. Perhaps this is evidence for the “amenity arbitrage” hypothesis?
So, which explanation is true? Honestly, it’s impossible to say without a lot more detailed analysis. My point in writing this is not to argue that there is a single explanation for changes in Auckland’s house prices, but to point out that there are many possible explanations. Housing markets are affected by a number of factors, and it’s inappropriate to focus on one without controlling for the rest.
This is, essentially, why Demographia’s analysis fails. Rather than articulating a model that encompasses all of the potential explanatory factors, they have settled on a single number and insisted that it must be interpreted in a single way. It’s hard to see the value in that approach. And it’s definitely not good economics.