A discussion on Twitter recently highlighted an important – and hard-to-understand – dimension of housing markets. Namely, what is the link between new construction – which is usually expensive – and housing affordability?

A common objection to new construction is that new apartments are expensive, so they won’t do anything to improve housing affordability. However, this isn’t a problem: New homes are more expensive than old homes… but they get cheaper as they age.

To illustrate this point, let’s consider an analogy: the market for new and used power tools. If you go to Mitre 10 to buy a power drill, you can expect to pay hundreds of dollars for a new tool:

Mitre 10 drill price

Or you could hop on Trademe to shop for used tools. Here’s a similar drill that’s currently selling for $90 (plus shipping):

Trademe drill price

So new tools are considerably  more expensive than old tools. Does this mean that importing and selling new power tools make DIY less affordable for low-income New Zealanders? Of course not! In fact, it’s the exact opposite: expensive new tools sold at Mitre 10 become affordable secondhand tools after they’re used for a while. If the supply of new tools dried up, the supply of cheap old tools would also vanish.

The exact same thing happens in housing markets: New housing is almost always expensive to buy, but after a while it gets a bit run-down and sells for a lower price. This process is called “filtering”, and we have evidence that it happens in practice:

[In a 2013 study] Stuart Rosenthal of Syracuse University uses nearly 40 years of data from the American Housing Survey to figure out the average pace of filtering across the country, and what makes housing filter more quickly in some places than others.

Rosenthal uses the AHS to compare the incomes of people living in the same units of housing over time. He estimates that nationwide, housing “filters” by roughly 1.9 percent a year—meaning that a 50-year-old home is typically occupied by someone whose income is about 60 percent lower than that home’s first occupant. (All of these numbers are adjusted for inflation.) You might think of this process as something like “reverse displacement.”

However, there’s an important caveat on this: Filtering happens much more slowly in cities that don’t build new housing in response to increased demand. In other words, restrictions on development will, in the long run, price out the poor:

…strong regional housing price inflation—that is, metropolitan areas where home values grow much more quickly than the cost of other goods—can make filtering happen much more slowly, or not at all. That helps explain why homes in New England and the West Coast filter about 35 percent more slowly than homes in the Midwest or South. In those coastal regions, severe restrictions on new housing construction since the 1970s have created a “shortage of cities,” driving up home prices and preventing the kind of filtering that has historically produced the lion’s share of affordable housing—and which still does in much of the rest of the country.

What this means is that we must consider housing affordability in a holistic way. Rather than insisting that individual new developments should be responsible for solving a big, intractable problem, we should ask: Are we building enough to make the filtering process work? If not, why not? Are there barriers in zoning, in the construction market, or in development finance?

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  1. Seriously? Older dwellings sell for less? Not in Auckland. Until there are changes to ensure quality builds and controls on body corp costs and increases apartments will always be looked at differently to stand alone housing. The current gouging of signed up buyers over ‘ increased costs’ before they are built does not inspire confidence in the companies selling. What corners are being cut, how much profit are they after, etc.

    1. yes in a well-functioning housing market older houses will usually sell for less.

      Your comment on not in Auckland is correct, and demonstrates exactly the point Peter is making.

    2. Older houses do sell for less in Auckland,comparing like for like. An old villa in grey lynn sells for about 1-1.3x the land cost. A new villa in grey lynn sells for about 2.5-3x the land price.

  2. I can understand what you are trying to get at, but used power tool arguments don’t apply to crazy housing markets. My 65yr old dump of a house just keeps going up in estimated value. I couldn’t even afford to buy it. The neighbors house sold for 25% above CV. With housing prices growth outstripping income growth and inflation at all time lows, housing will never get cheaper.

    We need a capital tax (not capital gains) to slash unproductive investment.

    1. You’ve clearly misunderstood the post then.

      Your dump of a house is going up in price because there’s *limited alternatives*.

      If we were building enough houses then your house wouldn’t be so expensive, and it would be far less than the cost of building a new one.

  3. Not the smartest analogy as these drills don’t have a location cost, land size and location being one of the biggest factors in the price of a house.
    The drill cost the same amount at Mitre 10 in Remuera, Ranui, Albany, Takapuna, Pukekohe, Tauranga and Hokatika but identical houses even on identical sized pieces of land would cost very different prices in these places.

    1. Yes, land markets undoubtedly have some peculiar characteristics. However, there are also things that we can do to overcome those peculiarities. For instance, we could build taller buildings in attractive places to allow more people to live there. The land under those buildings may be pricey, but as long as they’re available in sufficient quantities the dwellings themselves can be affordable.

  4. Of course something that is second hand will sell for less than the new. Thus there will be a filtering down process as those that can not afford the new buy the second hand. Another effect though is the new and the second hand are substitutes, if the new increases in price then so will the second hand and visa versa. We know this is an important effect, because in the past we have seen it in the new and second hand car market, when we had import controls which made cars more expensive.

    I have looked into a similar effect with regard to affordable food in 19th century Britain https://medium.com/@brendon_harre/housing-affordability-reform-or-revolution-ad3ac2d896c6#.317vduyn0. So I think we should be concerned about the price of new housing not just the quantity coming to the market. Of course the lower the price of the new increases the quantity sold -which seems to be Peter point. So maybe we are not really in disagreement?

    Also we should be looking at mechanisms that will lower the price of housing where the jobs are. This is the cities. Thus I disagree with those who see the higher skyline/density as a problem. I think we should make it easier for that skyline to rise, as much as we should allow the city to spread. In particular, I think Auckland is not so much missing inner city apartment towers, the major deficit is the ‘missing middle’ housing -the 3 story walk-ups….

  5. So what happens to the drill market if Local Government drew a line around a city and said nobody outside that line can have a drill- if you want a drill get inside the line. But when people point out that it simply isn’t possible for everyone inside the line to have a drill some twit then says ‘we will allow really big drills’ and people will have no choice but to share the big drills and pay a body corporate to recharge the massive drills. And then central government lets in 60,000 more people and they buy lots of the drills and there is a drill shortage but the Government says ‘there is no drill crisis in New Zealand’. And instead of having sufficient drills and holes we all realise we are screwed instead?

    1. Or even more stupid the government brought in a rule that there were only a certain amount of drills allowed per hectare. That means the price per drill goes up a lot where lots of people want to own drills but the limit is already reached.

      Who would be silly enough to support such a rule?

  6. Taking the drill analogy a little further – the second hand drill you show is a very tired old model, and the batteries are incompatible with the new series. Also – the analogy might be better showing a modern DeWalt (good quality, builders choice), and a poorer, crappier range available at lower price to an unsuspecting consumer (various cheap chinese ripoff brands can be inserted here). One of the cheap ones might be selling for only $50-$100 new. They last only a short time and then have to be thrown away.

    Its similar with housing. Building cheap, crappy housing stock is always an option, but is not a good solution in the long term. Quality lasts, and will hold its price, but a product that is undersized (i.e. micro apartments, or inadequately powered drill) will not fulfill the purpose. As a drill, it just then gets thrown away or sold for a dollar at a garage sale, but as a house or apartment, it goes down the food chain till its best use is a tinny house or P-lab. Its harder to throw away a whole house.

    But good quality second hand houses in Auckland are selling for high prices because they are actually made from better materials. Studs made of rimu – brilliant! Kauri weatherboards – brilliant! Many people will realise that buying that quality rimy-made housing material is better than a new, pinus radiata box that will almost inevitably rot away within 50 years if it gets wet. The analogy with drills there is difficult, except perhaps to point to a 1950s table mounted electric drill press, which even today is a highly sought after commodity. Drills better, straighter holes with more accuracy

    1. Yes, good point.

      One of the main ways people get affordable housing, throughout most of the world, is to compromise on build quality. Think informal settlements in developing-world cities, or the way that Ponsonby and Newton were originally constructed. You build yourself a shack, ignoring the building code requirements and using the materials you’ve got to hand, and then go back and extend and improve it when you’ve got more money.

      I’m a little bit reluctant to advocate this as a policy approach, because there are some quality standards that matter to health and social wellbeing, but I don’t think we should look down on it. It’s basically the way my grandparents and great-grandparents got housed: they built their own homes, or at least extended them when their families grew. There were definitely a few corners cut in the process. For instance, my grandma recently told me a story about something her dad had done – he had contracts to build post offices, and would take spare parts home to use after a job. When grandma’s sister went to get a new key cut, she found that the locks in the house were all post office locks, meaning that it was illegal to get the keys copied! A bit embarrassing for her…

      1. ‘One of the main ways people get affordable housing, throughout most of the world, is to compromise on build quality. Think informal settlements in developing-world cities, or the way that Ponsonby and Newton were originally constructed. You build yourself a shack, ignoring the building code requirements and using the materials you’ve got to hand, and then go back and extend and improve it when you’ve got more money.’

        Good point. I’d like to see a lot more development of modular housing. So a house might start as a 1.5 or 2 bedroom townhouse. But the town house can easily add on one more bedroom as the family and / or it’s income grows.

        However, there is probably usually not much incentive for the market to do this. As long as there is a large number of people happy or able to keep paying for large houses, why would a developer start to build modular small homes? (that can later be readily extended)

        For me, this is a flaw with the Unitary Plan. In my opinion, it should have required mandatory affordability price points in greenfield (not brownfield) locations. This would have ‘forced’ these sorts of innovative approaches on to developers. That’s what has happened in many parts of Aus.

        1. Good point Matt. re Modular housing – architecture schools around the country are all full of students working to try and design good modular housing systems (Victoria University has some excellent students working on excellent modular housing systems), and good modular housing companies (not many of them exist) are partnering with good architectural practices to design and bring to market some excellent systems. For more on this, you may want to read Pam Bell’s excellent book “Kiwi Prefab” where she delves into the back history, although of course now she is more concerned with the future story.

          What is apparent to me is that there is not an easy answer – believe me, we’re all searching for one – especially with the joints where houses join part A to part B. The ideal would be to get to a situation where you go down to Mitre-10 and buy an extension, which is fully Building Code complaint, and just bolts into place in half an hour. We’re not quite there yet. And then of course you may have another manufacturer (say, Bunnings), who have their own version, but because they are an Aussie company, their module doesn’t fit the kiwi module. Vexing problems.

      2. “is to compromise on build quality”

        So that’s why we organised the leaky home crisis? I don’t think that’s working out too well. There’s now this big gap between buying a new house, and buying a house which is at least 25 years old. Anything between 10 and 20 years old is potentially leaky, and buying that is a risk normal people can’t afford.

        And building a home and extending it later, in how many ways that is illegal over here, or at least prohibitively cumbersome? Last thing I heard you can’t even leave rooms unfinished or you’ll fail inspection.

        One of the more odd features of the housing market over here is that building your own house appears to be legislated out of existence. I never figured out what ended up in the final UP, but the proposed plan was pretty outrageous (things like a minimal land area of 400 m² for individual houses, vs 200 m² for those townhouse clusters built by developers).

        1. To be clear, I’m not arguing for deregulation at all costs. That would obviously lead to some perverse outcomes, especially when it came to building materials standards.

          But I *do* think that a lot of discussions about housing affordability are missing the fact that it used to be a lot more common to build your own home, or do extensions on it, to save money. As you say, we’ve largely regulated this out of existence.

          1. Yeah that first comment was a bit of sarcasm. But that ‘gap’ is definitely there, either go with something almost new, or something from the 80’s. If you want anything in between you’ll have to take a big risk.

    2. Couple of points on your points:

      Sure a $50 drill is crappy and would never be suitable for a builder working 6 days a weeks, but entirely suitable for someone who’s going to use it twice a year to hang a painting. Much like a large house for a family versus a tiny flat for a student for example.

      Old villas rely on their ‘weather proofing’ on the internal cavity between the weatherboards and the wall lining. Basically any water that gets in (and in our environment it does) is free to drain out. Of course this also means insulation is very tricky to install as you need to insert a weather barrier between the weather boards and the insulation that doesn’t interfere with this property. So villas are cold.

        1. As long as you are removing the wall lining yes it is to a degree. But that is a major task, and you can’t wholesale remove the match lining without replacing it with a suitable brace which makes inserting a moisture barrier tricky.

          And even once done a villa is nothing like a modern house in terms of heat retention, there is too much airflow and the windows are single glazed.

          1. Indeed, removing the cladding is better if you want a good insulation job and good weather-tightness (i.e. not rely on the paint). But more expensive.

    3. You forgot to include the bit where the cheaper crappier brand drill is LABELLED as a DeWalt and the average consumer can’t tell the difference.
      See that bit there is what government regulation should be about in my opinion.

      If the average person is unable to determine the true nature/costs of something without going to extraordinary lengths, then the market for that item cannot be a “undistorted free market” and enforced regulation is required.

  7. Hmmm – housing is a necessity and so I am not sure the analogy holds? otherwise comes dangerously close to saying poorer people just need to accept they will live in bad housing 🙂 The thing that strikes me from first hand observation about Auckland compared with say Cologne or Bonn, is the vast diversity in housing quality despite Auckland being a much younger city.

    1. Take a look at the paper on filtering that is linked in the post. It points out that housing affordability and availability is a long-run process – cities that build enough to keep up with demand over a longer period offer more choices to low-income people. Essentially, housing becomes available to them *faster* than it would in a more constrained market.

      That means that rather than moving into a run-down house that hasn’t been maintained in decades, they can move into a decade-old home that is still in pretty good condition.

  8. Peter, do you classify a villa/bungalow renovated to a new standard, or at least indistinguishable from, as a new house or an old house?

    1. Define “cheap”.
      Land developer gets cheap land, sells cheap houses, mitigates “local issues”
      Council and ratepayers cover
      New/improved motorways
      New/improved roads
      New/improved sewers, power, water,
      Increased traffic delays

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