ANALYSIS: One of the key comments made by people concerned about the soaring cost of purchasing a house compared with incomes over the past three decades is that it is all a matter of supply. If more houses can be built, then the average ratio of house prices to income may return to near three, which existed up until the early 1990s. The ratio now is closer to seven.
But this is not entirely accurate. In fact, it is well off the mark. Only if land prices and construction costs fall or hold steady as incomes rise, will the measure return to previous levels.
To see why, consider the position of someone looking to buy a house. They can buy something already built or something new. Sometimes the former is cheaper, sometimes the latter. Let’s say we see a boom in new house construction – such as the rise from 13,500 consents issued for new dwellings in 2011 to 51,000 two years ago.
Could such a boom cause house prices to fall or hold steady? Did such a boom cause this to happen? No. Since 2011 the average house price in New Zealand has risen by about 130%, while the CPI has gone up 35% and average wages about 60%. Why?
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Because construction costs have soared. One measure from the Capital Goods Price Index has exactly doubled since 2011. The cost of an existing house is going to be determined not just by the interplay of the number of buyers versus the number of sellers, but by how much it costs for the alternative – a new house.
Construction costs have risen strongly, and it is not just the costs for materials which are at fault. Health and safety requirements have been strongly increased, consenting fees have risen, new standards have to be met for insulation and earthquake sustainability etc. Traffic management is a whole new cost to be borne on large sites.
Independent economist Tony Alexander: "Increasing consent processing speeds, freeing up land on city outskirts, and allowing more intensification will help, but only at the margin." Photo / Fiona Goodall
Then there is the cost of land. People tend to want to live as close to their work as possible. But someone else is usually already there and encouraging them to leave so that some new townhouses can be built usually requires a high price.
Simply building more dwellings will not much change the cost of a dwelling compared with income unless land prices fall, materials costs decline, and the increased standards and rules introduced over the past few years are reversed. Land prices can fall but the retreats tend to be temporary. Materials costs are still creeping higher, according to the information I receive, and any watering down of construction standards and safety rules will only ever be minimal.
Tinkering at the edges with increased consent processing speeds, freeing up land on city outskirts, and allowing more intensification will help, but only at the margin. Higher house supply growth can help contain the premium buyers must pay over and above construction costs and restrain the margins earned by builders and others in the supply chain.
But unless construction costs retreat, we cannot reasonably expect much change in housing affordability. Going by the still large cost overruns being reported for most construction projects despite the economy having been in recession for almost two years, it seems reasonable to expect that once economic growth returns cost increases will worsen. In fact, consider what will happen to the costs of acquiring resources for residential construction once the surge in planned infrastructure projects starts.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
