01 January 2011

Urban development is vital

Urban development is vital to the future of our communities. The great majority of Australians live, work and shop in premises built by property developers.

When development slows the whole community loses out, socially and economically.

Housing markets need to work well

The OECD has observed that there is a strong need for a housing market that functions smoothly. Its an important element of wealth as well as the single biggest expenditure for a majority of households. As witnessed internationally in the recent financial and economic crisis, housing market outcomes can also have repercussions for the macro economy.

An efficient housing market supporting geographical mobility is also necessary to ensure an efficient labour market. Housing also deserves attention for social reasons, because - among other things - adequate housing may enhance childrens opportunities for educational achievement and their future employment.

A wide range of public policies affect the housing market. Such policies are justified on the basis of repairing market failures, pursuing broader economic efficiency goals and a desire to influence the housing opportunities available to citizens. These interventions include fiscal measures (such as subsidies and taxes), direct provision of social housing (i.e. housing let/sold at below-market rents and/or allocated by non-market mechanisms) and regulations aimed at influencing rental markets, as well as the quantity, quality and allocation of dwellings. They also involve public resources being directed to redistribute income by supporting housing consumption (e.g. housing allowances).

Badly-designed policies can have substantial negative effects on the economy, for instance by increasing the level and volatility of real house prices and preventing people from moving easily to follow employment opportunities.

Housing markets, and policies affecting them, have spillovers on the macro-economy. Badly-designed policies can have substantial negative effects on the economy, for instance by increasing the level and volatility of real house prices and preventing people from moving easily to follow employment opportunities.

Responsiveness of housing supply

Housing supply responsiveness to price changes varies widely across OECD countries, with potential consequences for the nature and speed of the stock-flow adjustment mechanism that characterises housing markets. The long-run response of new housing supply is estimated to be strong in the United States and Nordic countries, while supply is more rigid in some continental European countries and the United Kingdom.

In Australia, for every 1 per cent jump in home prices, we see just a half a per cent increase in supply. We rank poorly, when compared to other countries with a similar population density. In the United States, the same 1 per cent increase in home prices, delivers a 2 per cent increase in supply. Sweden, Denmark, Canada, Japan and Finland also all enjoy new home supply that is at least as twice as responsive to changes in home prices, than Australia.

The OECD report observes that our house prices have sustained the highest category of price increases - 90 per cent or more - over 1980 to 2008. A distinction avoided by two-thirds of developed countries in the study. Yet in the last 15 years residential investment has hovered around just over 5 per cent of gross domestic product, despite rising prices.

The OECDs has found that low supply responsiveness of new housing has tended to exacerbate the price effect of changes in housing demand (e.g. caused by financial and labour market or demographic shocks). Thus, in rigid supply environments, increases in housing demand are much more likely to be capitalised into house prices than to boost increases in the quantity of housing

.

Supply responsiveness depends not only on geographical and urban characteristics but also on public policies, such as housing market regulations. In particular, cumbersome land use and planning regulations are associated with a less responsive housing supply across countries.

Land-use and planning policies that are intended to reduce negative externalities (i.e. costs that borne by the whole community such as additional traffic, change view lines, etc), but they may also restrict supply responsiveness. OECDs estimates of new housing supply responsiveness tend to be lower in countries where it takes longer to acquire a building permit, suggesting that an efficient design and enforcement of land-use regulation can make housing supply more responsive to prices.

Differences in supply responsiveness at the aggregate and regional levels are important since they determine the extent to which increases in demand for housing result in higher prices or in more housing investment. In the short to medium term, an increase in housing demand (e.g. caused by mortgage market deregulation, higher levels of activity and employment or migration inflows) would translate into smaller increases in real house prices if housing supply is more responsive. However, in more flexible-supply countries, housing investment adjusts more rapidly to large changes in demand. The OECD believes that in the longer term a more flexible supply of housing is generally desirable as it allows a better match of housing construction to changes in housing demand patterns across the territory.

The OECDs cross-country panel estimation confirms that positive housing demand shocks caused by financial and labour market or demographic shocks translate into larger increases in real house prices in countries with more rigid housing supply.

Many government planners will informally express the view that they are helping to prevent boom and bust by placing a hand-break and supply. Yet the OECDs findings illustrate how this approach is misguided and that it is likely to accentuate the boom and bust cycle. This view is consistent with recent empirical evidence from the United States shows that the relaxation of interstate banking regulations resulted in larger increases in house prices in counties with less elastic housing supply.

The OECD has said that regulations on land-use were not the sole cause of a lack of responsiveness in housing supply. The OECD observed provision of infrastructure and other public services complementary to housing, such as road intersections or water drainage, is also likely to be a factor.

An unresponsive supply of housing affects the average availability of housing and regional housing market imbalances, which can reduce residential mobility. There is evidence that large price differentials between areas, for instance caused by region-specific shocks in combination with rigid supply, can lead to lower geographical mobility since households in lower-priced areas have a larger credit hurdle to clear if they wish to move to the higher priced region.

OECD empirical findings show that in countries with a more responsive supply of new housing, residential mobility tends to be much higher. For example, increasing the responsiveness of supply from the lowest level among the countries studied to the average level would raise the average household's mobility rate by around 5 percentage points. OECD empirical estimates also show that mobility is lower in US cities with more stringent land-use regulations, which are usually associated with an unresponsive housing supply.

Macroeconomic stability

House price volatility can be transmitted into macroeconomic instability, with adverse consequences for welfare. The OECD has concluded that a more responsive housing supply reduces real house price volatility.

House prices tend to rise faster in environments with lower responsiveness of new housing supply, and the variability of house prices is also likely to be higher if the supply of new housing is less responsive and if the demand for housing is subject to large shocks.
Cross-country estimates confirm a negative association between housing supply responsiveness and real house price variability.

Where housing supply is more responsive, residential mobility is higher, possibly because supply responsiveness reduces housing affordability differentials and/or housing inflation gaps across regions, which could potentially discourage mobility.

The ease of moving residence geographically (e.g. across regions) has implications for the functioning of the labour market as it affects the job-matching process and the efficient allocation of human resources across the national territory.

Housing affordability crisis

The COAG Reform has recently highlighted the connection between the constraints on housing supply and home affordability in its recent report National Affordable Housing Agreement: Baseline performance report for 2008-09. The Reform Council said
there is strong evidence of a disconnect between supply and demand in the housing market, resulting in a shortage of supply that has led to an increase in housing costs.

According to the report, 28 per cent of homes sold Australia-wide are affordable to moderate-income households. Melbourne, with its robust housing supply, has the highest proportion of homes affordable to moderate-income households at 39 per cent - while in Sydney only 26 per cent of homes sold were affordable to moderate-income households.

Reduced affordability has contributed to falling levels of home ownership. In the twelve years to 2006/2007 the proportion of the community who were owner-occupiers fell from 71 per cent to 68 per cent. This significant decline has hit key sections of our community particularly hard.

For example, home ownership in the 25 to 34 year old age group plummeted from 52 per cent to just 43 per cent. In the 35 to 44 year old band, home ownership dropped from 72 per cent of households to 65 per cent. In the 45 to 54 year old age group the level of home ownership fell from 82 per cent to 76 per cent.

Of 28 developed countries ranked by the OECD, Australia was ranked 22nd, with a relatively low number of dwellings per head of population. Perhaps, thereof, unsurprisingly, while homeownership rates have increased in many OECD economies over recent decades, they havent in Australia. In over the ten years to 2005, Australia suffered a 2 per cent fall in the level of home ownership. Of the twelve countries assessed, only Australia and Luxemburg were in this position. Our level of home ownership would have fallen further, if not for our aging population. The OECD says theres a likely link between this fall and changes in government policies. Countries whose housing markets were more able to respond to price increases with additional supply did see significant increases in home ownership.

The COAG Reform Council has observed that:" Home ownership is associated with many benefits for households ... . These can include financial benefits such as lower real housing costs over a lifetime and wealth accumulation through a growth asset. Owning a home can also bring social and cultural benefits such as a sense of family and belonging, security, control and privacy, and is linked to improvements in health and educational attainment."

In this context urban planning policy-makers have considered special measures to boost housing affordability. Regretfully, there seems to be an insufficient recognition that the lack of affordability is caused by a systemic mismatch between the demand for, and supply of, housing.

The answer to our problem is obvious: build more homes

The problem of housing affordability is a function of strong demand and limited supply. The affordability problem can be addressed, in the inner suburbs of major cities, by making more residential sites available for the construction of medium and high density housing. We also need to ensure that new suburbs are built on the edge of existing urban areas, so that the needs of those who want the choice of a house with a backyard are met. This means we must address those matters that restrict site availability.

We need to ensure that current and proposed planning policy is not overly restrictive and will in fact encourage development. The introduction of local plans that unfairly limit development potential of land, coupled with excessive development fees and charges including housing affordability contributions, would guarantee the continuation of limited housing supply and therefore further significant jumps in home prices.

Unfortunately, planning policy has been very effective at limiting urban expansion at the edge of existing urban areas, but has been hopelessly ineffective at encouraging infill development. It is this set of circumstances that are largely responsible for escalating house prices and diminishing access to home ownership. If we are serious about tackling the housing affordability crisis, we must challenge conventional town planning approaches.

There should be a reduced focus on micro-managing development outcomes and a greater focus on increasing the supply of new dwellings and associated workplaces and shopping precincts.

A good starting point for this would be to approach any comprehensive local planning process with a view of ensuring that land in suitable locations is assigned the appropriate zone, base density and height controls that will encourage the efficient development of land.
You know you have a real problem when the Reserve Bank is increasing interest rates partly because restrictive land use laws are choking off housing supply.

If we are serious about addressing housing affordability then we need significant supply-side reform.

Congestion

The current housing undersupply means more congestion, as people live further away from their place of work.

The complex system of prohibitions that prevents and delays vital urban development projects, is contributing to the sense of congestion in our cities and imposes huge economic and social costs on the whole community.

For example, for every two residents of the City of Sydney, five people work in the City. Thats 429,000 workers compared to 166,000 residents. The City of Sydneys resistance to new housing means more people are locate further away, and that Sydneys roads and transport system is more congested than it needs to be.

Jobs

Additional housing allows cities to better care for population growth. Additional population increases allow for additional employment throughout the broader economy.

An increase in population growth has an immediate effect on economic growth. Demand for many services tends to be localised such as retail trade, business services and restaurants.

In many cases, people who migrate are not employees, but operate small businesses.

These small businesses will allow economic growth to occur without a specific job vacancy being created. This source of activity can make economic growth quite localised even with one city.

Evidence for Sydney shows that many people who move to the ˜growth areas tend to live and work in the same area. In this respect, these are quite localised economies that function in areas where population growth tends to be high.

Any deterioration in population growth has a pronounced effect on demand for commercial property.

For example, consider NSWs comparatively moderate growth in commercial building activity from 2001/02 to 2007/08. If commercial building activity had increased at the same rate as that in Victoria, then there would have been an additional $4.4 billion in commencements in NSW (cumulative from 2001/02 to 2007/08). Over 7 years, this value would average about $0.6 billion per annum.

More information
For more information (and source details) please read our fact sheet:

Fact sheet: Economic and social value of development