Housing shortage: When is a shortage not a shortage
It is received wisdom that Auckland has had a housing “shortage” for a prolonged period of time due to insufficient supply. However, on the face of it this is a bit strange as:
- Residential investment: Yes building rates have been low during the past 7 years, but the value of residential investment in the prior 7 years was very high. The “volume” was lower, but what does that mean (we’ll come back to it).
- Growth in rents have been low. Low low low.
In this way many people have, justifiably, questioned the idea of a shortage.
However, there is one potential explanation that could match both these facts and still give us a “shortage” that can help to drive the high price for housing – a fundamental imbalance in the supply of “types” of housing.
Often you will hear economists say that renting a house provides a housing service, and buying a house is just purchasing a stream of future housing services – therefore the house price must represent future rents. This is true. However, the “service” provided by a rented house and a purchased house need not be the same thing!
As a base way of thinking about it, a service from housing may have two components – a “need” component (eg I need somewhere to sleep at night) and a “want” component (eg I want a house with a large lounge for my tupperware parties). Combined with the fact that renting and owning have fundamentally different flexibilities (when you rent you have an option to buy a house, when you’ve purchased a house you rely on the liquidity of the housing market to buy a new house), and different social views on renting and buying, the rental stock and the owner-occupied stock exist to satisfy different bundles of housing services.
In this way, the rental stock, which people are only interested in renting (except investors) is only sufficient to meet the “needs” base of housing, while the owner-occupied stock meets some of the “want” service of housing.
In this way, yes both types of housing are substitutes for the needs part of the service, but in terms of these “wants” there is no substitute for owner-occupied housing.
As a result, the “shortage” in this context could be just a shortage of housing for owner-occupied purpose – while the low rent growth is indicative of a potential oversupply in rental property.
Now this argument isn’t particularly complicated, and I think it meshes with the views of many – but it is interesting to think of what it implies:
- Is this really a “problem”? If needs are being met by the housing stock, and people are bidding up prices with regards to wants, the case for “social injustice” from housing is significantly weaker!
- What social expectations do people have if they are so willing to bid up prices based on these “wants” for the housing stock – what are these wants and what do they mean? (eg unrealistic expectations, status goods, a product of falling material scarcity)
- Why has this occurred (if it has)? Is it the structure of investment? Is it investors confusing the average return on housing with the return on rental stock (thereby “accidentally” accepting very low yields on housing)? Is it due to an institutional or policy related bias?
- Will the housing accord “help”? If the issue is the type of housing, and there is some bias, does making more land – or in Labour’s case building lower quality housing – address the issue? If this is the “problem” and we decide it is worthy of policy, then aren’t the policies of both political parties beside the point?
Now I’m not saying this is the way to consider it. However, I’d note that if this is your narrative for the housing shortage it leaves a lot of important unanswered questions – and on the face of it shows that the run up in house prices (with banks holding sufficient equity) is a lot less policy relevant (as it doesn’t impact upon the minimum bundle of goods and services available to the worst off)!
A big criticism of this theory is that I don’t think it really matches the data. If we were to use house size as a proxy for quality, additions to the housing stock got a lot larger between 2000 and 2008 – and have levelled off now. This is a pretty big empirical shortcoming of this explanation! However, it is still a useful thought experiment – and who knows, if we go through the data in detail we may be able to explain this, and we may find this is a good description of what happened, so considering it can’t hurt 😉
Great post, here is some more food for thought.
In March 2013, 42.5% of renters either received the accommodation supplement or social housing assistance. Even with the low growth rate of rent, a significant number of people still need state assistance to pay rent.
All up, including rest home subsidies, the government spends around $3.1 billion a year on housing assistance.
As well the Tax Working Group estimated in 2008 that the rental sector as a whole runs at a operating loss.
Without capital gains, and the previous favourable tax treatment, total rent appears too low. Yet even at this relatively low rate of rent, large numbers of people struggle to afford rent without assistance.
Is it a relative price issue or an income adequacy issue? That is a harder one. We know that each decile spends a similar amount on housing services (a fact that surprised me initially) – and so this points me towards income adequacy. But I’d need to think a bit more, within a broader framework, to make much sense of it.
There is also the matter of where you live. Have you seen Dog Patrol? Would you feel safe at night? Would you feel safe walking to the dairy?
Indeed, housing is a massive status good – and I think that can help support the idea of “multiple equilibirum” in house prices/price to rent ratios. A world with falling material scarcity will see status good prices bid up after all!
With more microdata becoming available, hopefully we can shed more light on these types of hypotheses!
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I don’t fully understand this. Why can’t you rent a big lounge?
Or are you saying houses with big lounges are not the sort of houses that become rentals?
The lounge may not have appropriate lighting or ambiance for the types of Tupperware parties I host. This is the importance of getting it custom built!
I think I may have made a similar reply on ‘Offsetting Behaviour’, but I think you need to consider the funding cost housing as well. The fall in interest rates from 2008/09 shifted the effective return (assuming that people refinanced at lower rates). So even at then current rentals the cash return increased. It is likely that this was partially capitalised into house prices, how much, I am not sure, but the leverage effect is quite large. You then also have to factor in expectations of future prices and whether people are motivated by current cash returns or future capital returns. These effects may have limited the scope for rental increases. I note that the weekly article on the queues for rental properties have stopped, but I am not sure whether the papers have moved on or it is just the new normal!
I completely agree, also the relative yield had been pretty attractive in 11/12. However, even accounting for that many people were stating there was a “shortage” – I was just noting a hypothetical point about differing types of “values” for a housing service 😉