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The Fifth Estate
Green buildings and sustainable cities – news and views
While housing under supply puts upwards pressure on prices, oversupply can be disastrous. So where is the Goldilocks zone?
According to current thinking reflecting economics 101 undersupply of housing is the root cause of rising house prices and rents. Addressing undersupply therefore is key to fixing our housing affordability problem.
Housing supply needs to be faster, cheaper, and more certain. While developers have always sought reform of this type, the increasing political clout of “generation rent” means policymakers are increasingly receptive to such demands.
However, does making housing supply faster and cheaper address supply deficits? The answer is no, but providing greater certainty is part of the solution.
Firstly, there is a more than adequate supply of zoned greenfield land, but it is not developed at the same rate at which it is zoned. Land banking occurs. Secondly, sites suitable for apartment development can sit idle for years. While popular consensus will have it that speculation is the problem, and plenty of landowners are motivated by the possibility of uplift in property prices, there is a much more fundamental economic issue here.
While under supply puts upwards pressure on prices, oversupply, although rarer is disastrous. The capital losses can be huge, firms bankrupt, jobs are lost, careers disrupted, tax receipts plummet, the general economy falters. The only beneficiaries are people who manage to keep their job or wealth who are presented with the opportunity to purchase property on the cheap. Property booms create very significant wealth, but property busts can bring down whole economies.
While there are speculative hotheads who engage in risky behaviour, the development industry (and, importantly, financiers) anxiously watches economic indicators for the signs that demand is about to falter. Between the time the money is committed and when a development is finished —typically years – the market can turn, and projects can end deeply in the red. This is why development is a risky business and why higher profits are needed to incentivise investment.
The economic problem we have is the “chronically asynchronous relationship between the demand for and supply” of housing (Weber 2016, p.588). A lag in supply lessens the risk of being the developer who fails to get a chair when the music stops. Supply must lag demand to sustain prices to ensure project viability at outset and profitability at project completion (Sharam et al. 2018, Sharam 2019).
What does reducing costs do? Reducing taxes and charges makes more projects stack up financially at the feasibility stage and all going well increases the developer’s margin. It will incentivise development. However, economics 101 tells us that when cost savings can be achieved the developer has more headroom, in terms of the price they will be willing to pay, for land.
So, making development cheaper has the perverse effect of driving up land prices and so the feasibility bonus is eroded. Conversely, where taxes and charges are increased land prices are discounted. Developers already owning land, however, have to assume the additional expense will make their development less viable. Hence the need for grandfathering provisions to protect developers in this position. Existing landowners hoping to sell to a developer are of course penalised by increased taxation but this not a problem as tax on land is a non-distorting and encourages productive uses.
What does making planning faster and easier do? Reforming planning can in effect make more existing land available through permitting housing intensification in existing suburbs. Planning approval processes can be streamlined to speed up the development process, making development cheaper and more certain. Certainty is important as it affects the feasibility analysis and profitability. Reducing the cost of development as noted above will ultimately be offset by higher land prices. Economics also suggests that when there is undersupply, cost savings will not be passed through to the end buyer but become windfall profit. So far, so good for supply but no affordability dividend.
Housing development is comprised of “systems of systems” in which autonomous subsystems integrate in complex ways (Keating et al 2008) and participants voluntarily interact to serve an agreed-upon purpose (Maier 1998). The housing development systems of systems self-regulates to avoid oversupply. Key to this regulation are the financiers – especially debt funders.
Developers fund the early stages of development and other people’s money (debt) is used for construction and the loan monies are only released by the lender at the construction stage. The offer to fund construction can be withdrawn up until this point and it will be if the lender sniffs a downturn in demand on the breeze.
This has occurred several times in recent years.
Apartment development is the canary in the coalmine for the property cycle, where “multifamily housing starts lead on the downturn and tend to turn up with the end of the recession”, (Jud, Benjamin & Sirmans 1996, p 248). This reflects an initial collapse in demand, followed by a long period of inactivity before economic recovery can address pent-up demand for housing (Sharam et al 2018; Sharam 2019). This explains why, at times, 25 per cent of planning permits are not acted on. At times this figure will be much higher.
Housing production needs to become a boring service sector rather than a speculative process. If risks are reduced margins should drop
Housing undersupply cannot be cured by simply focussing on how fast housing is produced, or costs. It must take account of the chronic asynchroncity of demand and supply and policy should be aimed at moderating the cycle of boom and busts. Developers rely on economic indicators to understand aggregate demand, which is not enough. There needs to be more sophisticated ways of understanding demand.
Further, given demand is hostage to economic conditions we need to consider how demand can be supported when economic conditions deteriorate. If demand can be stabilised, development is not as risky. If it is less risky, profit margins do not need to be as great as they generally are.
Housing production needs to become a boring service sector rather than a speculative process. If risks are reduced margins should drop.
If we look to Vienna, 60 per cent of housing is in the social housing (with broad eligibility) and cooperative sectors. Financing is underpinned by special taxation. Demand is held up by rents being relatively affordable. The construction sector has a steady stream of work permitting it to invest in training and innovation. Without severe booms and busts driven by housing speculation their economy is more resilient, so job losses are less likely to undermine demand.
We have the choice of a vicious circle or a virtuous one, between speculation and damaging property cycles or a steady state industry. In the end we have a market problem, and we should be looking to understand how the market is “designed” instead of narrowly examining the tool kit.
Jud, D., Benjamin, J. & Sirmans, S. (1996), ‘What Do We Know about Apartments and Their Markets?’, Journal of Real Estate Research, vol. 11, no. 3, pp. 243-257. 
Keating, C. B., Padilla, J. J. and Adams, K. (2008) ‘System of systems engineering requirements: challenges and guidelines’, Engineering Management Journal, vol. 20, no. 4: 24-31.
Maier, M. W. (1998) ‘Architecting principles for systems?of?systems’, Systems Engineering: The Journal of the International Council on Systems Engineering, vol. 1, no. 4: 267-284.
Sharam, A., Byford, M., Karabay, B., McNelis, S. and Burke, T. (2018) Matching markets in housing and housing assistance, AHURI Final Report No. 307, Australian Housing and Urban Research Institute Limited, Melbourne, 10.18408/ahuri-5315301, 
Sharam, A. (2019) ‘Disruption and the matching market for new multifamily housing in Melbourne, Australia’, Journal of General Management, vol. 44, no. 3: 160-169. 
Weber, R. 2016, ‘Performing property cycles’, Journal of Cultural Economy, vol. 9, no. 6, pp. 587-603.
Dr Andrea Sharam is a Senior Lecturer within the School of Property, Construction & Project Management More by Andrea Sharam, RMIT
Dr Andrea Sharam is a Senior Lecturer within the School of Property, Construction & Project Management
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