Interest rate falls, land shortage keys to pricing

The global decline in interest rates and restrictions on land supply have been the main causes of higher house prices over the last 20 years, a new report says.

A lack of housing supply relative to demand was often cited as the key driver of rising prices, but the report from the Housing Technical Working Group, a joint Treasury, Ministry of Housing and Urban Development, and Reserve Bank initiative, found other factors came into play.

Evidence of this could be found in the fact that while supply and demand should affect rents as well as prices, prices had increased far more than rents, and the price of land rose much further than the cost of constructing new homes.

The group’s chair, Dominick Stephens, said the global decline in interest rates led to a sustained reduction in borrowing costs in New Zealand, and increased demand to buy houses.

‘‘If land supply had been more responsive this would have sparked a larger housing supply response, moderating any initial lift in prices and putting downward pressure on rents.’’

But that was not the reality in New Zealand, where effective land supply, which provided cities with the ability to grow either up or out, was reasonably restricted, he said.

‘‘Instead, much of the fall in interest rates was captured by higher urban land prices, and those higher urban land prices led to higher house prices without increasing the incentive to build dwellings.’’

This explained why house prices rose so much further than rents, which had evolved largely in line with income over the last 20 years.

While factors such as population growth and construction costs played a more modest role, the report found that land supply restrictions also influenced how the tax system affected prices relative to rents. The more restricted the supply of land, the more tax changes would be captured as changes in the value of land, rather than affecting incentives to build more homes and reduce rents, Stephens said.

‘‘There have been worries that tax changes, such as a capital gain tax, would be borne by renters, but if a change was to be introduced, it would be more likely to be captured in land prices.’’

The report’s goal was to provide an assessment of the key market drivers of the last 20 years, and it focused on the Hamilton-waikato area to generate insights for the rest of the country.

In the Hamilton-waikato area, house prices increased by 372% and rents by 114% between March 2002 and June 2021.

At the same time, incomes increased by 98% over the same period, while national construction costs increased by 142%. Section prices increased by 405%, but 658% in Hamilton City.

Stephens said that while the paper was an assessment of what had happened, a lot was now changing.

Urban planning was being reformed to free up land supply, via such policies as the national policy statement on urban development, and the medium density residential standards, and tax settings had been changed for investors, he said.

‘‘Improving the availability of land supply could shift the dial for the housing market. Identifying where land is most restricted in supply, and what policies will help make more available, is key and will change the situation over time.’’

As interest rates had lifted the likely outcome would be downward pressure on house prices in the short term, and long-term that would be aided by changes to the tax system and the availability of land, he said. The group now planned to focus on work around improving understanding of urban land supply and the drivers of rents.