Increased supply not the solution

This Issue This is a part of the Affordability feature

By - , Build 150

Experience elsewhere shows increasing housing supply isn’t necessarily the panacea to the housing affordability problem.

DESPITE THE COMPLEX processes that shape housing markets, government policies have increasingly emphasised the role of expanding housing supply as the primary tool for moderating house price growth.

Blame laid on planning constraints

In England, Australia and New Zealand, it has been argued that planning constraints have adversely affected housing supply elasticities, resulting in higher house prices. Consequently, it is stated that an increase in housing supply will reduce house prices and make housing more affordable.

The simple notion that increasing housing supply will result in more affordable housing is incorrect. Three factors support this:

  • Evidence of house prices in Ireland – a market that experienced an unprecedented increase in housing supply.
  • The findings of econometric modelling of the impact of housing supply on house prices.
  • Research on developer behaviour during price cycles.

High output and prices kept rising

Before the global financial crisis, countries such as the US, Ireland and Spain experienced considerable house price inflation in conjunction with sustained increases in housing output.

Ireland, with a similar-sized population to New Zealand and also described as ‘a rock star’ economy, experienced demographic growth, increased migration, rising incomes and increased wealth from the 1990s onwards.

In response to the growing demand, housing production rose from 20,000 units per annum in the early 1990s to 89,000 units in 2006.

The result was an additional 553,267 units added to the dwelling stock between 1996 and 2005. Yet this unprecedented increase in production was not sufficient to reduce house prices.

From the mid-1990s to 2006, average new house prices in Ireland increased by 323% and second-hand houses by 455%. In Dublin, the largest city, new house prices increased by 425%, and second-hand house prices increased by 553%.

Ireland experience highlights the risks

While not addressing housing affordability, the massive shift in resources directed to the construction sector had a profound effect on the wider economy.

Significantly, the Irish banking system became increasingly exposed to construction and property development debt, and after the global financial crisis, the banking sector became vulnerable to a property downturn.

The decline in house prices in Ireland post 2008 is directly related to the global financial crisis, a banking crisis and a sovereign debt crisis. The Irish property boom-bust cycle resulted in a significant decline in house prices but at considerable economic and social costs. These included widespread negative equity, increased mortgage arrears and the rise of ghost estates – unfinished developments in low housing demand areas.

The Irish experience illustrates that relying on increased housing production does not ensure housing affordability. In addition, it highlights the inherent risks for an economy that relies on housing production as a key economic activity.

UK model of supply and prices

In response to critiques of traditional planning models of housing supply in England, increasing official attention has been directed to modelling the impact of planning on both housing supply and house prices.

In England, the CLC-Reading Housing Affordability model is used to make 25-year supply forecasts. Its key output variable is ‘housing affordability’ (defined as the ratio of lower-quartile house prices to lower-quartile earnings).

Significantly, this government-supported model indicates that, even under a high housing production scenario, the affordability ratio will continue to rise. In effect, the benefit of high-volume housing output would be to simply moderate the rate of worsening housing affordability.

Geoff Meen, a key author of this model, argues that relying on an increasing housing supply, especially in markets with high rates of price increases, is not sufficient to ensure affordable housing.

Developer behaviour

Relying on housing supply to address housing affordability issues requires a deeper understanding of residential developer behaviour throughout the price cycle.

An international study of housing supply elasticities in the Journal of Housing Economics drew on evidence from the US, Britain and Australia. It found that housing ‘supply is more responsive to the change in house prices than their level’.

This suggests that expectations around future house price inflation, rather than house prices per se, are a key feature in developer decision making. Thus, rising prices are an important driver of supply.

If this is the case, if house price growth decelerates as housing supply increases, developers may not proceed with new developments, even if zoned land were available.

Moreover, under conditions of rapid price increases when house prices are increasing at a faster rate than inflation, developers might delay production to secure higher profits from house price appreciation.

In combination, the research on developer behaviour indicates that, even in situations where a plentiful supply of zoned land is available, development processes will not necessarily produce affordable housing.

Issue is complex

House prices are determined by a complex set of demand (demographic shifts, income changes, homebuyer demands, mortgage market dynamics) and supply interactions.

Relying on housing supply to solve the housing affordability crisis is problematic. Policy makers must acknowledge that housing supply is a necessary but not sufficient condition for ensuring housing affordability and consider other avenues to address affordability.

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