Wellington's Fisher-Price zoning war
Wellington's Fisher-Price zoning war
A public sector town forgets that private housing supply incentives matter
A couple of quick notes.
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I am speaking at UBC in Vancouver on 12th Feb, 7pm. The topic: “Is local democracy in the way of affordable housing?” Tickets are sold out. Use this live stream link (1pm Tues 13th in Bris, 2pm Syd/Mel).
Wellington is in a war of words over zoning.
New Zealand’s capital city is in the process of changing zoning rules, and the first reports from a review panel have driven local YIMBYs to hysteria.
One outlet even declared a “War for Wellington”, the kind of tiny tantrum one sometimes sees in a town where policy debate can feel like a life-or-death struggle.
Developers in Wellington currently build on only a tiny fraction of land that can legally and profitably be developed. At issue is whether further upzoning will increase that rate of supply, and so make housing cheaper.
In a city surviving on public dollars, it’s easy to forget that the private sector won’t necessarily come to heel when politicians proclaim the need for more housing.
But Wellington’s Independent Hearing Panel (IHP) were cognisant of this. They appeared persuaded that since private investment was not currently constrained by development capacity, adding capacity would likely not increase housing supply or reduce prices. On that basis, their recommendations revolved around traditional planning concerns — amenity, environment, transport capacity, etc — cueing meltdowns and toy-tossing from local YIMBYs, as well as dark warnings that central government economists might need to take the wheel.
The local story is that since we all know restrictive zoning is why Wellington housing is expensive, the (independent) panel should have “read the room” and played along.
But that fundamental claim is difficult to reconcile with certain facts:
Zoning for more housing is not the same as supplying more housing. So it’s not simply “ECON 101” that looser zoning causes lower prices. Rather, it depends on whether there’s existing spare capacity, and whether flooding the market with more would change the return to building new housing relative to landbanking.
It’s not clear that widespread upzoning boosted supply in Auckland. There was a building boom after 2016, and rents fell, but the key study attributing this to the reforms relied on the unjustifiable assumption that the growth rate of new supply would otherwise have fallen to half that prevailing beforehand (as we explained here and here).
Wellington developers are already flooded with choice. They develop about 1,000 dwellings each year from 35,000 dwellings worth of feasible capacity available. That capacity is set to broadly quadruple. Construction is slumping right now due to falling demand, suggesting capacity limits aren’t binding.
The panel’s conclusions broadly aligned with my consulting colleague Tim Helm’s evidence to the hearings. His statement included a concise summary of the economics of new housing supply. (It also discussed empirical studies and the local context).
I’ve presented that material below to help readers understand why worries about zoning and affordability are so often misplaced.
The economics of new housing supply
The economics of new housing development — the science of what, why, when and how much housing development occurs — is a relatively new field. These questions have been historically underexamined. Past lines of enquiry focused on the determinants of land prices (classical rent theory) and the long-run determinants of urban form (urban economics), but not on the conduct of developers and its consequences for housing supply.
The following sections step through core concepts from this field relevant to the question: how do zoning rules affect housing affordability?
The rate of new supply is the key policy outcome
Housing affordability is a matter of housing costs (e.g. rent) against income. Housing costs are determined by demand — which depends on population, incomes, and preferences — against the supply of dwellings available.
The housing stock only grows via the ‘flow’ of new housing. Therefore if zoning makes housing less affordable, it must do so by reducing the rate of supply of new housing. If relaxing zoning rules (‘upzoning’) improves affordability, it must do so by increasing the rate of new supply.
This rate is the key metric for assessing the impact of policy on affordability.
New supply, zoned density, urban density and feasibility are distinct concepts
Zoned density (or intensity) refers to the number of dwellings allowed on a site. Density is distinct from new supply, because although developers typically build to the maximum zoned density, they typically do not build on every site available to develop. Thus supply can change without any change in density limits, and density limits can change without changing supply. Zoned density and new supply are not synonymous.
Site density and urban density are also different. Urban density relates to the geographic concentration of people. High site density a long way from population centres can result in low urban density. Equally, high urban density can be achieved with relatively low site densities (when more sites are fully developed). Urban density is the proper goal for productivity, environmental impact, and efficient infrastructure use. Site density is a better predictor of disamenity impacts, e.g. tree loss, run-off and overshadowing.
Development feasibility refers to the profitability of converting land from lower-value to higher-value use (e.g. farmland to housing). Development feasibility can change without changing the rate of supply, because although development must be feasible to take place, most sites feasible to develop are not developed in any given period. Policies that increase feasibility will not necessarily increase supply.
Distinguishing these concepts is important. Claims about upzoning and affordability are often based on the unexamined premise that zoning for density is identical to providing new housing. This ignores the critical role of the private sector, which develops most housing.
Housing development is a timing choice
For the private sector, there exists an equilibrium rate of new supply that is privately most profitable. This equilibrium is in the flow of new housing, not the stock. The equilibrium does not involve developing all projects profitable to develop.
The reason feasible projects are not developed is that property development is fundamentally about asset reallocation — converting land and cash to housing. Because this is irreversible, and because under-developed land and cash assets earn returns, development is at heart a timing choice (a choice of when to build).
From models of timing choices under uncertainty economists study the drivers of the rate of development.1
Development happens at a market absorption rate
The market rate of new supply is called the ‘absorption rate’. Economists explain this as the rate which balances the profitability of development and the profitability of speculation (landbanking).2
Even when it is profitable to build, it can be more profitable not to build, because development-ready land rises in value through time, and over-supplying housing means selling at a discount. The absorption rate is determined by the balance of these considerations.
The absorption rate is primarily a function of growth in demand (e.g. population). It acts to stabilise price growth: when demand grows and rents rise, market supply responds to limit that rise. Similarly, in a declining market, developers will pull back and supply less new housing, limiting the amount by which rents fall: developers will not voluntarily ‘flood the market’ with housing.
There are no alternative theories of new housing supply that can explain the fact of profitable development opportunities not being taken up other than the idea of a built-in market ‘speed limit’ for the supply of new housing.
Land-use regulations do not constrain the absorption rate
Paradoxically, zoning rules can bind on each and every housing development, reducing the profits of each and every developer, without binding (constraining) the market rate of new housing supply. This is because most feasible development opportunities are rationally left undeveloped as strategic investments, in what is described as speculation or landbanking.
This means that zoning rules just shape where housing goes and what it looks like—not how much is built.
For example, if total demand growth is for six dwellings per year, zoning rules determine whether a city sees the development of:
(a) Six buildings with single dwellings under low-density zoning;
(b) Two buildings of three dwellings each under medium-density zoning; or
(c) One building of six dwellings, with other sites held vacant, under high-density zoning.
How much housing is built is a market decision. The public decision to allow more housing is necessary but not sufficient for the private decision to build it.
Economic models find the absorption rate to be generally unaffected by zoning rules. The only effect is a counterintuitive one: looser zoning on a site makes development less likely. This is because delaying development is more profitable when developers can benefit not only from rising prices but also from step-changes in the optimal built density (e.g. six stories instead of three). Restrictive zoning, by contrast, discourages developers from speculating on the possibility of a higher-density development becoming profitable later. The upshot is that upzoning a site to encourage its development might achieve the opposite.3
Zoned capacity has no influence on new housing supply
There is no grounding in theory (or evidence) for the idea that the stock of zoned sites determines the rate of new supply, or that without extensive zoned capacity (e.g. 30 years) supply will slow and house prices will rise.
Price pressure reflects changes in population and income relative to changes in housing stock. Nothing suggests that additions to the housing stock depend on the stock of zoned land. Rather, new supply depends primarily on the rate of growth in demand.
Subject to there being enough zoned capacity to meet market demand for new housing, increasing zoned capacity is like pushing on a string.
In particular, it is important to note that the share of zoned capacity developed over a period (the ‘realisation rate’) is an outcome of the absorption rate (new dwellings per period) — not the other way around. The realisation rate is an effect, not a cause.
Arguments that “only X% of zoned capacity is developed, therefore to increase development we must increased zoned capacity” are flawed. There are no credible theories that the rate of new supply (dwellings per period) responds to zoned capacity. The realisation rate (proportion of zoned capacity used for new housing in a period) is a summary statistic, not a fixed parameter that is independent of zoned capacity. It is not an economic variable with any causal influence.
Development costs and development rights affect land values, not house prices
Taxes that increase development costs, and regulations that reduce development profit by restricting site density, are not passed forward into higher house prices, but back into lower land values. This is one of the oldest findings in the economics of land.4 It is formalised in professional development feasibility and land valuation practices.
If developers could increase their sale prices in response to higher costs without losing sales, they would clearly do so regardless of the specific costs they face.
Rents and prices reflect the market’s willingness-to-pay for housing, not the costs of construction or the price paid for land. Housing is not priced on a ‘cost-plus’ approach, since the major component, land, has no underlying cost of production. The price it sells for is a residual, determined by buyers’ willingness to pay for housing, less development costs.
Equivalently, zoning changes that grant new development rights are capitalised into higher land values. Landowners do not receive a financial benefit from restrictive zoning — rather, additional land use rights provide option value to develop, causing houses to appreciate in value. The more development-ready the land, the higher the uplift (windfall gain) from upzoning, as was observed in Auckland following the 2016 upzoning.5
More housing makes for a larger city, and trickles down slowly to the bottom
More supply with unchanged demand does lower prices. But this is not the whole picture of how housing policy interventions work. More supply and lower prices also induce two adaptive responses on the demand side:
(a) Faster in-migration
(b) Increased consumption of housing by all consumers, not just low-income households.
Migration and spatial equilibrium
A key principle in urban economics is ‘spatial equilibrium’, summarised in the phrase “migration equalises quality of life”. The elements of quality of life that drive migration include wages, rents, travel times, crowding disamenity, and location-specific features (e.g. natural features, climate).
In-migration bids up rents and bids down wages by way of competition. It also increases congestion and crowding. These changes erode quality of life differences between locations over time, re-establishing equilibrium.
When a construction boom pushes rents lower, this induces in-migration, which restores rents to levels comparable to elsewhere. Thus lower rents are only ever a temporary outcome. The long-run outcome is that more supply creates a larger (not cheaper) city. If it remains cheaper, it is because another element of quality of life has changed, e.g. congestion or amenity.
The recent experience of Christchurch, where cheaper housing prompted fast population growth and quickly-rising housing costs, illustrates this point.
Housing consumption
Demand for housing is ‘elastic’ — as the price falls, people consume more and better housing by renting or buying more floor space or land area and by bidding up preferred locations. As a stylised empirical fact, the share of household budgets dedicated to housing is fixed.6
Faster market supply therefore does not mean more housing will be provided for those in greatest need. Markets allocate resources — e.g. land and construction resources — according to purchasing power, not need. More market housing will ‘filter’ or ‘trickle down’ to improve affordability for low-income households only slowly and indirectly.
The upshot of migration and consumption responses is that supply-side policy interventions to lower housing costs can only ever have temporary and limited effect. The primary levers for affordability for those on low incomes are income support and non-market housing, not market supply.
The ‘absorption rate’ framing and findings discussed below are from Murray (2021). Other timing choices models of housing development include Lange and Teulings (2021) and Guthrie (2022). See Murray (2021), A housing supply absorption rate equation, Journal of Real Estate Finance and Economics; Lange and Teulings (2021), The option value of vacant land: Don’t build when demand for housing is booming, Tinbergen Institute Discussion Paper; Guthrie (2022), Land Hoarding and Urban Development, Journal of Real Estate Finance and Economics.
The ‘absorption rate’ framing and findings discussed below are from Murray (2021). Other timing choices models of housing development include Lange and Teulings (2021) and Guthrie (2022). See Murray (2021), A housing supply absorption rate equation, Journal of Real Estate Finance and Economics; Lange and Teulings (2021), The option value of vacant land: Don’t build when demand for housing is booming, Tinbergen Institute Discussion Paper; Guthrie (2022), Land Hoarding and Urban Development, Journal of Real Estate Finance and Economics.
Murray (2021), A housing supply absorption rate equation, Journal of Real Estate Finance and Economics; Titman (1985), Urban land prices under uncertainty, American Economic Review.
In his 1817 work Principles of Political Economy and Taxation classical economist David Ricardo expressed this by saying that “[the price of] corn is not high because a rent is paid, but rent is paid because [the price of] corn is high”. Ricardo’s theory of rent remains central to the economic understanding of land.
Greenaway-McGrevy (2018), Rezoning to allow more intensive development brought windfall profits for some property owners, not so much for others, Interest.co.nz, 19 April.
Murray (2022). Why is the rent-to-income-ratio flat?, Fresh Economic Thinking, 3 October.
Great article Cameron. I have been thinking about a more intuitive explanation for why up-zoning does not lead to the short term increase in development that people might expect. I think the issue is that the idea of up-zoning is based on a set of assumptions about competitive markets that do not apply to a natural resource like land.
The thinking behind up-zoning goes something like this: it starts with the infamous Econ 101 example: Given a market for a product, say left handed screwdrivers, producers would like to sell at the most profitable price known as the Monopoly Price. However if everyone in the market is selling at the Monopoly Price, any individual producer could make more money by lowering their price and selling more screw drivers. This creates a prisoner’s dilemma where every individual producer could make more money by lowering their price, but would lose money if everyone else lowers their prices. In this scenario producers will either find a way of coordinating (ie form a cartel) or they will have to lower their prices to the competitive market price. So far so good, nothing new here - this is the basic example we all know and love. In this theory, if the total number of “allow units” increases through up-zoning, then the increased supply should lead to a decrease in prices.
The thing that makes this example work is the fact that producers in a commodity market have a way to make more money from lower prices. So why doesn’t this supply-demand prisoners dilemma apply to housing? If I own 10 acres of land, I can only sell up to 10 acres of land. Land owners have no incentive to “defect” and lower price, because they cannot make up the difference by increasing the volume of land sold, because the supply is fixed. I can sell the 10 acres that I have at higher prices and make more money, or sell the 10 acres that I have at a lower price and make less money. There is no dilemma, there is not really even a choice, there is no scenario where I make more money by selling land at a discount. Based purely on the incentives of each individual owner to hold rather than sell at a discount, the market will move towards the Monopoly Price without requiring any kind of collusion.
In order to build more housing, the developer must first acquire the land on which to build. Whether the land is zoned for high or low density, the sale of land and construction will be constricted by the sellers to maintain their desired prices, preventing a construction boom. Up-zoning does not create more supply of land, it does not increase the number of land owners and it does not add any incentive to sell land at a discount. Owners will continue to follow the same incentives to get the price they want, in exactly the same way they did before rezoning. The result is that the lot will become more valuable rather than the units becoming cheaper. In effect up-zoning provides a free handout to existing owners whether they choose to build or not.
In short, the idea that up-zoning will increase construction does not account for the pricing power of sellers in a market with fixed supply, because this is not included in the supply-demand model for a competitive market that is implicitly being referenced. I think the core of the confusion comes from combining the building which behaves like a commodity, with the lot which behaves like a natural resource. In many respects, these two things operate in the complete opposite way, which makes it very hard to reason about “housing” without separating it into the two components. I have basically just restated the same points you have made, but I hope that makes intuitive sense.
Pure gold:
> Taxes that increase development costs, and regulations that reduce development profit by restricting site density, are not passed forward into higher house prices, but back into lower land values. This is one of the oldest findings in the economics of land.
A great and thorough article!