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.
> 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.
Hi Cameron, while the price of land is residual, when it comes to the redevelopment of a property with an existing house, do you think there is a tipping point where developers are unable to purchase land any cheaper because they are competing with homebuyers who value the property differently (as a house rather than as land for development)? At that point, higher input costs would presumably impact on the feasibility of a development.
So good and so clearly articulated about each of these factors and their role.
The more I think about it, the more I think that there should be an entire university degree that brings together the topics you talk about, i.e. macroeconomic theory vs the real world calculations taking place in the development industry.
This may be getting too deep into the weeds but another factor where the policy hits the reality of renewal is housing typologies vs site structure / block sizing.
Upzoning an area with lots of small, developed blocks has to face an uphill battle of having to pursue amalgamating smaller blocks in order to create larger sites that are appropriate for the new building typologies allowed under the upzoned controls. So upzoned land does not equal desirable development opportunities for the industry.
This is often an important underlying factor of why many upzoning initiatives fail. If larger sites are available, they are always the path of least resistance. Just because somewhere has been upzoned, doesn’t mean owners are willing to sell and the odds of there being two or more owners looking to sell at the same time gets progressively more unlikely, the more blocks you are combining.
Land captures a lot of the value of location and other amenities. So pricing of houses is restricted of how low it can go. Thus, affordability itself won't be solved until we decouple location value (which is really job opportunities) from land value.
What changes in this scenario when combined with an increase in the holding cost of land (e.g. an LVT)?
Is the only real solution non-profit-driven entities building housing without regard to the market saturation rate, such as state housing and social housing providers?
If "There is no grounding in theory (or evidence) for the idea that the stock of zoned sites determines the rate of new supply." and "Subject to there being enough zoned capacity to meet market demand for new housing, increasing zoned capacity is like pushing on a string" (ie. zoned area is not a constraint on housing construction)
Then how could it be that "zoning changes that grant new development rights are capitalised into higher land values"
Either there is enough zoned land for development, and therefore no premium from upzoning more, or there is not enough, and more high density zoned land supply would decrease the economic rent that holders of developable land can extract from new housing development.
Your argument would seem to imply that if you could somehow create a big supply of new land (let's say you could reclaim land in Wellington harbour from the sea for free) and made it available to build on, this wouldn't decrease the price of housing because it doesn't effect the market’s willingness-to-pay for housing.
Great article! It is great to see the long form discussion. If we didn't have a supply issue what else could we be doing to alleviate the Australian "Housing Stress" so often cited in headlines?
When you say “The recent experience of Christchurch, where cheaper housing prompted fast population growth and quickly-rising housing costs, illustrates this point.” how are you measuring housing costs?
Granted that knowing how much (including zero) more housing and commercial development would occur with fewer restriction on land use and building codes is hard, why not just deregulate and find out? What's the cost?
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!
Hi Cameron, while the price of land is residual, when it comes to the redevelopment of a property with an existing house, do you think there is a tipping point where developers are unable to purchase land any cheaper because they are competing with homebuyers who value the property differently (as a house rather than as land for development)? At that point, higher input costs would presumably impact on the feasibility of a development.
So good and so clearly articulated about each of these factors and their role.
The more I think about it, the more I think that there should be an entire university degree that brings together the topics you talk about, i.e. macroeconomic theory vs the real world calculations taking place in the development industry.
This may be getting too deep into the weeds but another factor where the policy hits the reality of renewal is housing typologies vs site structure / block sizing.
Upzoning an area with lots of small, developed blocks has to face an uphill battle of having to pursue amalgamating smaller blocks in order to create larger sites that are appropriate for the new building typologies allowed under the upzoned controls. So upzoned land does not equal desirable development opportunities for the industry.
This is often an important underlying factor of why many upzoning initiatives fail. If larger sites are available, they are always the path of least resistance. Just because somewhere has been upzoned, doesn’t mean owners are willing to sell and the odds of there being two or more owners looking to sell at the same time gets progressively more unlikely, the more blocks you are combining.
Wellington City Council just (14 Mar) rejected the IHP recommendations to abandon housing density upzoning. Let's see what happens...
Great piece! It almost perfectly summarizes the economics research housing price deep dive I just did in 3 parts (https://www.nominalnews.com/p/housing-supply-side-and-affordability).
Land captures a lot of the value of location and other amenities. So pricing of houses is restricted of how low it can go. Thus, affordability itself won't be solved until we decouple location value (which is really job opportunities) from land value.
What changes in this scenario when combined with an increase in the holding cost of land (e.g. an LVT)?
Is the only real solution non-profit-driven entities building housing without regard to the market saturation rate, such as state housing and social housing providers?
I'm slightly tired of people who claim to care about a shortage of housing supporting rules that make it harder to build houses.
If "There is no grounding in theory (or evidence) for the idea that the stock of zoned sites determines the rate of new supply." and "Subject to there being enough zoned capacity to meet market demand for new housing, increasing zoned capacity is like pushing on a string" (ie. zoned area is not a constraint on housing construction)
Then how could it be that "zoning changes that grant new development rights are capitalised into higher land values"
Either there is enough zoned land for development, and therefore no premium from upzoning more, or there is not enough, and more high density zoned land supply would decrease the economic rent that holders of developable land can extract from new housing development.
Your argument would seem to imply that if you could somehow create a big supply of new land (let's say you could reclaim land in Wellington harbour from the sea for free) and made it available to build on, this wouldn't decrease the price of housing because it doesn't effect the market’s willingness-to-pay for housing.
Stu Donovan's counter-view (of sorts) is given here https://thespinoff.co.nz/politics/15-02-2024/opinion-wellingtons-housing-panel-is-out-of-step-with-the-economic-evidence
Great article! It is great to see the long form discussion. If we didn't have a supply issue what else could we be doing to alleviate the Australian "Housing Stress" so often cited in headlines?
When you say “The recent experience of Christchurch, where cheaper housing prompted fast population growth and quickly-rising housing costs, illustrates this point.” how are you measuring housing costs?
Granted that knowing how much (including zero) more housing and commercial development would occur with fewer restriction on land use and building codes is hard, why not just deregulate and find out? What's the cost?