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.
Those arguments, as with your comment, explain why upzoning can't make land cheaper via competition.
But that's not the policy issue. The question is how zoning relates to housing development, i.e. the rate of new supply.
Theory about investment choices based on landowners maximising the NPV of returns from their site is the key to answering this question. I mentioned that in relation to "timing choices" and the "absorption rate" in the explanation above.
By contrast, theory that assumes the inputs to housing are elastic is wrong (because land is not elastict), and theory that assumes all development has already taken place (standard urban economics) is also fairly unhelpful. That's why so many people reach such different policy conclusions - they're working with different mental models.
A mental model that recognises the fixed monopoly nature of land and the dynamic investment choice that underpins property development is the right one, in my view.
Hey Tim, yes the point I'm making is constricting supply and raising prices are two sides of the same coin. In effect I’m saying that sellers will continue to maintain prices by restricting supply, and there will not be a significant effect on the rate of construction. It could potentially even go in the other direction as the expectation of future up-zoining would encourage developers to wait.
The question becomes how do developers choose when to build? Clearly the absorption rate is an important factor. I would expect that the relative returns compared to other investments like stocks would also factor in. This is an interesting question that deserves a more detailed exploration.
In my opinion you've correctly reasoned your way to the right question: what factors determine the amount of dwelling investment that occurs? What determines the rate of new housing supply, i.e. the amount of new housing brought to market over any given time period?
The question is, equivalently, when and why do landowners choose to speculate or 'landbank' - i.e. hold a site that could be profitably redeveloped in an under-developed state?
Speculation and new supply are opposites. New supply happens when speculation ends. Understanding the drivers of that decision, and in particular whether, when and how zoning rules affect it, is an important field of inquiry.
Surprisingly these questions have not been central to economics until relatively recently. Economists traditionally cared about what determined land prices (classical economics), and what determined the broad patterns of built form within and across cities (urban economics), but not what determined the flow of new housing.
Those fields - classical and urban economics - are not directly relevant to policymakers grappling with questions about zoning. That some economists are using the tools they've been taught, rather than the right tools for the job, is the source of their frustration and the reason for disagreement about zoning within the broader economics profession (as per Cameron's post).
I don't doubt that within a few years we'll all agree that the question you've arrived at is the most relevant one for these areas of policy.
Only that property prices are much more affordable in Christchurch and never went through the same growth in mid to late 2010s.
Rental prices also drifted back to be more attractive following an initial bump, owing to reduced dwelling supply (from red zoned properties) in conjunction with increased population of people moving to the area to help with rebuild.
I happened across a chart made by Michael Reddell that illustrates nicely the example I gave about how Christchurch's recent population growth and rental acceleration illustrated the process of spatial equilibrium.
After the supply boom in the mid-2010s led to declining/flat rents, such that Chch became quite affordable, internal migration kicked up and rents converged back to levels commensurate with Wgtn and Akl.
It's a really neat illustration of spatial equilibrium/convergence, i.e. any supply-driven affordability gains don't last long, but simply lead to a bigger city. That was the point I made in my evidence.
The interesting thing is the difference in house prices (and house price change) between the centres then. Perhaps illustrates that rents are more tied to tenant income while long term house prices are influenced by zoning and supply.
It would also be interesting to look at the make up of stock in each of those places (which I’ll check at some stage). I suspect in Christchurch there are far more larger houses and they’re more modern than what there would be in Wellington in particular, but to some degree Auckland. So bang for buck in Christchurch is much greater.
"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."
Sorry, I think the argument fails. The key thing about upzoning is that it reduces the cost of land per square metre of buildable floor space. Land is fixed and cannot be increased, but regulation can certainly increase the amount of floor space that can be built on the land.
In other words, it's the actions of regulators rather than suppliers that's critical to the land market.
Hi Russel thanks for sharing! I agree that regulators have a key role to play here. I think difference between the two ideas comes down to this: are prices driven by the costs of construction or pricing power?
To see how pricing power works in practice, developers in cities like Vancouver pre-sell most condo units. If the developer cannot find the buyers during the pre-sale, then construction will be cancelled or delayed until buyers can be found at the price the developer wants. This constraint can even be imposed on developers by lenders who require a fraction of revenue to be raised in pre-sale before providing financing for construction. In this way, sellers can slow the construction of new buildings when there is slack in demand rather than allowing the price to come down. The result of this slowed construction is … slowed construction.
In referencing your article, the cost per potential unit of housing would drop exactly as you have shown. The challenge is converting these potential units into actual units. Existing owners will delay construction and/or sales in order maintain prices regardless of changes in the total number that could theoretically be built or sold.
On the flip side, if we consider the cost of inputs as the driver of current housing prices, how do we explain the price of the biggest input - land? Why do we see empty lots and knock-downs in areas with high density that already have permissive zoning? If a new developer can buy a site, and build a building profitably, all of the existing landlords in the same zoning area have the same opportunity. The existing land owners could make a larger profit selling the same size building at lower prices because they have the same construction costs, the same zoning but paid less for the land. I'm not sure how to explain empty lots in high density areas without considering the pricing power enjoyed by sellers?
> 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.
In Vancouver (where Dr. Murray will be speaking), the counterargument is that municipal governments have not been leaving this money on the table. They've been extracting as much revenue as possible, using high development charges on new housing. (From 2011 to 2020, the City of Vancouver extracted $2.5 billion in "Community Amenity Charges" alone.)
Once the "land lift" (redevelopment value minus current value) is almost entirely gone, there's not much reason for landowners to sell for redevelopment. So then prices and rents have to rise further before projects will be economically viable.
In other words, higher development charges are first paid by landowners, but once the land lift is gone (too many bites of the apple), they're paid by homebuyers and renters.
My understanding is that land value is a "residual": the price that a project is willing to pay for land is the expected selling price of the new building, minus all the costs of building it.
That means that it's volatile: a small change in selling prices or in construction costs results in a much larger change to land value. (Like the way you get large changes in home equity from small changes in price - with an 80% mortgage, a 10% increase in price results in a 50% increase in equity, and a 10% decrease results in a 50% drop.) I set up an interactive spreadsheet to illustrate this: https://russilwvong.com/blog/proforma/
Problem is, that means that when government sets up a schedule of development charges based on land value, small changes in selling price or construction costs (e.g. labour and materials) can result in projects no longer being viable. So a government which is trying to maximize revenue by setting charges as high as possible may easily end up slowing development.
If the charge is set in relation to actual costs incurred by the public sector due to the development, it's a good outcome.
If the charge is arbitrary, or is intended to capture a share of windfall gains without reference to costs, that's a problem.
One sensible model is that of the ACT in Australia, which sets a schedule of "lease variation charges" (developer charges payable upon change of land use) calculated to capture 75% of the value of changing use. They are updated from time to time.
Thanks Tim, that's quite an interesting paper. How often is the ACT schedule updated? (In the city of Vancouver, certain areas have fixed community amenity charges, but they're only updated every four years.)
I think there's two schools of thought regarding land lift.
- Land lift is good: it provides the incentive to redevelop property and add more housing. Because land value is a residual, high land value is a signal that prices and rents are too high, strengthening the incentive to redevelop faster. Taxing away land lift reduces that incentive.
- Land lift is bad: it's a form of speculative unearned gains. It raises the cost of building new housing. [Because land value is a residual, this is getting cause and effect backwards: housing scarcity causes high property prices and therefore high land values.] It should be taxed so as to maximize the revenue, for the benefit of the whole community.
The ACT consultation paper notes certain objections and criticisms, but basically says, "We haven't seen the data."
In BC, the MacPhail Report (published in 2021) reached the opposite conclusion. It observed that incentives for local governments are backwards: because they take 70-80% of the increase in land value, they directly benefit from keeping land prices high. The report recommends finding some other way to finance local governments.
"CACs are negotiated in exchange for rezoning property to accommodate more homes. As a result, local governments that proactively increase zoned capacity or update zoning codes to better reflect anticipated growth and community priorities (as outlined in regional growth strategies and official community plans) lose that revenue opportunity. Indeed, local governments can generate CAC revenue by keeping zoning below levels that make redevelopment possible, and selling additional 'air rights' through the zoning powers they have been delegated. Consequently, the additional costs, time, and uncertainty associated with the rezoning process—including their negative impacts on housing supply—persist."
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.
Yes. Exactly. If the residual from development is below the value at current use the a site is unfeasible. Add development costs can remove some sites from this pool of feasible sites. But remember, the pool of feasible sites is large, often 100 of times larger than the rate they are taken up for development.
This article explains that what you are saying is why missing middle is so difficult
Thanks Cameron. This appears to be the dilemma we’re facing here in Hamilton. Years back when we allowed duplexes as permitted activities across the whole city, and enabled some medium density areas, we had massive uptake and had very high levels of infill/redevelopment (this reached a high of 70% compared to 30% greenfield). However, I think this was enabled by the fact there were a lot of larger sections with single dwellings on them (e.g. quarter acre sections) so it made economic sense to knock down one house and build four. Development contributions were also very low because the council did minimal investment and relied on the capacity still available in the existing waters network. Now we’ve got to a point where a) large, easy to develop sections are becoming relatively rare, and b) development is becoming incredibly constrained by the lack of infrastructure capacity - to the point we’re stopping infill/redevelopments in large areas of the city.
Our recent housing and business capacity assessment said there was plenty of zoned land, a shortage of zoned land serviced by infrastructure, but the main driver of the shortage of forecasted housing was commercial feasibility - the cost of construction for medium density housing and the lack of a ‘mature market’ for that kind of housing etc.
At the same time we’re seeing an increasing trend of medium density housing in greenfield area developments.
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.
Yes, amalgamation is an issue. Building skinny buildings seems to be a way this is solved in practice in high value locations, but obviously the returns are better for more sensibly-shaped buildings!
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.
Then how could it be that "zoning changes that grant new development rights are capitalised into higher land values"
Because the value of a property right for developable land comes from its option value. You can create new options which have large positive value without depressing the value of the "underlying" asset (dwelling prices).
I agree that the options value is the thing driving up the price. But I don't think that addresses my question.
My mental model here is that developers and landowners are in a market for developable sites. There is a supply, that depends on things like the value of existing buildings, and a demand depending on how valuable is the location to prospective new homebuyers and how difficult is it to build on the site. Developers will buy the most promising sites (low current density, high amenity area) until an equilibrium is reached. For example, currently, I value my house in the suburbs higher than a developer would be willing to pay for the land, so it won't be developed. If my house was in the central city, it probably would be worth more to a developer and be bought out and densified.
Now I think that good zoning should have little effect on this market - there would be sufficient zoned capacity in the right areas that it is unconstraining on that market. But the existence of premiums for high density zoned sites implies that it is constraining and there will end up being less development activity as a result (supply curve shifts left, price increases and quantity of new development falls).
How could this be, when there is 'enough' zoned capacity for the market demand for new housing? Because the available zoned capacity isn't in the right place within the city. In the example about my house above, increasing the allowable density has no impact on my decision to sell to a developer - it's 'capacity' according to planners, but its not actually changing the supply curve of developable sites.
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?
This section of the article addresses your question:
> 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.
So the solution here is a land value tax high enough to remove the speculative value of land so that landbanking isn't a viable alternative to productive use.
My I take this opportunity to ask about the LVT? I hear it mentioned frequently in relation to promoting housing and commercial development (though I think of it not as "promoting" as not discouraging). My question is how a LVT is different from an ordinary property tax? Is it just a property tax with a deduction for the value of the structures on the property? And why does taxing just the land rather than the total value of the property encourage (overcome the discouragement of other restrictions?) development.
I confess I do not understand how the removal of a restriction on a parcel creates an incentive not to build. Does this mean the parcel would have been built upon subject though subject to the restriction, but when the restrictions removed, the owner decides NOT to build? It's a phenomenon I've never heard commented on in the US context. I'm not denying it can happen, I know nothing about Australian real estate, just that I do not understand how the incentives work.
You’re correct in that removing the tax on improvements is more technically “not discouraging” than actively encouraging/promoting (more) improvements. And that’s precisely how it is different from an ordinary property tax. It looks like Australians often use these terms interchangeably while in the US we do not. In the US, when we talk about property tax, we are talking about improvements and land/location value together because the only state which recognizes a difference is Pennsylvania. From what my Australian friend showed me, it looks like an Australian land value tax can, in some contexts, be a tax on just land values and other times be a tax on both land values and improvements. I can imagine this makes everyday discourse on the subject unnecessarily difficult.
There are ways to frame/structure the tax so that it circumvents certain unjust restrictions on sensible taxation. One of those ways is, as you described, leaving the property tax in place and simply deducting/abating taxes on or exempting taxes on improvements.
Right now, taxing the whole property value means that if you build more, you get taxed more. The thing you can control is how much you build, so if you abstain from building, not only do you not have to put up money to build and maintain the addition, you also don't have to shoulder the additional tax. The thing you can't control is the underlying land value, which will increase or decrease based on surrounding activity and amenities. So if the tax is assessed based on land values, there's not a response from the land owner which could change their specific tax liability (other than to appeal the valuation). This is the more relatable explanation.
I'll throw in a paraphrasing of the economic explanation, just in case mirroring helps bridge any gaps. If it doesn't help, feel free to ignore it.
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While locations are immobile and can’t be hidden, improvements are mostly immobile and often difficult to hide. This makes location values the ideal tax base and improvements the next best tax base when compared to anything mobile and concealable. Further, the supply of land within any given jurisdiction is fixed, barring something drastic like annexation.
As Professor Murray points out in the article, “land, has no underlying cost of production.” By contrast, supply of improvements is elastic (at least moreso than the supply of land). When you tax something elastic, you get less of it. When you tax something inelastic, its supply doesn’t change. This has implications on the economic incidence of the tax. As the Professor wrote: “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.”
Any increases to land values becomes windfall gains to the title holders of land. In most cases, the title holders of land are the government under which a jurisdiction is governed. In some cases, it is shared between the government and those private entities and individuals to whom government extends a specific privilege. So when I "own" land in the US, I am actually sharing title with the government. When the government fails to adequately tax land values, land has a sale price. As a title holder, I get to capture these windfall gains.
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Anyway, you asked about how the removal of a restriction on a parcel creates an incentive not to build.
When government artificially restricts a parcel from certain uses, government devalues the land. When government upzones the parcel, government increases the value of the land. Even though I could possibly put the land to better use and generate more returns than if I did nothing, I've just been rewarded for doing nothing. Why would I risk anything to generate higher returns if I'm already getting higher windfall gains from doing nothing? I can just sit on it as (more) other people who (might) actually want to make use of the (now upzoned) parcel bid against each other and increase the value of the land.
This does not necessarily mean that if that parcel had not been upzoned that someone may have built on it. It's entirely possible that the owner might've insisted on not developing either way. Maybe they can afford to keep paying the low level of taxes to keep things as-is. But if the owner had been cost-conscious and felt pressure to put the parcel to good/better use (develop) under the previous zoning restrictions in order to make enough to surpass the holding costs of the property, upzoning would relieve that pressure because the rise in land value means there is more room to realize gains without the effort of developing it.
I believe in a different article, the Professor argued that when parcels are upzoned, taxes should be increased based on the highest-and-best use of that parcel. (Hopefully I'm not misquoting here.) In other words, increase the land value tax in tandem with upzoning.
Sometimes, governments can end up charging more than full land value tax. In these cases, the overage ends up acting like a tax on improvements where improvements exist and a tax on some other form of income where no improvements exist and other income exists (when payments for the overage must come from some other source).
Wow! This is such a different environment than what I'm used to thinking about: a city, totally built up with the question being can we put up a 6 story building where two houses stood.
Still, wny not upzone unimproved and tax (property and LVT being the same) it? I'm not getting the LTV v property tax as having any importance and LTV v upzoning being alternatives or having any trade off?
Yeah, totally should upzone unimproved, increase valuation, and tax it. We're not in disagreement there. The key is to do all three, not just any one or two.
LVT is not an alternative to upzoning. They need to increase in tandem.
The tax on land only (LVT) versus land and improvements (property) can be subtle but important. It takes a while to wrap one's head around, even for many economists. Hoping you'll stick around until someone explains it better than me and it clicks.
Well we agree on the taxing. My question is, are the benefits of LVT enough better than ordinary property taxation to be worth the trouble, especially since for undeveloped and they are the same thing??
I guess I can see the a shift from property to LVT giving a property owner MORE of an incentive to convert his property to a denser use, if legally possible as the shift would not increase his LVT but it would his property tax.
OTOH in a property tax regime the city shares in the increase in value when the use is creating an incentive to allow the conversion and generating revenue to use for side payments to opponens of the conversion. And might not the converted use generate demands for city services that the unconverted use did not?
The advantage of a code is to a) set a kind of standard such that, because all builders follow it, costs are reduced b) centralize inspection for flaws that any buyer would want to avoid but might not be as easily able to discover (leaky homes sounds like this case. The problem comes if code just arbitrarily requires that buyers do not necessarily want, or that b) the typical buyer would have wanted in the past but not today. The "reform" I talk about is constant revision to keep code doing the good things and avoiding the excess costs, especially that make it difficult to switch a building from one use to another as is often necessary in a dynamic real estate market.
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.
Hi Simon
Very clear take - thanks. I agree. We laid out similar arguments in a paper titled "Ownership illusions", profiled here: https://www.fresheconomicthinking.com/p/ownership-illusions-housing-policy
Those arguments, as with your comment, explain why upzoning can't make land cheaper via competition.
But that's not the policy issue. The question is how zoning relates to housing development, i.e. the rate of new supply.
Theory about investment choices based on landowners maximising the NPV of returns from their site is the key to answering this question. I mentioned that in relation to "timing choices" and the "absorption rate" in the explanation above.
By contrast, theory that assumes the inputs to housing are elastic is wrong (because land is not elastict), and theory that assumes all development has already taken place (standard urban economics) is also fairly unhelpful. That's why so many people reach such different policy conclusions - they're working with different mental models.
A mental model that recognises the fixed monopoly nature of land and the dynamic investment choice that underpins property development is the right one, in my view.
Hey Tim, yes the point I'm making is constricting supply and raising prices are two sides of the same coin. In effect I’m saying that sellers will continue to maintain prices by restricting supply, and there will not be a significant effect on the rate of construction. It could potentially even go in the other direction as the expectation of future up-zoining would encourage developers to wait.
The question becomes how do developers choose when to build? Clearly the absorption rate is an important factor. I would expect that the relative returns compared to other investments like stocks would also factor in. This is an interesting question that deserves a more detailed exploration.
Hi Simon,
In my opinion you've correctly reasoned your way to the right question: what factors determine the amount of dwelling investment that occurs? What determines the rate of new housing supply, i.e. the amount of new housing brought to market over any given time period?
The question is, equivalently, when and why do landowners choose to speculate or 'landbank' - i.e. hold a site that could be profitably redeveloped in an under-developed state?
Speculation and new supply are opposites. New supply happens when speculation ends. Understanding the drivers of that decision, and in particular whether, when and how zoning rules affect it, is an important field of inquiry.
Surprisingly these questions have not been central to economics until relatively recently. Economists traditionally cared about what determined land prices (classical economics), and what determined the broad patterns of built form within and across cities (urban economics), but not what determined the flow of new housing.
Those fields - classical and urban economics - are not directly relevant to policymakers grappling with questions about zoning. That some economists are using the tools they've been taught, rather than the right tools for the job, is the source of their frustration and the reason for disagreement about zoning within the broader economics profession (as per Cameron's post).
I don't doubt that within a few years we'll all agree that the question you've arrived at is the most relevant one for these areas of policy.
Hi Tim, I see the Christchurch reference came from your paper - do you have a source for the data used to arrive at this conclusion?
Hi Nick,
Yes it did. No, the Christchurch example was not a specific piece of analysis. Do you know of analysis that suggests otherwise?
Only that property prices are much more affordable in Christchurch and never went through the same growth in mid to late 2010s.
Rental prices also drifted back to be more attractive following an initial bump, owing to reduced dwelling supply (from red zoned properties) in conjunction with increased population of people moving to the area to help with rebuild.
Hi Nick,
I happened across a chart made by Michael Reddell that illustrates nicely the example I gave about how Christchurch's recent population growth and rental acceleration illustrated the process of spatial equilibrium.
https://twitter.com/MHReddell/status/1759403481285423251
After the supply boom in the mid-2010s led to declining/flat rents, such that Chch became quite affordable, internal migration kicked up and rents converged back to levels commensurate with Wgtn and Akl.
It's a really neat illustration of spatial equilibrium/convergence, i.e. any supply-driven affordability gains don't last long, but simply lead to a bigger city. That was the point I made in my evidence.
Best,
Tim
Thanks for clarifying Tim.
The interesting thing is the difference in house prices (and house price change) between the centres then. Perhaps illustrates that rents are more tied to tenant income while long term house prices are influenced by zoning and supply.
It would also be interesting to look at the make up of stock in each of those places (which I’ll check at some stage). I suspect in Christchurch there are far more larger houses and they’re more modern than what there would be in Wellington in particular, but to some degree Auckland. So bang for buck in Christchurch is much greater.
Wow. A very solid and clear logic there. If you don't mind, I will be borrowing that explanation!
Please do!
"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."
Sorry, I think the argument fails. The key thing about upzoning is that it reduces the cost of land per square metre of buildable floor space. Land is fixed and cannot be increased, but regulation can certainly increase the amount of floor space that can be built on the land.
In other words, it's the actions of regulators rather than suppliers that's critical to the land market.
A great illustration from Auckland: https://morehousing.ca/land-cost
Hi Russel thanks for sharing! I agree that regulators have a key role to play here. I think difference between the two ideas comes down to this: are prices driven by the costs of construction or pricing power?
To see how pricing power works in practice, developers in cities like Vancouver pre-sell most condo units. If the developer cannot find the buyers during the pre-sale, then construction will be cancelled or delayed until buyers can be found at the price the developer wants. This constraint can even be imposed on developers by lenders who require a fraction of revenue to be raised in pre-sale before providing financing for construction. In this way, sellers can slow the construction of new buildings when there is slack in demand rather than allowing the price to come down. The result of this slowed construction is … slowed construction.
In referencing your article, the cost per potential unit of housing would drop exactly as you have shown. The challenge is converting these potential units into actual units. Existing owners will delay construction and/or sales in order maintain prices regardless of changes in the total number that could theoretically be built or sold.
On the flip side, if we consider the cost of inputs as the driver of current housing prices, how do we explain the price of the biggest input - land? Why do we see empty lots and knock-downs in areas with high density that already have permissive zoning? If a new developer can buy a site, and build a building profitably, all of the existing landlords in the same zoning area have the same opportunity. The existing land owners could make a larger profit selling the same size building at lower prices because they have the same construction costs, the same zoning but paid less for the land. I'm not sure how to explain empty lots in high density areas without considering the pricing power enjoyed by sellers?
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!
In Vancouver (where Dr. Murray will be speaking), the counterargument is that municipal governments have not been leaving this money on the table. They've been extracting as much revenue as possible, using high development charges on new housing. (From 2011 to 2020, the City of Vancouver extracted $2.5 billion in "Community Amenity Charges" alone.)
Once the "land lift" (redevelopment value minus current value) is almost entirely gone, there's not much reason for landowners to sell for redevelopment. So then prices and rents have to rise further before projects will be economically viable.
In other words, higher development charges are first paid by landowners, but once the land lift is gone (too many bites of the apple), they're paid by homebuyers and renters.
A couple graphical illustrations, based on analysis by Coriolis: https://morehousing.ca/cost-bottleneck
> once the land lift is gone, they're paid by homebuyers and renters
This is true. Governments are absolutely capable of charging more than 100% LVT at the peril of the community.
My understanding is that land value is a "residual": the price that a project is willing to pay for land is the expected selling price of the new building, minus all the costs of building it.
That means that it's volatile: a small change in selling prices or in construction costs results in a much larger change to land value. (Like the way you get large changes in home equity from small changes in price - with an 80% mortgage, a 10% increase in price results in a 50% increase in equity, and a 10% decrease results in a 50% drop.) I set up an interactive spreadsheet to illustrate this: https://russilwvong.com/blog/proforma/
Problem is, that means that when government sets up a schedule of development charges based on land value, small changes in selling price or construction costs (e.g. labour and materials) can result in projects no longer being viable. So a government which is trying to maximize revenue by setting charges as high as possible may easily end up slowing development.
Nice comments, Russil.
I agree in principle this could happen.
If the charge is set in relation to actual costs incurred by the public sector due to the development, it's a good outcome.
If the charge is arbitrary, or is intended to capture a share of windfall gains without reference to costs, that's a problem.
One sensible model is that of the ACT in Australia, which sets a schedule of "lease variation charges" (developer charges payable upon change of land use) calculated to capture 75% of the value of changing use. They are updated from time to time.
Info for your interest here:
https://hdp-au-prod-app-act-yoursay-files.s3.ap-southeast-2.amazonaws.com/6215/3688/6997/Lease_Variation_Charge_consultation_paper_PDF.pdf
Thanks Tim, that's quite an interesting paper. How often is the ACT schedule updated? (In the city of Vancouver, certain areas have fixed community amenity charges, but they're only updated every four years.)
I think there's two schools of thought regarding land lift.
- Land lift is good: it provides the incentive to redevelop property and add more housing. Because land value is a residual, high land value is a signal that prices and rents are too high, strengthening the incentive to redevelop faster. Taxing away land lift reduces that incentive.
- Land lift is bad: it's a form of speculative unearned gains. It raises the cost of building new housing. [Because land value is a residual, this is getting cause and effect backwards: housing scarcity causes high property prices and therefore high land values.] It should be taxed so as to maximize the revenue, for the benefit of the whole community.
The ACT consultation paper notes certain objections and criticisms, but basically says, "We haven't seen the data."
In BC, the MacPhail Report (published in 2021) reached the opposite conclusion. It observed that incentives for local governments are backwards: because they take 70-80% of the increase in land value, they directly benefit from keeping land prices high. The report recommends finding some other way to finance local governments.
"CACs are negotiated in exchange for rezoning property to accommodate more homes. As a result, local governments that proactively increase zoned capacity or update zoning codes to better reflect anticipated growth and community priorities (as outlined in regional growth strategies and official community plans) lose that revenue opportunity. Indeed, local governments can generate CAC revenue by keeping zoning below levels that make redevelopment possible, and selling additional 'air rights' through the zoning powers they have been delegated. Consequently, the additional costs, time, and uncertainty associated with the rezoning process—including their negative impacts on housing supply—persist."
https://morehousing.ca/macphail-report
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.
Yes. Exactly. If the residual from development is below the value at current use the a site is unfeasible. Add development costs can remove some sites from this pool of feasible sites. But remember, the pool of feasible sites is large, often 100 of times larger than the rate they are taken up for development.
This article explains that what you are saying is why missing middle is so difficult
https://www.fresheconomicthinking.com/p/missing-middle-housing-blame-economics.html
Thanks Cameron. This appears to be the dilemma we’re facing here in Hamilton. Years back when we allowed duplexes as permitted activities across the whole city, and enabled some medium density areas, we had massive uptake and had very high levels of infill/redevelopment (this reached a high of 70% compared to 30% greenfield). However, I think this was enabled by the fact there were a lot of larger sections with single dwellings on them (e.g. quarter acre sections) so it made economic sense to knock down one house and build four. Development contributions were also very low because the council did minimal investment and relied on the capacity still available in the existing waters network. Now we’ve got to a point where a) large, easy to develop sections are becoming relatively rare, and b) development is becoming incredibly constrained by the lack of infrastructure capacity - to the point we’re stopping infill/redevelopments in large areas of the city.
Our recent housing and business capacity assessment said there was plenty of zoned land, a shortage of zoned land serviced by infrastructure, but the main driver of the shortage of forecasted housing was commercial feasibility - the cost of construction for medium density housing and the lack of a ‘mature market’ for that kind of housing etc.
At the same time we’re seeing an increasing trend of medium density housing in greenfield area developments.
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.
Thanks for the kind words.
Yes, amalgamation is an issue. Building skinny buildings seems to be a way this is solved in practice in high value locations, but obviously the returns are better for more sensibly-shaped buildings!
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.
You ask:
Then how could it be that "zoning changes that grant new development rights are capitalised into higher land values"
Because the value of a property right for developable land comes from its option value. You can create new options which have large positive value without depressing the value of the "underlying" asset (dwelling prices).
I agree that the options value is the thing driving up the price. But I don't think that addresses my question.
My mental model here is that developers and landowners are in a market for developable sites. There is a supply, that depends on things like the value of existing buildings, and a demand depending on how valuable is the location to prospective new homebuyers and how difficult is it to build on the site. Developers will buy the most promising sites (low current density, high amenity area) until an equilibrium is reached. For example, currently, I value my house in the suburbs higher than a developer would be willing to pay for the land, so it won't be developed. If my house was in the central city, it probably would be worth more to a developer and be bought out and densified.
Now I think that good zoning should have little effect on this market - there would be sufficient zoned capacity in the right areas that it is unconstraining on that market. But the existence of premiums for high density zoned sites implies that it is constraining and there will end up being less development activity as a result (supply curve shifts left, price increases and quantity of new development falls).
How could this be, when there is 'enough' zoned capacity for the market demand for new housing? Because the available zoned capacity isn't in the right place within the city. In the example about my house above, increasing the allowable density has no impact on my decision to sell to a developer - it's 'capacity' according to planners, but its not actually changing the supply curve of developable sites.
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?
@tim helm I see this came from your paper, do you have a reference to the data used for this conclusion?
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?
This section of the article addresses your question:
> 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.
So the solution here is a land value tax high enough to remove the speculative value of land so that landbanking isn't a viable alternative to productive use.
My I take this opportunity to ask about the LVT? I hear it mentioned frequently in relation to promoting housing and commercial development (though I think of it not as "promoting" as not discouraging). My question is how a LVT is different from an ordinary property tax? Is it just a property tax with a deduction for the value of the structures on the property? And why does taxing just the land rather than the total value of the property encourage (overcome the discouragement of other restrictions?) development.
I confess I do not understand how the removal of a restriction on a parcel creates an incentive not to build. Does this mean the parcel would have been built upon subject though subject to the restriction, but when the restrictions removed, the owner decides NOT to build? It's a phenomenon I've never heard commented on in the US context. I'm not denying it can happen, I know nothing about Australian real estate, just that I do not understand how the incentives work.
Thanks for elucidation on either point. :)
Glad you asked!
You’re correct in that removing the tax on improvements is more technically “not discouraging” than actively encouraging/promoting (more) improvements. And that’s precisely how it is different from an ordinary property tax. It looks like Australians often use these terms interchangeably while in the US we do not. In the US, when we talk about property tax, we are talking about improvements and land/location value together because the only state which recognizes a difference is Pennsylvania. From what my Australian friend showed me, it looks like an Australian land value tax can, in some contexts, be a tax on just land values and other times be a tax on both land values and improvements. I can imagine this makes everyday discourse on the subject unnecessarily difficult.
There are ways to frame/structure the tax so that it circumvents certain unjust restrictions on sensible taxation. One of those ways is, as you described, leaving the property tax in place and simply deducting/abating taxes on or exempting taxes on improvements.
Right now, taxing the whole property value means that if you build more, you get taxed more. The thing you can control is how much you build, so if you abstain from building, not only do you not have to put up money to build and maintain the addition, you also don't have to shoulder the additional tax. The thing you can't control is the underlying land value, which will increase or decrease based on surrounding activity and amenities. So if the tax is assessed based on land values, there's not a response from the land owner which could change their specific tax liability (other than to appeal the valuation). This is the more relatable explanation.
I'll throw in a paraphrasing of the economic explanation, just in case mirroring helps bridge any gaps. If it doesn't help, feel free to ignore it.
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While locations are immobile and can’t be hidden, improvements are mostly immobile and often difficult to hide. This makes location values the ideal tax base and improvements the next best tax base when compared to anything mobile and concealable. Further, the supply of land within any given jurisdiction is fixed, barring something drastic like annexation.
As Professor Murray points out in the article, “land, has no underlying cost of production.” By contrast, supply of improvements is elastic (at least moreso than the supply of land). When you tax something elastic, you get less of it. When you tax something inelastic, its supply doesn’t change. This has implications on the economic incidence of the tax. As the Professor wrote: “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.”
Any increases to land values becomes windfall gains to the title holders of land. In most cases, the title holders of land are the government under which a jurisdiction is governed. In some cases, it is shared between the government and those private entities and individuals to whom government extends a specific privilege. So when I "own" land in the US, I am actually sharing title with the government. When the government fails to adequately tax land values, land has a sale price. As a title holder, I get to capture these windfall gains.
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Anyway, you asked about how the removal of a restriction on a parcel creates an incentive not to build.
When government artificially restricts a parcel from certain uses, government devalues the land. When government upzones the parcel, government increases the value of the land. Even though I could possibly put the land to better use and generate more returns than if I did nothing, I've just been rewarded for doing nothing. Why would I risk anything to generate higher returns if I'm already getting higher windfall gains from doing nothing? I can just sit on it as (more) other people who (might) actually want to make use of the (now upzoned) parcel bid against each other and increase the value of the land.
This does not necessarily mean that if that parcel had not been upzoned that someone may have built on it. It's entirely possible that the owner might've insisted on not developing either way. Maybe they can afford to keep paying the low level of taxes to keep things as-is. But if the owner had been cost-conscious and felt pressure to put the parcel to good/better use (develop) under the previous zoning restrictions in order to make enough to surpass the holding costs of the property, upzoning would relieve that pressure because the rise in land value means there is more room to realize gains without the effort of developing it.
I believe in a different article, the Professor argued that when parcels are upzoned, taxes should be increased based on the highest-and-best use of that parcel. (Hopefully I'm not misquoting here.) In other words, increase the land value tax in tandem with upzoning.
Sometimes, governments can end up charging more than full land value tax. In these cases, the overage ends up acting like a tax on improvements where improvements exist and a tax on some other form of income where no improvements exist and other income exists (when payments for the overage must come from some other source).
Hopefully this is a good start.
Wow! This is such a different environment than what I'm used to thinking about: a city, totally built up with the question being can we put up a 6 story building where two houses stood.
Still, wny not upzone unimproved and tax (property and LVT being the same) it? I'm not getting the LTV v property tax as having any importance and LTV v upzoning being alternatives or having any trade off?
Yeah, totally should upzone unimproved, increase valuation, and tax it. We're not in disagreement there. The key is to do all three, not just any one or two.
LVT is not an alternative to upzoning. They need to increase in tandem.
The tax on land only (LVT) versus land and improvements (property) can be subtle but important. It takes a while to wrap one's head around, even for many economists. Hoping you'll stick around until someone explains it better than me and it clicks.
Well we agree on the taxing. My question is, are the benefits of LVT enough better than ordinary property taxation to be worth the trouble, especially since for undeveloped and they are the same thing??
I guess I can see the a shift from property to LVT giving a property owner MORE of an incentive to convert his property to a denser use, if legally possible as the shift would not increase his LVT but it would his property tax.
OTOH in a property tax regime the city shares in the increase in value when the use is creating an incentive to allow the conversion and generating revenue to use for side payments to opponens of the conversion. And might not the converted use generate demands for city services that the unconverted use did not?
Interesting discussion
In terms of deregulating the building code isn't leaky homes the example of the massive cost of slack regulation?
Possibly, I am not familiar with the situation.
The advantage of a code is to a) set a kind of standard such that, because all builders follow it, costs are reduced b) centralize inspection for flaws that any buyer would want to avoid but might not be as easily able to discover (leaky homes sounds like this case. The problem comes if code just arbitrarily requires that buyers do not necessarily want, or that b) the typical buyer would have wanted in the past but not today. The "reform" I talk about is constant revision to keep code doing the good things and avoiding the excess costs, especially that make it difficult to switch a building from one use to another as is often necessary in a dynamic real estate market.