Planning deregulation, especially rezoning, has been repeatedly touted as a key policy solution to Australia’s eye watering house prices.
The story goes that prices remain high because the supply of new dwellings in accessible, desirable locations has not kept pace with demand due to zoning restrictions. Rezoning for higher uses will increase supply and make housing more affordable.
Prosper Australia has repeatedly critiqued this reasoning, leading to some bewilderment among fellow economists.
Our recent discussion paper Planning deregulation, Housing Supply and Affordability: What if land markets are monopolies? is intended to clarify and communicate our current thinking.
Two conceptual models of land rent
We contend that there are two conceptual models of land rent active within the planning deregulation-housing supply debate. We refer to these as the quota model and the monopoly model.
Quota
In the quota model, the way that planning constrains the supply of housing is conceived as a quota of development opportunities, like taxi licences prior to deregulation. Rezoned sites are valuable because development permissions are scarce, leading to a market failure in which development regulation itself is generating rents.
This model argues that increasing the supply of development permissions would devalue them, eventually leading to development rights having no value. It would be the policy equivalent of abolishing taxi licences.
The implication is if we rezoned just enough land, it would reduce the price/value of all existing zoned land and make housing more affordable. More dwellings would also be completed each period than otherwise, leading to further reductions in prices.
The quota model says, for example, that rezoning Fishermans Bend made existing Melbourne Capital City Zoned CBD land less valuable, because it increased the supply of that type of land.
The monopoly model contends that development rights are a monopoly right bundled into the land. Conferring the right to build at higher densities is effectively the same as privatising the vertical airspace above the land itself and no different to transferring public land into private use – or horizontally subdividing public land and gifting part of the subdivision to a private landowner.
Granting these rights provides an option, but not an obligation, to construct additional housing at some point in the future. This option has value due to uncertainty, as it is irreversible once used.
Monopoly
The monopoly model does not assume free entry into the property market, or a supply curve determined by input costs (which are zero). In order to become a competitor, you must first buy property from an existing landholder in the property market. Supply is not independent of demand, meaning landholders can observe their own-supply effect on prices. Instead supply is a reflection of demand i.e. demand determined.
In this formulation, land derives value from what exists around it and the subsequent highest and best use to which that land can be put (its demand).
For example, rezoning Fishermans Bend added many more development permissions for higher density, but this would not decrease the value of land in the adjacent Melbourne Capital City area with the same development permissions. However, if Fishermans Bend was suddenly developed overnight, the added dwelling supply would place downward pressure on rents (and thus feed into lower prices) of the Melbourne Capital City area.
The value of existing dwellings might decline, with the lower prices reflecting an increased risk to profits due to this uncertainty, and the potential for more dwellings and lower rents in future. However rental prices would not be affected unless dwellings are built and are put on the rental market. Lower rents would feed further into lower property values.
As in the quota model, if the government owned enough public land it could flood the market in a one off auction and drive the price of land to $0. The same applies to the market for development rights (by mass rezonings).
However, unlike the quota model, this would not remain the market outcome. Once land (or the development right) is obtained by private owners, the market value reverts to highest and best use – due to the nature of the market being one trading monopoly rights to location.
The implication is that rezonings can allow more dwellings to be built, but are not necessarily the main policy barrier to increasing the number of aggregate dwelling completions. Nor would rezoning necessarily address high aggregate property prices. Rezonings (on any scale) would not devalue existing land values. Development must occur before existing values are affected.
Open City, Closed City
Whether the city is conceived as open or closed helps us to see that quota model and monopoly focus on different effects of planning regulations.
Resource Justice economist, Steve Hoskins, proposes three different categories of land value impacts from planning regulation:
- Amenity effects: planning regulations around amenity add value.
- Scarcity effects: planning regulations impact values on the whole market due to restricting land supply and development rights.
- Profit effects: planning regulations impact the value of individual sites due to altering the legal highest and best use.
The quota model focuses on scarcity effects, and impacts are largely viewed as closer to a closed city model. Whereas the monopoly model focuses on profit effects, and impacts are largely viewed as closer to an open city model.
In an open city, the pool of prospective residents is virtually infinite because people relocate to cities with high amenity (in this case, relatively inexpensive housing). As planning restrictions are eased, housing becomes more affordable, attracting more residents: an induced demand effect.
In a closed city, the resident population is fixed. Thus planning regulations have substantial impacts and no induced demand effects.
How “open” a city is also changes what impact these different planning regulation effects have on land rents.
In the real world?
In general, these models for how planning and property markets function aren’t well supported by empirical evidence. This is totally understandable. Testing the hypothesis would require massive, experimental rezonings in a brave real world city. Luckily, we have one of those across the Tasman.
The most recent and highest evidence comes via quality case studies of the Auckland Unitary Plan (AUP) which became operational in 2016. The AUP entailed a massive city wide upzoning of about 77.6% of the city’s urban area to four zones.
Research by Ryan Greenaway-McGrevy & Peter Phillips at the University of Auckland, found a significant increase in dwelling approvals in upzoned areas compared to non-upzoned, with the gap estimated to be equivalent to an additional 5% of the dwelling stock over the five years since the plan change. They found an especially large increase in townhouses and mixed-use developments, which now make up half of dwelling approvals, compared to less than 10% a decade prior.
In Auckland, relaxation of planning regulations coincided with reduced aggregate property price growth over a 4-year timeframe. However, it is difficult to know to what extent this was due to the AUP and not to an internal market correction that would’ve taken place regardless, especially when rents continued to rise, albeit at a slightly slower rate.
Unresolved issues and points of contention
What is the effect of upzoning on dwelling completions?
If a million properties are rezoned but dwelling completions remain unaffected, did the rezoning make any difference to supply aggregates and thus affordability?
Dwelling completions are influenced by market conditions, holding costs, and future expectations, material availability etc – all of which can be affected by policies other than planning deregulation.
If there is sufficient zoned capacity to enable dwelling supply to keep up with population growth in the aggregate, then it is inaccurate to say there is not enough building due to zoning; zoning is not a bind on the rate of dwelling completions.
This is not to say zoning cannot be a barrier to localised dwelling completions in infill suburbs. We accept that zoning may constrain development in areas where social, environmental or economic factors warrant such constraint.
Hypothetically, if some planning restrictions were removed in Carlton North – a high amenity, inner city suburb of Melbourne – we’d expect bigger apartment buildings to go up. These additional apartments should result in (transient) localised rent and price decreases.
However, if all the residents who can now move into Carlton North would have otherwise bought new greenfields housing, then the inner-city infill has simply displaced greenfield development, and the wider market impacts become ambiguous.
This is further complicated by how “open” a city is when it comes to considering housing demand. Perhaps the new supply at Carlton North simply attracts more residents from interstate, meaning the price impacts of planning deregulation in Melbourne may show up in Sydney.
Zoning is intended to direct urban growth in a coordinated way. This is why Prosper advocates for an accurate measurement of “zoned capacity” (how many dwellings could be legally built under today’s zoning).
A reliable, consistent measure of zoned capacity would help us answer the question: does zoning constrain dwelling completions? If so, where, and is that a problem for the wider market in aggregate?
Do restrictions on infill cause high aggregate house prices?
Whether there are enough houses for people to live in is best measured by rental costs not housing prices. Trend data suggests that in most Australian cities over recent decades rental prices have largely tracked incomes. If this is the case, then aggregate housing supply is not really the issue.
This is not to say there are no localised barriers to development in premium locations (which could be addressed by upzoning). However, the media headlines about housing affordability are more often about high median house prices, and the entry prices faced by first home buyers.
If high dwelling prices in aggregate are considered the problem while rents in aggregate are stable, then we need to focus our attention on policies that make land a less attractive asset class and reduce “overinvestment” in housing.
Alternative or non-market tenure models such as Community Land Trusts, Land Rent Schemes, Share-Equity, as well as government taxation of land rent (through broad based land taxes) reduce the share of land equity buyers are required to purchase. This in turn reduces the size of home loans and associated deposits which has become the biggest barrier to owner-occupation among first home buyers
The very act of framing land and housing as a private investment vehicle to build household wealth undermines its function as a consumption good, and upzoning private land does not address this fundamental problem.
How does upzoning affect land value in aggregate?
We are not aware of any empirical evidence that conclusively finds that upzoning reduces the average land price across an entire urban area as predicted by the quota model.
Under the monopoly model, it is not possible to prevent windfall gains by increasing the amount of rezonings, or flooding the market all at once with infinite development rights – this merely defers when the gains accrue.
It is true that builders and developers (who don’t own development sites) would benefit from rezonings that increase the potential pool of available development sites. However, greater site availability does not equate to lower land values, reduced land acquisition costs or lower house prices. It grows the size of development opportunities and the market. Unless upzoning translates into additional dwellings it will not reduce rents and prices for homebuyers.
Conclusion
The conceptual models that economists use to explain the interaction of land use regulations on aggregate dwelling completion are incomplete and contested.
Emerging models that account for the dynamic, open nature of cities and land market competitiveness are moving towards coherence.
There is a significant gap in empirical data on zoned capacity and how this interacts with dwelling completions. The findings of future empirical studies will have crucial implications for planning regulations and land taxation policy. New Zealand’s current push for nationwide land-use intensification is an important opportunity in this context.
Prosper continues to advocate for a fair share of rezoning uplift, either via auction or taxation. Not only can this revenue fund the necessary infrastructure required to accommodate development, but reduces the rewards of rent seeking.
