Bubble, Bubble, Boil and Auckland Housing Trouble.

Treating the Auckland housing bubble as a supply-side problem doesn’t work; neither does blaming some group without a careful analysis of what is happening. What might work?

There are two separate Auckland housing issues which are only loosely linked. The first, dealt with here briefly, is providing sufficient housing in the region. Beset by long term population pressures, the awkward geography of the isthmus means that an increasing number of dwellings may have to go up, rather than out and that the opportunities to fulfil New Zealand’s dream of a quarter acre (increasingly less) section are diminishing in Auckland. (The European practice of an apartment in town and a bach/dacha/retreat/weekend cottage in the country may become more common among those on middle incomes.) This is a long-term supply-side problem.

The second issue is the more immediate issue of the rising price of Auckland houses. The stock of housing hardly changes in the short run so supply measures have little effect. The rise in price must be mainly from the demand-side. One factor may be migration to Auckland. But this cannot explain all the inflation.

Moreover, house prices have risen to the point where, apparently, it is no longer economic to service the debt on an investment from the rents which the tenants pay. This suggests that Auckland has a housing bubble in which purchasers, especially investors, expect handsome returns from the (untaxed) capital gains caused by rising house prices.

Saying a financial market is a ‘bubble’ can be contentious within the economics profession. There are those who say that bubbles cannot happen because that implies investors are irrational; the more cautious may say bubbles can happen but they cannot be identified until they pop and there is little that can be done before that. Others – among whom I am one – say that sometimes investment returns can get so skewed that you can identify a speculative bubble before it pops. We would probably all agree that the Auckland housing market is now a bubble.

A lot of the last few paragraphs has been analytic conjecture; plausible yes, but hardly definite. In any case we need to be clearer about what is happening. There are a lot of anecdotes. A persistent one is of Asians (or Chinese – New Zealanders are not always good at differentiating between them) being successful at house auctions. The anecdote goes on to say that such purchasers are not really buying for family needs but for investment-speculative purposes. (Their tenants may well be grateful though – unless they have been trying to buy a house.) On the other hand, there is the claim that Asians make up only a very small proportion of purchasers (although only a little extra demand can stimulate a bubble process).

From that perspective the recent data showing that 40 percent of the purchasers of one real estate agency had Chinese surnames may be helpful. There are numerous caveats; for instance, the anonymous agency may have cornered the market of Asians purchasing houses.

(I do not think this fact is ‘racist’. That arises from how one responds to it. When I first studied poverty in New Zealand – some forty years ago – I was able to show that Maori were more likely to be poor than non-Maori, and I brought together other features of their lives, such as poor outcomes in education, health, housing and unemployment which seemed associated. I was trying to use the Maori data base to help understand poverty more generally; As far as I know, nobody said I was racist..I am doing the same here.)

Insofar as this data sheds any light on what is happening in the Auckland market, it seems to support the anecdotal evidence that there is a strong demand from Asian purchasers. Moreover it suggests that much of the demand is coming from offshore although some may be from immigrants (since Asians arrivals into Auckland are greater than their proportions of residents). Of course, the offshore investors need not all be Asians. But there are similar bubbles in Sydney and Vancouver while Chinese living in China are being told that New Zealand housing is cheap and a good investment. If they are allowed to invest in New Zealand housing, why not?

Supposing this offshore investor scenario is true. Financial crises are caused by leveraged borrowing. We do not know to what extent that their New Zealand equity is borrowed from offshore (in renminbi, say) and vulnerable to a financial downturn in China – or wherever. For a major issue of public policy, it is surprising how little we know about the Auckland housing market – the government should have got onto finding out, years ago.

If Asians, or whomever, think New Zealand property prices are low it is possible we are getting a price adjustment which is equilibriating offshore and Auckland housing prices. I wont go into an analysis – ask your favourite economist – because it does not explain why housing prices have risen to the point that there is no return to being a landlord. No, I am persuaded there is a housing price bubble where expectations of future capital gains are driving up housing prices.

What can be done? The government’s policy of tackling the supply-side muddles up the long-term challenge with the short-term demand-side problem. It wont have much impact on the bubble.

The Reserve Bank has used its statutory powers to reduce the exposure of New Zealand banks to the popping of the bubble (but it cannot do anything about financing coming from offshore).

The government is to impose a property speculation tax when the house is turned over within two years. (Own homes are exempt; I would not exempt the ‘residential’ houses of ‘non-doms’ – those who are not domiciled here for full taxation purposes.) I have sympathy with the Treasury recommendation of five rather than two years.

I am not persuaded that the Australian restriction of offshore purchases only to newly built houses will be particularly effective; it is reactive populism without careful thought. But it is interesting that Australians are able to make this distinction because international obligations can prohibit discriminating between nationals and non-nationals for tax purposes.

I remain of the view that a comprehensive capital gains tax would be an important step to reducing speculative bubbles, although it should not be imposed on the homes taxpayers are living in. I would not confine it to housing either: land generally and the sharemarket should be included.

As its grudging property speculation tax shows, the government is reluctant to think about tackling the demand-side, instead offering ineffective long-term supply-side nostrums to tackle the short-term problem. So here is a compromise.

Why not apply capital gains taxes to all non-doms (including offshore Asian investors) who have to pay taxes on their New Zealand income but not on offshore income? No, it would not be a tax on non-nationals. There are non-nationals living here who are not non-doms, while not all non-doms are non-nationals;  there are New Zealanders who arrange their tax affairs so they are not domiciled here for tax purposes. The effect would be to reduce the number of players speculating in New Zealand markets, taking the heat off bubbles without entirely preventing them. Those who live here would still be able to participate in the tax avoidance, but that cannot be helped until we are willing to treat all income on the same basis irrespective of how it is generated. My preference remains for a comprehensive capital gains tax.