The new coalition government has made a start on addressing  the housing crisis with the just-announced independent housing review. But Jenny McArthur warns that Labour’s proposed KiwiBuild policy could risk adopting solutions that actually fuel the problems they claim to solve, reinforcing inequality for decades to come.

After years of futile policy interventions, it’s time to stop buying into accepted economic wisdom and supply-side solutions – the metaphorical Kool-Aid in our housing policy – and face up to the reality of our housing and debt markets.

New Zealand’s crisis is framed as a chronic shortage of homes: a problem that you can build your way out of by expanding land and housing supply, and relaxing planning regulations. This view treats housing markets as a simple equation of ‘supply and demand’ with frequent reference to Economics 101. What the experts have overlooked from Economics 101 is that bit you learn before supply and demand: the assumption that we operate in perfectly competitive markets with no access to debt, perfect foresight into the future, and no monopolistic behaviour.

The housing market fails when referenced against most of these assumptions and behaves much differently to the idealised competitive markets. Changes in the housing market are treated like natural phenomena, shaped by the market’s invisible hand when the reality is that human beings make markets. Prices reflect our own irrational and speculative decisions to buy, sell, and borrow.

This way of thinking about the housing market and the economic models that support it makes two fatal assumptions. First, that we pay for houses out of our income instead of mortgage debt. Second, that houses are only ever bought to provide shelter, not as a financial investment.

The critical oversight is that demand for housing doesn’t just come from people needing a place to live – it’s the primary form of financial investment in New Zealand. You don’t have to spend long in Auckland to notice that buying, selling and doing up houses is almost a national obsession. Assuming that demand comes only from population growth dramatically underestimates the impact of investment demand. Fuelled by the expectation of continued price growth and access to cheap debt, this type of demand is incredibly responsive. We’re all interested in becoming property investors when the news headlines trumpet double-digit annual price increases, rankings of the hottest suburbs, and banks obliging with the debt to make it possible.

New Zealand’s debt – a growing share of it due to household mortgages – is the $530b elephant in the room. We simply couldn’t have seen the excessive prices rises over recent years without a permissive debt market that allows households to take on mortgages up to twelve times their income. Following the global financial crisis, interest rates have been at record lows, meaning that debt is cheap and abundant. The chart below shows a concerning trend in New Zealand after 2010: relative to incomes, debt is getting higher and higher, but with interest rates so low, the actual cost of servicing the debt continues to fall.

With this combination (cheap debt, affordable servicing costs and growing property values), investors are willing to pay ever-higher prices to get into the market. As long as mortgage lending continues to outpace expansion of housing supply, prices will continue to rise. Boosting housing supply relies on construction sector capacity and eliminating incentives for land banking, which are both difficult to shift. Meanwhile, mortgage lending has only slowed due to successive restrictions put in place by the Reserve Bank. So far, these have been too few and too weak to prevent the average house price from doubling over an eight-year period.

The growing mountain of debt propping up New Zealand property values

This has led us to the point where homeownership is near impossible without an inheritance or substantial parental support, and a disturbing acceptance that having some of the most unaffordable housing in the world is both inevitable and unavoidable. While a handful of media articles have suggested that the stratospheric levels of debt and prolonged period of low-interest rates have artificially boosted purchasing power, this hasn’t stood up against the prevailing argument for supply-side solutions. The surge in New Zealand’s housing market has been incredibly profitable for the banking, real estate and construction sector, whose actions have been rational and legal but completely at odds with the public good.

Homeownership isn’t always necessary for secure housing, however, the bubble in the market means that housing is increasingly concentrated into the hands of the wealthy, which drives up inequality. The chart below shows just how much of the mortgage debt issued in New Zealand is lent to high earners over recent years – many of whom are borrowing more than five times their annual income.

Who is borrowing all that money?

KiwiBuild, intentionally or not, plays right into the trap of boosting housing supply in the hope of improving affordability. By guaranteeing to buy 100,000 homes from private developers over the next decade with the intention of on-selling to first home buyers at prices that are still unaffordable for most, Kiwibuild effectively sets a price floor in the housing market that may shut out a large share of the population for good.

KiwiBuild’s affordability criteria is much lower than the average price in Auckland, but affordable is not a relative term. If a price is beyond your means – whether it’s the current median of $1 million or the KiwiBuild affordable price of $500,000 – it makes no difference since you can’t afford it either way.

It’s argued that higher-density housing is affordable through more efficient land use. This approach works to an extent, however, when land values in cities like Auckland are hugely overpriced. There is no guarantee that ‘building up’ is enough to reduce prices to a genuinely affordable level. The possibility of debt-to-income ratios and changes in the interest rate will determine affordability, but the ratio of house price to income is a general guide: the graph below shows that for the KiwiBuild thresholds – $600,000 in Auckland and $300,000 for the rest of the country are out of reach for many median income households, let alone those on lower incomes.

Is KiwiBuild really affordable?

Private property developers will be relieved if the government intervenes to de-risk their investments at a point when the Auckland market is just beginning to drop, but this won’t result in more homes that are genuinely affordable. Auckland’s population is growing fast, and the housing stock must grow to accommodate this. It’s naive to think that boosting the supply alone will have any effect when demand expands so rapidly as investors seek to buy or at least get on the property ladder.

The Reserve Bank has taken measures to limit household debt, cooling this demand moderately. However, the combination of excessive price growth and no tax on capital gains have given wealthy buyers preferential access to debt and therefore the housing market, taking a generous share of the $330 billion gain in New Zealand’s housing and land market since 2008.

While a large amount of buying, selling and borrowing has been going on in the housing market, the more urgent crisis is the growing number of people who don’t have adequate housing at all, let alone ownership. This crisis relates to both housing and incomes: under-provision for low-income groups in the social rented sector, and wages that aren’t high enough for working people to meet their basic needs.

The chart below shows the growth in populations who are ‘severely housing deprived’. Not just homeless, but also those living in overcrowded dwellings, or constantly shifting between temporary accommodation. While solving homelessness is more complex than just building more housing, access to affordable accommodation is an important component. This is not just an issue for larger cities: smaller centres in Northland and Gisborne have troubling levels of housing deprivation as well.

The real housing crisis

The provision of social housing is a political decision, depending on the government and public’s willingness to provide a safety net for everyone to have adequate shelter. This is up to the government, but it must be made clear that subsidies to help middle-class buyers to get onto the property ladder have little ‘trickle-down’ effect on people living out of their cars. Labour’s planned rental reforms and investment in social housing are long overdue and will address the more urgent needs, increasing the social housing stock and improving housing quality.

For homeownership, the current predicament is politically difficult. The new government is caught between homeowners who don’t want to see their property values drop, and everyone else for whom buying a house is near impossible. Most New Zealanders can’t count on an inheritance or wealthy parents to help them into the property market. The concept of the ‘Bank of Mum and Dad’ is just a polite way of saying that you’ve regressed to Edwardian times, where financial security is a circumstance you are born into.

There’s no silver bullet solution, but the government has some options. First, rein in the financial payoff from speculative investment. The current plan targets foreign investors, but is this investment behaviour any less harmful when it involves New Zealand residents?

Second, introduce affordability criteria that mean something. A price to income ratio of 3-5 is viewed as reasonable, and policy should carefully consider which income brackets are included. In its current form, KiwiBuild’s approach is the real estate equivalent of ‘let them eat cake’ – safeguarding developer risk to get housing we can’t afford.

Lastly, Urban Development Authorities can expand their scope: if the profitability of housing in New Zealand drops, the government may need to provide housing for more than just the social rented sector. If this means that housing is actually affordable, we may be more willing for the government to provide what was previously dominated by the private sector. Development agencies can focus on timely delivery of housing for urban growth, co-ordinated with transport upgrades and ensuring that the right kinds of housing is provided.

Getting out of the current predicament will be challenging – but both the government and the public would be foolish to accept that chronically unaffordable housing has to be the new norm.