Position, Position, Position

House prices.gif

This chart is quite revealing. Troppo readers either gloating over their high house prices, or groaning in anticipation of trying to ever buy one, are wondering what’s driven house prices up. In the last few years an international deregulationist movement based around the website demographia has been promoting the idea that ‘smart growth’ ideas for cities have been driving house prices up. This is the policy of resisting ‘urban sprawl’ by constraining the amount of land on the periphery of cities available for housing and encouraging ‘densification’ closer in.

I think the evidence for this view is pretty strong. The most persuasive evidence it seems to me is the comparison between American cities that ration access to land on the periphery and generally impose stronger restrictions on land development – LA, New York, Boston – compared with the ‘unzoned’ cities like Houston. Houston has about the same population as Sydney and the same average nominal income at around $50,000 (US in Houston’s case and $A in the case of Sydney). Yet (again measured in their respective currencies) Houston’s house prices are around 250K and Sydney’s are more than double that. Sydney has a water frontage ‘distorting’ its shape from a rough cicle, but it seems way to much to account for the difference.

Anyway, based on these ideas I had a go at these issues here. Still it’s been nagging at me. I know that land substitutes for other land all the way from the periphery to the centre. But surely – I think to myself, much cheaper prices on the periphery won’t reduce prices in the centre all that much.

Now Rory Robertson of Macquarie Bank has done a little research resulting the graph above. It looks like a fairly hefty blow to the Demographia view of the world. It shows that the lion’s share of the house price growth has occurred not as (I think) the Demographia view of the world requires it, more or less across the board as rising prices on the periphery arising from land starvation drive up prices everywhere. Rather the growth is, as in the hopeful breast of the property investor, driven by the growing attractiveness of land in the centre.

Where this valuation comes from is an interesting question in itself. As cities get larger the relative benefits from being closer rise presumably with rising congestion. Then again there’s also a movement to ‘edge cities’ connected by freeways. But another theme in all this it seems to me is the increasing proportion of our wealth devoted to positional goods. The appropriate policy response is probably a tax on positional goods (because one person’s good position is another person’s worse position – negative externalities should be taxed).

The other thing that is emerging is that there is more speculative excess in the areas that have gone up, so some of the effect may be emphemeral. But I expect a fair bit is not.

I also think it might be time to go invest in Sydney real estate again. I’m thinking about buying into some development which is having difficulty getting buyers off the plan but which will complete in a year or more (when rates should be falling and Sydney’s excess demand for rental housing makes itself felt again. Any ideas?

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David Rubie
David Rubie
15 years ago

After living in sydney for 11 years and getting the hell out of there 2 years ago, my take on the situation was that successive years of poor infrastructure planning have made the place almost unliveable unless you can afford to live somewhere close to your place of work. Working in the CBD and living in the north west was a six year creeping nightmare that got worse as Kellyville (even further out than us) became developed.

I think this heavily distorts market values of older, inner suburbs. If you want speculative investment advice, the logic of your article would suggest buying into an apartment somewhere close to the city that is yet to be completed (might help to have two different possible close attractions i.e. the university and the CBD to increase the attractiveness of the purchase). One other effect might be immigration from Hong Kong and the U.K. – lots of cashed up buyers from even more expensive places used to work where I worked, and bought some pretty flash real estate. I have no idea how big that effect might be, it might be vanishingly small.

I had a workmate who insisted Redfern was the safest bet. Train station, close to CBD, access to eastern suburbs, access to UTS and sydney university. If you’re brave it might be worth a go. Personally, I’m never going back.

Grumpy Old Economist
Grumpy Old Economist
15 years ago

You say “The appropriate policy response is probably a tax on positional goods (because one person’s good position is another person’s worse position – negative externalities should be taxed).”

Ken Parish
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Ken Parish(@ken-parish)
15 years ago

“So if people want to take it easy on a lower standard of living, that should be OK shouldn’t it? ”

Not sure about the economics, but on a first principles basis this sounds dubious. Surely if people want to take it easy on a lower standard of living, they opt for a “sea change” somewhere slightly cheaper and quieter. Your proposal seems to want to take away/penalise the choices of people who choose to work hard to afford a well-located house in the big smoke. However, these people already pay higher income tax (leaving aside tax minimisation strategies), and a higher price for the house they buy, and higher local council rates. Why is it a good idea to also slug them with a “positional goods” tax? I wouldn’t, however, argue against a congestion tax, which would fall on people living in inner urban areas who chose to use their cars on crowded inner urban roads during peak periods (rather than commuting by public transport).

On your more immediate question about Sydney apartment investments, the Ultimo/Balmain/Rozelle area is worth a look. These suburbs are very close to the CBD and you can commute by ferry, bus or light rail. Personally I’d opt for either Manly or Mosman/Cremorne Neutral Bay, partly because of proximity to harbour and ocean, but also because you can commute to work by ferry. The near eastern suburbs through to Bondi Junction are also good because you can commute by train (like Malcolm Turnbull). Personally I wouldn’t touch Redfern because of the drug/crime problem, nor Randwick and nearby areas because of congestion issues (no immediate train or ferry option).

Russ
15 years ago

Nicholas, a few comments.

Firstly, despite being commonly applied, comparisons with US cities can be problematic. Houston and other US cities have governance structures (localised school boards for example) and demographics that have had strong decentralisation effects: inner-city decline (if not abandonment), exurban sprawl, extensive freeways and a dispersal of urban activities. Sydney and other Australian cities have strong state-based centralising influences: centralised infrastructure (CBD investment, roads, p/t) and the state bureaucracy, as well as the ocean and Blue Mountains acting as geographic constraints. Even without zoning, Sydney would retain strong inner-city house prices whereas US cities are generally the opposite (see here for example).

Secondly, as much as planners would love to think otherwise, their ability to restrict sprawl has been marginal at best: Australian cities retain densities lower than most US cities. They have been marginally more successful in restricting (not encouraging!) higher density developments in existing suburbs. A point that can be noted by comparing Houston’s pockets of high density development with Australian cities tendency to restrict it to the CBD. These restrictions (or the red-tape surrounding them) may be causing an increase in inner-city house prices, but not necessarily; despite the planners, rental returns have generally been falling.

Thirdly, land doesn’t really substitute from periphery to the centre. Our central cities are full of young singles or couples without children. Couples with children generally buy on the periphery – although this may be changing as the periphery gets further out and people make trade-offs between a large house/backyard and local amenity. The graph you show seems to suggest that all areas have gained a return of slightly more than double over the past ten years. This implies to me that house prices are being driven by investment returns (or perceived returns), but others would know much more about that.

Grumpy Old Economist
Grumpy Old Economist
15 years ago

I think Ken has the economics correct. We want the optimal amount of work effort -and a tax on it results in too little.

Now I can see why you are unconcerned about high effective marginal tax rates Nick, as ‘excessive leisure’ is their main cost.

David Rubie
David Rubie
15 years ago

Ken parish wrote:

Personally I wouldn’t touch Redfern because of the drug/crime problem, nor Randwick and nearby areas because of congestion issues (no immediate train or ferry option).

I suggested Redfern because the crime/drug problem makes it cheap. Surry Hills used to be nearly as bad but it’s almost gentrified now, which leaves Redfern as the last inner suburb that has potential. I’d agree it has problems, but I think there could be a massive potential upside.

As for the idea from Nicholas about the positional tax, there’s an easier way already within the grasp of the state government i.e. go back and fix the infrastructure problems. It’ll be painful and unpopular with the inner city residents to build new train tracks and fix the roads, but if you have to keep centralising Sydney around the CBD, that’s the only choice. Houses are going to have to be bought and knocked down, pockets of greenery will be concreted over, and it’s going to be very expensive. However, it will have the same effect as a positional tax by making the proximity of houses to the centre of sydney less valuable without necessarily penalizing those residents directly as with a tax.

As an alternative, Castle Hill, Campbelltown etc. should be expanded instead, by shifting NSW goverment departments there to relieve the pressure on the CBD.

Jason Soon
Jason Soon
15 years ago

Isn’t it inefficient to reduce the relative price of seachanging which is what Nick seems to be suggesting by adding to the costs of us city-dwellers if we want to preserve more greenery? The aim should be to increase density in the city, make even more efficient use of the land there with higher rise higher density apartment blocks and have even more economies of scale to make mass transit systems (e.g. trains and buses and trams) commercially viable. Subsidising seachanging is exactly the opposite of what you’d want if you’re concerned about sprawl and land use.

Jason Soon
Jason Soon
15 years ago

Houses are going to have to be bought and knocked down, pockets of greenery will be concreted over …

David, not sure why you think this is going to be more painful for us but go for it. A lot of us city dwellers have made the choice that we don’t give a stuff about greenery which is why we’re here (don’t know Clover Moore is obsessing over this issue) – as Trugiboff said, people who do are welcome to live elsewhere. It could all look like Sydney Airport for all I care as long as there is adequate infrastructure.

David Rubie
David Rubie
15 years ago

Jason Soon wrote:

David, not sure why you think this is going to be more painful for us but go for it. A lot of us city dwellers have made the choice that we don’t give a stuff about greenery which is why we’re here … It could all look like Sydney Airport for all I care as long as there is adequate infrastructure.

I didn’t mean to imply it was necessarily bad, just that there would be a backlash against it. As has been stated in this thread, inner city dwellers before they have kids seem happy with higher housing densities and good on ’em. They mightn’t be so happy when one corner of their apartment block collapses as the tunnel being built underneath it (a) kills property values and (b) sends their Ikea lounge 50 metres into a hole and (c) their local park gets a big smokestack stuck in it.

It’s going to take a shipload of money and a big set of cojones to make Sydney work like outer-suburbanites think it should, and somebody will lose. Alternatively, a fundamental rethink of what an Australian mega city should look like will take place. Either way, I’m a spectator now rather than a participant so it’s a totally academic question to me.

One thing though – when your heavily pregnant good lady wife explains with a trembling voice and tears welling in her eyes that your precious offspring will never feel the joy of grass under their toes living in in your current abode, you will yearn for the outer suburbs just to have some peace :-)

Grumpy Old Economist
Grumpy Old Economist
15 years ago

If you view status (or the goods that produce status) as just another good in the utility function, then why single it out for extra taxation? One answer is that the optimal Ramsey tax regime would do so: that it is inelastically supplied or a complement for leisure. That seems to be Nick’s position. Personally, I’m a fan of uniformity over a large tax base. I think attempts to introduce Ramsey style taxation creates more problems than any possible efficiency gains for a number of reasons:
1.Do we really have the information to introduce such a tax system?
2.Do the politicians have an incentive to set efficient tax rates, or will the tax system instead be a response to special interest lobbying? Uniform value added taxation is safeguard against pressures for special treatment by all sorts of special interests. This is a political-economy argument for uniformity, not a neoclassical one.
3.Do we really want a government to set taxes, and change, taxes according to our preferences?

GMB
GMB
15 years ago

The problem is height restrictions on buildings everywhere. And monetary debauch.

I would have thought this was obvious.

GMB
GMB
15 years ago

“To use Jason’s terminology, I’m not trying to subsidise ‘seachangers’. Just have a level playing field. If we can tax rent away from people buying positional goods – then there’s an efficiency gain because the same quantity and quality of positional goods get distributed – only at higher (tax inflated) prices and we can increase the consumption of non-positional goods.”

Thats an incredibly absolutist position to take. Just what are these positional goods that you speak thereof? Lets hear some specifics. We want to see these offending goods so deserving of chastisement.

Peter Parker
15 years ago

Nick, that graph is supposed to convey the impression that inner suburbs have had more capital growth than outer areas.

Visually it does, but it looks like the presentation method is playing games with our mind. It would have been better if the academic concerned used a more ‘neutral’ and less biased presentation method that does not convey an impression contrary to underlying figures.

To prove my point, check the figures themselves. Then do the sums on the percentage increases across all distances.

It looks as if the percentage of growth is about the same between inner and outer.

If in 1996 you bought $600k worth of property in the inner zone you’d have only slightly more worth now than if you bought it on the outskirts. But the percentage difference is negligible and small compared to normal variations between house prices. You’d have 4 houses on the outskirts vs 1 inner-city, but the overall outcome would be about the same (Jan Somers has figures on this from an investing viewpoint in her book).

The figures behind the graph actually debunks the idea that capital growth is highest in inner city areas, which is opposite to what its author was trying to prove!

Peter

SJ
SJ
15 years ago

“It shows that the lion’s share of the house price growth has occurred not as (I think) the Demographia view of the world requires it, more or less across the board as rising prices on the periphery arising from land starvation drive up prices everywhere.”

Are you sure that’s what the data show? It looks to me that prices have grown by factors of between 2.5 and 3 across the board, and that the largest increase is actually at the low price end.

Jc
Jc
15 years ago

Pardon for asking but aren’t “positional goods” taxed now?

1. We pay GST and Luxury tax on expensive cars. We pay a larger amount of stamp duty on expensive home purchases. We pay more GST the more expensive the goods or services.

Lets not forget that we are also paying income tax at a higher rate and more of it as income increases.

What this really means is that we need to place an even larger burden of tax than we already have, this time on goods that aren’t regarded as essentials.

It would be interesting to see how a ” positional” home would be spliced. Is it by suburb, home or region?

Damien Eldridge
Damien Eldridge
15 years ago

In terms of the situation where “position” enters the utility function, it seems that there is a fundamental difference between this and other goods. In principle, we can imagine situations in which an increase in one persons consumption of one good does not directly alter the amount of consumption that another person obtains. However, by its very nature, an increase in one person’s position in society must lower at least one other person’s position. This is where the so called externality comes from. Should we be worried about these externalities? I don’t know. Maybe people would be better off if they could be avoided. You can imagine a situation in which competition for position did not alter the ranking of social status and hence resulted in wasted resources. This is not unlike the argument that Stiglitz and others have made for taxing share transactions. The question is, where do you draw the line?

As an aside, I suspect that this situation might be best modelled in a Lancaster and Becker “preferences over characteristics and household production” framework. The characteristic would be social status. The inputs in the “social status” production function would be things like waterfront mansions, luxury cars and the like.

Regards,

Damien.

David Rubie
David Rubie
15 years ago

Damien Eldridge wrote:

The characteristic would be social status. The inputs in the “social status”

Damien Eldridge
Damien Eldridge
15 years ago

David,

It is certainly the case that positional externalities, if they exist, could be said to result from an extreme form of envy. It is not enough to keep up with the Jones’, people weant to get ahead of them. Nonetheless, to the extent that this results in everyone using lots of resources with no impact on the ranking (or, if you are a utilitarian who weights everyone equally, regardless of the impact on the social status ranking), this is a market failure. Resources that could be used to increase everyones welfare are wasted on what is essentially rent seeking.

The section of my earlier comment that you quote is not really relevant to this line of reasoning. However, an elaboration of that section of my earlier comment does provide some indication of how difficult it is to correct for positional externalities. The inputs into the “social status” characteristic that I listed will also be inputs into other characteristics. In effect, the consumer has a multiproduct production technology for characteristics. It may well be the case that attempts to reduce any resource misallocation that arises from positional externalities results in some degree of resource misallocation elsewhere.

Should we be concerned about positional externalitiues? I don’t know, but I suspect not. If only because it is hard to see any credible way to design a policy to correct for them that is not open to capture by some special interests group. Furthermore, there is probably an inbuilt correction mechanism that prevents positional externalities from becoming too big a problem. This correction mechanism is the foregone consumption of other goods that positional competition might entail.

Regards,

Damien.

Grumpy Old Economist
Grumpy Old Economist
15 years ago

There are two ways of modeling status which have very different policy implications. One way is to put a good called status (or some good that gives you status) in the utility function. It is in fixed supply and the more you consume of it, the higher your status. If this good is bought in a competitive market, then the outcome is fully efficient. There is no externality and no inefficiency from bidding up the price of the status good (just a transfer from buyer to seller). Although a person’s utility only depends directly on his own status, indirectly it depends on that of others. The availability of status to everyone else is reduced when other people acquire a lot of status. But that would happen under any system of allocating the status good.

Another way is to assume that people directly care about the consumption and status of other people. In that case, there is an externality and some forms of competition for status may lower efficiency. For example, if people care about their relative rank in the income distribution they may work long hours to raise their relative income. If everyone worked equally long and hard, all incomes rise proportionally and no-ones relative status changes, but everyone’s utility goes down because they worked excessively. This problem does not arise in the first way of modeling status competition because when people compete for status there, they bid up the price of the status good which accrues to its initial owner.

I don’t think the proponents of ‘envy taxes’ have made the case that the second model is more accurate than the first.

Damien Eldridge
Damien Eldridge
15 years ago

Grumpy Old Economist,

The modelling approach that I suggested is not quite the same as either of these approaches, although it is closer to the second. The household production function for “social status” would include as inputs both the luxury goods purchased by a consumer and the luxury goods purchased by other consumers.

Regards,

Damien.

Grumpy Old Economist
Grumpy Old Economist
15 years ago

Damien,

I hadn’t read your 10.14 am post when i made my 10.15 am one. My post was meant to be the simplest way to get at the question: ‘is there an exernality?’. Your proposed approach begs that question and assumes there is an externality.

Your more complicated approach is relevant for answering the question: assuming an externality could the government actually improve matters? (even assuming it has the incentive to).

Damien Eldridge
Damien Eldridge
15 years ago

Grumpy Old Economist,

No problem. I initially mention the modelling approach in my earlier 3:29 am comment (comment number 20 above).

I suspect that it is likely to be difficult in practice to distinguish between a situation in which it is just the status goods that enter the utility function and the positional externality situation.

Regards,

Damien.

harry clarke
15 years ago

Hotelling theory suggests that if land is an exhaustible resource its value should increase by the rate of interest everywhere. Land prices and rentals will be more expensive near the centre because of reduced transport costs and agglomeration benefits but given the rental gradient values should increase at the same rate.

The best way to deal with sprawl is to price traffic congestion not to impose boundaries.

I had a go at some of these issues here.

harry clarke
15 years ago

Sorry, here.