WEEK 10: REGULATION & OUTCOMES HOUSING TCD M.SC.(EPS) RONAN LYONS EC8015 COMPETITION & REGULATION

Transcription

1 WEEK 10: REGULATION & OUTCOMES HOUSING TCD M.SC.(EPS) RONAN LYONS EC8015 COMPETITION & REGULATION

2 STRUCTURE Regulation & Outcomes Housing 1. Housing Supply & Demand 2. Regulation & Housing 3. Setting Land Prices 4. Setting Structure Prices 5. Housing & Social Equity 2

3 KEY READINGS Katharina Knoll, Moritz Schularick and Thomas Michael Steger, No Price Like Home: Global House Prices, (September 2014). CEPR Discussion Paper No. DP Albert Saiz, The Geographic Determinants of Housing Supply, Quarterly Journal of Economics (2010) 125 (3): doi: /qjec

4 STRUCTURE Regulation & Outcomes Housing 1. Housing Supply & Demand 2. Regulation & Housing 3. Setting Land Prices 4. Setting Structure Prices 5. Housing & Social Equity 4

5 OPENING DISCUSSION Which market structure best describes the housing market? Monopoly? Oligopoly? Monopolistic Competition? Perfect Competition? Putting it another way, what barriers to entry are there in housing? 5

6 HYPOTHESIS FOR TODAY Because the construction sector has very few insurmountable barriers to entry housing prices (and rents) should be close to marginal cost and where they are not, this is largely due to policy (i.e. decisions that can be changed) In other words, societies can choose to have cheap or expensive housing Regulation is the key way they do this 6

7 IN THEORY Anyone can set up a construction firm Many people set up effectively a temporary one, to build a one-off house Suggests very low barriers to entry Without barriers to entry, a good s equilibrium price should reflect all costs, including normal profit In housing, costs include materials, labour, capital, land and permits Ceteris paribus, high prices should be a signal for new houses to be built 7

8 IN PRACTICE Median sale price Q DC: $490,000 West Virginia: $110,000 8 Source: Trulia.com

9 START WITH A TEXTBOOK MODEL Starting point in the analysis is a housing market in equilibrium Price of housing sufficient to cover MC (which includes return to capital) Consider a positive demand shock E.g. net migration, or an increase in incomes (YED) Standard model suggests initially a higher P, Q but supernormal π will cause outward shift in S P S P=MC D D Q 9

10 WHAT IS THE SUPPLY RESPONSE? Outward shift in S in the short run brings prices back down to MC P S S Socially efficient outcome In long run, think instead about the elasticity of a given supply curve P=MC D D Q 10

11 TOWARDS PERFECT ELASTICITY Ideal scenario would be perfectly elastic long-run supply Any positive D shock for housing would be offset by additional supply Practically, housing market faces perfectly inelastic supply in SR Quantity of housing cannot jump to equilibrate adjustment left to prices instead P S S LR 11 D Q

12 FROM PERFECT INELASTICITY Ideal of perfectly elastic LR supply but in practice, what is the elasticity? P S SR S LR? What barriers to entry reduce this elasticity? S LR? In other words, empirically, interested in the long-run impact on house prices of a positive shock to demand D D %Δhp/ %ΔD Q 12

13 STRUCTURE Regulation & Outcomes Housing 1. Housing Supply & Demand 2. Regulation & Housing 3. Setting Land Prices 4. Setting Structure Prices 5. Housing & Social Equity 13

14 SAIZ ADDRESSES GEOGRAPHIC & REGULATORY CONSTRAINTS How do house prices in US cities respond to shifts in the demand curve? (I.e. what is the LR supply elasticity?) Paper measures both regulatory and geographic constraints on housing supply Data: Constructs a measure of exogenously undevelopable land in cities, based on area foregone within 50km to sea, internal water bodies and wetlands, slopes above 15% Uses survey-based measure of land-use regulations 14

15 MEASURING THESE CONSTRAINTS Wharton Regulation Index (of residential urban land) 15

16 EMPIRICAL METHODOLOGY ΔP: long-run change in median price σ k : 1970 construction cost share, city-specific intercept ΔH: change in housing stock Endogenous, so instrumented by range of demand shifters (incl 1974 employment mix, January sun, immigration) β S : common supply elasticity (can impose as zero) β LAND, β REG : elasticity due to natural, man-made barriers λ: land availability (expectation: δβ/δλ<0) WRI: index of regulations R: region fixed effects 16

17 SAIZ S RESULTS Price changes are positively associated with demand shocks and more so if land is unavailable or regulations are strict Land constraint only becomes binding with higher populations 17

18 WHAT ABOUT ENDOGENEITY OF REGULATIONS? So far: impact of demand on prices is mediated by physical land availability and regulation Going from 10% to 40% land unavailable means effect of demand shock on prices increases by about 25% But regulations may result from house price increases Fischel s homevoter hypothesis: Restrictions are how owners maintain their wealth no insurance market against zoning changes Do regulations depend on geography? % of non-traditional/evangelical Christians taken as exogenous indicator of taste (for limited government) 1 SD increase in 1970 non-traditional Christian share associated with SD change in land use regulations 18

19 OVERVIEW OF IV METHOD Instrumental Variables method is now common in social sciences Arose due to potential endogeneity of most important social and economic outcomes IV relies on the following logic We want to investigate whether X has impact on Y (X Y) But we are worried about reverse causality (possible that (Y X) So we identify a variable, Z, that only affects X (Z X; relevant ) it has no direct impact on Y (other than through X; valid ) By exploiting the impact of Z on X, we can see the impact X has on Y 19

20 IV RESULTS ARE SIMILAR TO OLS MODELS

21 ACTIVITY: EXPLAINING SUPPLY If you believe that β S is indeed zero, what does that say about Saiz s work? 21

22 REGULATION & LIMITING DEMAND Housing market outcomes are determined by two sets of factors Fundamentals, such as income, demographics and supply Asset factors, including user cost (expected capital gain, interest rates, property tax) and credit conditions Differentiating between boom-bust and bubblecrash Boom and bust: Fundamentals are typically slow-moving Bubble and crash: asset factors can change overnight and drive more extreme swings in housing markets : failure of regulation to limit expectations and leverage (credit) hence mortgage caps 22

23 THE IMPORTANCE OF LEVERAGE The deposit required of the typical first-time buyer is a vital indicator Measure of how much real economy is multiplied Where minimum deposit is small (below 10%), banks need to rely on other indicators E.g. debt/income ratio Central Bank rules (early 2015) on both LTV and LTI Savings Minimum Deposit House Price 20,000 25% 80,000 20,000 20% 100,000 20,000 15% 133,333 20,000 10% 200,000 20,000 8% 250,000 20,000 5% 400,000 20,000 2% 1,000,000 23

24 CREDIT CONDITIONS & PRICES Credit market Housing market r CS hp HS SR HS LR CS hp 1 hp 2 hp 0 r 0 r 1 HD CD HD C 0 C 1 C H 0 H 1 24 H

25 IMPACT OF CAPS ON EXPECTATIONS Expected change in house prices in next 12 months 15% 10% National Dublin Ex-Dublin 5% 0% -5% 2011q4 2012q4 2013q4 2014q1 2014q2 2014q3 2014q4-10% -15% Source: Daft.ie Sentiment Survey 25

26 STRUCTURE Regulation & Outcomes Housing 1. Housing Supply & Demand 2. Regulation & Housing 3. Setting Land Prices 4. Setting Structure Prices 5. Housing & Social Equity 26

27 LONG-RUN EVIDENCE SUGGESTS β=0 (BUT WITH VOLATILITY) 400 Inflation-adjusted Herengracht house prices

28 IRISH EVIDENCE NOT DISSIMILAR ALTHOUGH CYCLES EVIDENT 200 Real house prices in Dublin, (1950=100) % rise 166% rise 185% rise 24% fall % fall 53% fall 48% fall Source: My own on-going research 28

29 BUT HAS β SHIFTED IN THE DEVELOPED WORLD SINCE THE 1970S? 29 Source: Knoll et al (2014)

30 ONE CANDIDATE IS SUPPLY OF LAND Price of construction Price of land 30 Source: Knoll et al (2014)

31 ALTERNATIVE IS CREDIT CONDITIONS Credit market Housing market r CS hp HS SR HS LR CS hp 1 hp 2 hp 0 r 0 r 1 HD C 0 C 1 CD C Note that this still requires barriers to housing supply for prices to stay above MC (their LR trend) H 0 H 1 HD 31 H

32 LAND AS THE RESIDUAL FACTOR How much should a developer bid for a site? Suppose a one-acre site, on which you have permission to build 100 units The average unit will cost 200,000 to build including normal profit margins and will be sold for 220,000 20,000 x 100 = 2m Maximum bid for a one-acre site in these circumstances would be 2m 32

33 THREE ROLES OF REGULATION 1. Degree to which land market is efficient vs. reference pricing, speculative holdings, etc. Important of land tax as externality pricing = SMC Currently, role of NAMA in land market 2. Maximum number of units per acre For any given site, limit is either not binding (i.e. useless) or binding (i.e. limiting supply response to demand) 3. Potential range of uses Zoning by land use creates artificial market boundaries for otherwise substitutable plots of land Preservations orders also limit supply costs vs. benefits 33

34 RECYCLED FROM LAST YEAR! Dublin Bus core routes & depots 34

35 TAXATION & LAND USE Train station DCU Green space ~150 acres Phoenix Park Terminus of X-city Luas O Connell St (1 km) Back-of-envelope: as industrial land, worth ~ 0m as residential, worth ~ 3,000m 35

36 THOUGHT EXPERIMENT Suppose Merrion Square were rezoned for potential development 12 acres, close to Dublin s CBD Could likely provide 1,000 homes and 30,000m 2 of office space What elements should be included in the costbenefit ratio? 36

37 STRUCTURE Regulation & Outcomes Housing 1. Housing Supply & Demand 2. Regulation & Housing 3. Setting Land Prices 4. Setting Structure Prices 5. Housing & Social Equity 37

38 DUBLIN S GEOGRAPHIC BARRIERS 38

39 PARAMETERS IN BUILDING COSTS Hard parameters (,#) 1. Target size of units 2. # units per acre 3. Build cost per sqm 4. Site cost (if not residual) Market vs. regulatory Soft parameters (%) 1. Interest rate (+length) for site, construction 2. Fees (e.g. legal, professional) 3. Local authority levies 4. Profit margin 5. VAT rate 6. Desired net yield 7. Management margin Apply to lettings unit cf. user cost 39

40 SAMPLE PARAMETERS CURRENTLY Two-bedroom apartments in Dublin Number per acre: 36 [some flexibility cf. orientation] Minimum size: 85sqm [little flexibility] Construction costs: 1,800-2,000 per sqm Site costs:??? [cf. NAMA] Site/construction interest rate: 6% [market] Local authority levies: 538/sqm [higher with Luas, etc] Other fees: 5% [market] Profit margin: 10%-15% [market] VAT rate: 13.5% [fixed] Desired net yield: 5% [market Management margin: 20% [gives gross yield] 40

41 SAMPLE REGULATORY BARRIERS Min. dwelling size (m2) Dublin Ireland UK Denmark France Spain 1-bed 2-bed Dublin City Development Plan, Chapter 15 The majority of apartments in a development must be dual aspect. Where single aspect buildings are unavoidable, they should be designed to avoid exclusively northern orientation. 41

42 CURRENT MATHS OF CONSTRUCTION E.g. building bedroom apartments in Dublin DCC rules include effective min size of 85m2 but also height restrictions which limit number of units per acre This is aside from costs relating to numbers of lifts and basement car parking spaces per unit, balcony depths, ceiling heights, orientation At 1,830/m2, hard costs of ~ 155,000 per unit This figure is combined with the soft cost multiplier Soft costs: 6% 1-year loan for hard costs, local authority levies, VAT, 12.5% profit margin, professionals fees of 5% Full cost of a unit excl all land costs is ~ 275,000 At a net yield of 5%, and allowing 20% maintenance costs, this converts to a monthly break-even rent of ~ 1,400 excluding land 42

43 SIGNIFICANT CHALLENGE IN REDUCING CONSTRUCTION COSTS 2,500 Break-even rent for 2-bedroom apartment, by scenario 2,000 1,500 1,000 VAT Profit Fees Levies Finance Build Site Rent Rent West Dub Baseline Cost 2m site Zero profit Wage fall Vat/levy cut Higher yield Smaller units Greater density Smaller + denser 43

44 STARTING FROM REAL INCOMES Key guiding principles Choice (between housing / across housing & other goods) No more than one-third of disposable income on accommodation Take a household on 45,000 (roughly 60 th %ile) Monthly disposable income: ~ 3,000 Max spend on accommodation per month: ~ 1,000 Household on 18,000 (roughly 20 th %ile) Gross disposable income; monthly disposable income ~ 1,500 Max on housing a month: 500 How many square metres of new construction could each of these families afford? 44

45 BEST ESTIMATES OF CURRENT COSTS Status Quo 2+2 family Hard costs / sqm 1,830 Min sqm 80 Multiplier 1.77 Total unit cost (excl land) 259,128 Cost/rent ratio 200 Break-even monthly rent 1,296 Break-even rent / sqm 16 Annual gross income 45,000 Max monthly housing spend 1,000 Max sqm 62 Monthly subsidy required

46 REALIGNING STRUCTURE COSTS Status Quo 2+2 family Scenario 2+2 family Hard costs / sqm 1,830 1,500 Min sqm Multiplier Total unit cost (excl land) 259, ,300 Cost/rent ratio Break-even monthly rent 1, Break-even rent / sqm Annual gross income 45,000 45,000 Max monthly housing spend 1,000 1,000 Max sqm Monthly subsidy required

47 STRUCTURE Regulation & Outcomes Housing 1. Housing Supply & Demand 2. Regulation & Housing 3. Setting Land Prices 4. Setting Structure Prices 5. Housing & Social Equity 47

48 KEY QUESTION What fraction of households should we subsidize to boost their housing? (Everything else falls out from this ) 48

49 STANDARDS AS DISCRIMINATION Current DCC rules mean that, if land cost 2m/acre, the break-even rent would be ~ 1,800 To sustain this, the household would need to have a disposable monthly income of ~ 5,500 This applies to only the top ~15% of households i.e. a gross annual income of ~ 90,000 What would break-even rent need to be if we wanted 60% of households to afford 2-bed apt? 60% percentile earns ~ 30k gross annual This translates into ~ 2.5k disposable monthly And roughly 825 per month a 55% reduction on current levels! 49

50 FIXING HOUSING SUBSIDIES System based on fixed rent supplements merely pits working tenants against welfare tenants An increase in supplements relative to rents advantages the latter at the expense of the former Maths of construction shows how housing subsidies should be done Top up third of income so that all households have sufficient means to cover their accommodation costs Maintained assumption: newly built accommodation should be available to all, not just those on higher incomes Income-varying housing subsidy, based on construction costs Major step towards the principle of a universal income 50

51 QUESTION FOR DISCUSSION As a policymaker, would you support a resolution requiring new builds to be passive standard? What information might you want to know to decide? What groups might be the biggest winners/losers? 51

52 REVISITING TODAY S HYPOTHESIS Because the construction sector has very few insurmountable barriers to entry housing prices (and rents) should be close to marginal cost and where they are not, this is largely due to policy (i.e. decisions that can be changed) In other words, societies can choose to have cheap or expensive housing Regulation is the key way they do this 52