Why new house prices are higher than they should be

A commentary by Dave Fermah

21 May 2007

I read the conflicting media reports about a housing price bubble and the impending fall, how there’s a shortage, how it costs so much more now and then I also read that sales are at high levels with strong volumes and continuing high levels of building consents, it gets rather confusing. Where are house prices headed? Why does it cost so much more for a new house? It isn’t hard to tell where new housing prices are headed, save an economic catastrophe, or what houses we will be living in over next five to ten years.

Why is new housing so expensive seems a good place to start. A combination of factors beyond the control of Mr Joe Average have conspired to drive the future price of new entry level housing up. It’s actually not hard to work out why new houses have gone up around $30,000 to $100,000. Unfortunately this helps drive up older housing prices.

In 2006 we were selling 4 bedroom, 2 bathroom, double garage houses with Housing NZ leases to investors for $375,000. This year we need to sell them for $475,000. Why?

The real effects of this increase will be to reduce the demand for new houses, therefore compounding the problem and driving older house prices up as more arriving immigrants or new to the market NZ born people fight to buy the same restricted amount of older housing stock. New housing stock has been affected by normal economic ebbs and flows as well as regional and local Government policies.

It is apparent to most that the housing and building cycle is on, or just after the peak. Just where is only truly 100% apparent with hindsight. Higher interest rates and inflation and all the things you notice in a person’s immediate environment point to us being at the peak. This would normally by itself take the steam out of construction and development margins, and landowner’s expectations of land or house values.

But the main new factor that is and will cause strangulation of new housing primarily lies with the new local and regional bodies' costs and processing.

A sample of the over 100% cost increases that await starts simply.

Since the leaky home crisis, the Building Industry Authority has increased the levy they put on houses (BIA levy charge on Building Consents) around 300% (from 65 cents 2000 to $1.97 in 2005). Thankfully it only equates to $236 per house.

The next ‘new’ cost (introduced nationally in July 2004 but now also being reviewed upwards from July 2006 on) is the development levies. In Auckland, for a new section (i.e. a subdivision) this is payable at the Building Consent stage. This development levy on July 2006 is:

Auckland City $6300 or $8360 per section or house
Manukau City $6,383 per section or house
Waitakere City $10,449 ($13,653 Hobsonville) per section or house
North Shore City $14,000 per section or house

These levies charged by local government are to cover new roads, amenities, sewage and storm water services that are required for new houses that existing ratepayers shouldn’t pay. Obviously there are grey areas as local bodies attempt to move or disguise ongoing maintenance or capital expenditure into the new levy, so as to try to control rate increases.

Of interest is that of the above (approximately) $10,000 development levies, some $4500 is charged by the Auckland Regional Council. With ARC charging about 25% of residential rates, you may wonder how and where they manage to spend all this money. Although this $4500 is purported to be spent on sewage services I am sure most would be interested to see exactly the breakdown of how ARC is spending this money. A rough breakdown on the balance of the levy (based on Waitakere) is:

Stormwater $12 %
Wastewater (Sewage) $49%
Water supply $2%
Transport $26%

The breakdown varies between councils. It is not a exact science as evidenced by North shore city council varying its development levy to us on a commercial site (after we queried the breakdown) from $75,000 down to $15,000 (what we than paid), then with a new consent application for a smaller building loading a new $126,000 levy at us. We again queried it, and they argued it was right and attached an invoice for $106,000?! Hardly confidence inspiring and probably why they are now in court over these levies.

The next big ‘new’ charge is a requirement for both commercial and residential developments to be storm water ‘neutral’. This means simply no extra clean water can be discharged by a new building into the storm water system or streams. This is to prevent the possibility of flooding. To do this developments are required to have a retention/detention system. Basically this is a big underground tank to capture storm water off roofs and drives which is held for a period (say 2 hours) and then allows a ‘trickle’ into the storm water drains. Sounds fair enough at first.

ARC also requires that all water off drives be filtered. This is to ensure that any oil or contaminants do not end up in the lakes or seas. A grand idea but in reality a waste of capital resources. The end costs of the tanks are around $5000 a section and a filter or rain garden is $2000 to $3000 a section. Some again may wonder if this is value for money or indeed whether it even works. I suspect they are not alone thinking this.

Many feel that the money could be better spent on energy efficient designs such as solar power, built in natural heating and cooling features and clean and waste water reticulation/restriction. This includes using roof water for toilets, pushing natural heat from roof cavities into floor slab storage devices etc. Warmer houses for children, lower power bills, and a reduced need for power station and transmission lines may be a better use of the $8,000. But unfortunately Mr. Joe Average doesn’t have this option as engineers and bureaucrats at Regional and National levels make unilateral decisions.

The above three factors:

BIA levies (average $ 236)
Development levies (average $10,500)
Stormwater tanks & filters (average $8,000) have added around $21,000 to a new house.

That coupled with the demand in the construction cycle for raw materials (globally due to China etc), has increased prices around 7% to 15% in the 18 months to Dec 2006. This adds up to another $15,000 on an average 4-bedroom house. Since January 2007 we have had another 2.5% on house building quotes adding $3,750 per house. In two years a 150m2 (the new average NZ family house) has cost an additional $18,750 to build.

Then we have the cost increases of actually subdividing the land .The costs of preparing bare land and installing stormwater, sewerage, phone, power, and water services, has escalated $10,000 per section in the last three years. About a 25% per section increase, due to more rigorous council demands and cost pressures driven by staff shortages, work loads. Add on top local and national infrastructure building, which is utilizing all spare capacity in the construction trade.

The final nail in affordable housing prices is the tougher resource and building consent requirements. To get rid of a few cowboy developers and builders, bad building product systems from multinationals and foolish central building authority decisions to get rid of treated timber, we are now all having very strict processes and requirements to lodge resource and building consents.

Councils (rightly) cannot be open to be sued as a last stop, by negligence caused by others. Their reaction to all this has been to lay off risk to the private sector (like consultants professional indemnity insurance) by getting everything peer reviewed. However the problem with all this is the size of the consents has increased and councils are under-resourced in these areas due partly to the lack of skilled staff (another sign of a peaking economy).

The delay in consents is now legendary. Councils have statutory requirements to process building consents in 20 working days but the reality is more like 4 months. A similar situation existing with resource and land use consents. Instead of an efficient developer being able to obtain resource consent in 3 months, it is now drawn out 6 to 18 months. This delays projects at least 12 months but more importantly doubles the time and therefore increases holding costs. Of course the Council’s answer to rate increase pressures has been to lift all consent fees and charge out staff time at $75 to $120 per hour. Currently the cost of lodging consents appears to be doubling every twelve months. The dollar value on increases for an average 4 bedroom house and section are:

$3,000 increased cost to prepare documents
$1,500 increased cost to lodge in Council building consent fees
$1,250 increased cost to lodge in Council resource consent fees
$15,000 due to raw land holding costs whilst awaiting resource consents
$6,000 due to subdivision improvements holding costs whilst awaiting building consents.

This equals around $26,750 per house and section.

When all the above are added together:

$5,986 BIA/Resource/Building consents
$21,000 Holding costs
$8,000 Retention tanks/filters
$10,500 Development levies
$18,750 Increased house building costs
$10,000 Increased Subdivision works costs

You end up with a new house costing $74,236 more than two years ago.

Normally this is what would start the end of the current new housing cycle. Following this, older houses will increase in value to reflect replacement costs. However with the demand for extra accommodation in Auckland it is hard to tell what will occur.

What then of the miracle salvation of high-density housing? This is pretty much an illusion driven by bureaucrats who have no idea of costs to build houses and develop land. A standard 4-bedroom brick and tile 150m2 NZ house costs around $147,000 to build. The land cost for the “new” average section of 400m2 or 600m2 is around only $40,000 per site more compared to the high density average size 200m2 site. This is because existing landowners think they are sitting on a goldmine since their land was rezoned medium to high density. In reality it is only worth about 40% more, not the 100% they think as they do the wrong equation of twice the houses equals twice the value.

However a two story house (usually on a small section as developers seek to cram in houses) costs 20 % more to build per m2, than a single level one. Another $30,000 for a house with stairs, on a smaller site. Two story houses are also 10m2 larger due to lost room for stairs. Hardly compelling features.
Terraced housing costs 38 % more to build per m2 but are only normally 3 bedroom 2 bathroom and about 120m2 on 200m2 land. So it costs $161,000 to build this tiny place compared to $147,000 for the single level family home on 430m2 land. The discount on the smaller land gives you only a net benefit of $20,000 on end costs.

Which house do you think most New Zealanderrs want to live in?

The kicker in all this is the final valuation of the houses. Even though all three end up costing the same, the single level family homes on larger sites value up higher. So why as a developer or owner would you build the others? This illustrates why there has not been an explosion of medium to high-density building where councils have rezoned near train stations and arterial routes. The figures don’t simply add up.

Back to why the existing housing stock increases in value. Since 1951 to 2006 the average NZ house price has increased 3900%. However in 1953, 1974 & 2006 they peaked at a level 50% higher over a period of 3 to 4 years, than the prior 4 plus years. These peaks are far higher than the normal seven year cycle ebb and flows. In the period 1953 to 1963 the market value stayed basically the same for the next 10 years before it started increasing again to the early seventies. In the 1970’s the average value went back to where it started before the peak. This may have been due to the oil crisis and global economic impacts. The current boom is basically a global Western phenomenon. It may be due to globalization and the strong economic growth of Western and Asian economies, or maybe that this millennium the population expects better quality housing or may simply be another boom in the normal patterns of time?

The problem with any crash reducing the price of new dwellings is that bare land cost is only 25% to 40% of completed section value. A 50% crash in land prices will only reduce a $400,000 new 4 bedroom house $15,000 to $30,000. Only the same as what local government costs have increased in the last 3 years.
Hardly a ray of hope for reducing new house costs.

At the same time as the slow down in new house stocks occurs you have the Reserve Bank and Government attempting to control the problem by lifting interest rates. It does not take a rocket scientist to work out without central, regional & local bodies exerting some control of the costs they are feeding through that New Zealand’s average house price will move to a new plateau over the next 5 years. Perhaps the ARC recent idea of adding $5000 to a new house to cover traffic congestion is as ludicrous as it sounds.

Well, Dave Fermah is no rocket scientist but does successfully invest in and develop both commercial and residential property.