The RBA has pointed out a problem in Australia's property market that is artificially inflating prices

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  • An RBA research paper says restrictive zoning laws have increased Sydney house prices by 73% above the cost of supply.
  • The report cites examples where property prices have doubled overnight after rezoning announcements were made.
  • However, other experts have criticised some of the report’s findings.

A research paper released by the RBA today suggests that restrictive zoning laws have had a key part to play in driving up property prices in Australia’s major housing markets.

To illustrate their point, analysts Ross Kendall and Peter Tulip broke down the value of a property into two components — structure and land.

“Although we find that differences in the value of dwelling structures and the physical value of land account for some of the variation in average housing prices across the four cities we examine, our zoning effect estimates account for the majority of the differences,” the analysts said.

They estimated that the average price of a Sydney house — $1.16 million dollars in 2016 — was represented by a $395,000 structure and a $765,000 block of land. But the land component, they argue, is way overpriced.

“The reason land is expensive is not because it is physically scarce,” they said.

In fact, “home owners do not value it, as land, especially highly. Specifically, they value land as worth about $400 a square metre on the margin — or $277,000 for the average Sydney block”, based on the opportunity cost of forgoing the land to someone else.

In order to reach that conclusion, the analysts crunched some pretty advanced statistical analysis — which can be found in the appendix of their research paper.

And that analysis is not without its critics. Economist Dr Cameron Murray — whose research was quoted in the report — issued sharp rebuke on Twitter this afternoon:

Kendall and Tulip said that for everything else being equal, the marginal cost of additional land doesn’t increase nearly as fast as the actual costs built into the value of a Sydney property.

“The extra $489 000 reflects administrative restrictions. That is, zoning restrictions raised prices 73 per cent above the cost of supply,” the analysts said.

Relative to supply costs, zoning restrictions have raised prices by 69% in Melbourne, 42% in Brisbane and 54% in Perth.

“We emphasise that this is not the amount that house prices would fall in the absence of zoning,” the pair said, noting that such a view would require them to calculate the vagaries of supply and demand in Australia’s huge $6.8 trillion housing market.

They added that the physical cost of land — excluding zoning laws — is higher in Australia’s major cities than overseas markets.

However “overall, our results suggest that development restrictions (interacting with increasing demand) have contributed materially to the significant rise in housing prices in Australia‚Äôs largest cities since the late 1990s, pushing prices substantially above the supply costs of their physical inputs,” the pair said.

Among the examples used to back up their argument, the analysts cited:

  • 2017 research which showed the value of a 363 hectare property 40 kilometres west of Melbourne increased from $120 million to $400 million after being rezoned from rural to residential land; and
  • Anecdotes from a Penrith real estate agent who said properties zoned for six-story apartment buildings in the area doubled in value overnight after the rezoning announcement was made.

“We also find evidence of a large gap opening up between apartment sale prices and construction costs over recent years, especially in Sydney. This suggests that zoning constraints are also important in the market for high-density dwellings.”

The analysts said that due to zoning restrictions, the marginal cost of land in a Sydney apartment complex rose by a whopping 85%, because developers are banned from building additional levels:

The analysts concluded that effective zoning laws do have some benefits, such as providing safeguards against the negative consequences of unregulated development.

But the numbers strongly suggest that restrictive zoning laws have played a role in price dynamics for Australia’s major housing markets, which saw Sydney house prices double between 2009 and 2017.

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