Land speculation and "Pass the Parcel"
We've all read or heard that houses are overvalued and that we are not building enough houses. Often the focus is on the cost of building (which is admittedly high) and the amount of bureaucracy (which there is in spades, and some.) I think the issue is simpler and more fundamental than that. It's all about land and I think in the current market many are playing a high risk game of pass the parcel. When we look at the economics of property it usually comes down to a simple notion of supply and demand and what someone is prepared to pay. So scarcity will drive prices up and excess supply will drive prices down. The attributes that will determine price are things like the community, the size and condition of the house, aspect to sun and noise, and land size. Of all of these drivers, it is the land attributes that are "scarce." There are only so many waterfront properties. New standalone houses in Ponsonby cannot be built without knocking one down. Overinflated house prices fundamentally comes back to demand, scarcity .... and land. In my opinion most "investors" make poor, often uneducated decisions, around purchasing land. That's my view, and investors wont see it that way! Arguably the value of land should reflect the value of the end product (a house) discounted back to allow for development costs, but it doesn't. So what does it cost to develop land?
Costs of developing land
GST is the first thing that most investors forget to factor in. Whether they end up developing the site themselves, or a developer does, someone will have to pay GST on the improvements. At 15% GST is the largest cost, and surprisingly often missed out in any feasibility analysis.
Auckland council charges roughly $20,000 per site, which is effectively an infrastructure tax on new development.
Civil costs and services
There is no appreciation for the cost of getting services and building platforms into a site from those that have not done it before. This is especially true for land in a volcanic area or on a slope, i.e. most of Auckland.
If you're splitting a site into two a surveyor can do that for you at all all up cost of around $15,000. When you're doing a 30 unit site you'll need a whole team of consultants to navigate you through Consent Hearings and probably Environment Court. The number of paper shufflers at council goes up exponentially and every piece of inefficiency and bureaucracy compounds on its-self. A resource consent can cost $500,000 and take over a year. Then add in another $500,000 for earthworks and building consents. Below I've itemised my pre-development expenses. These reflect the money we've had to put into our development before we even start building. It will give you an idea of just how large the upfront costs can be. We spent over $500,000 before getting resource consent, a resource consent that was initially declined.
Powell Street - Pre Development Costs
|Planner & Urban Design||$206,000|
About the cheapest cost I've seen (with reasonable quality) is $1,600 per sqm. For an average 160sqm house that equates to $260,000. There is also the issue that as land get more expensive, you need to build a higher quality house on it to make it stack up value wise.
Bringing the whole thing together and funding it and taking the risk will require a profit margin for the developer. As a guide, lenders won't fund developers with much less than a 20% margin.
When buying land you need to factor in accurate development costs. A rational investor would buy land factoring in holding costs, consent costs, and subdivision costs. If they were doing a bigger development they'd also need to factor in a profit margin for the developer whether they do it or on-sell it to someone else. Contrary to what most investors seem to believe, developers don't take on huge risk and invest capital over a number of years for free.
The NZ market has been dominated by small builders and 2 or 3 unit "developments." With these small scale developments the investor can usually piggyback off existing infrastructure, fund it through their own means, and they will be prepared to take a lower margin. Profit generally translates to "wages." The majority of immigrants end up being self-employed or being employed in their community and this often ends up in the building industry. It's not surprising that a lot of immigrants end up involved in small scale development with low margins. They simply want to work and earn a living and that's hard in New Zealand. Often with infill housing, tax is also avoided. The most common reason is that an investor is subdividing their own land with a view to keeping both properties. I suspect there is also a lot of tax avoidance with builders "living" in their properties until such point as the profit is tax-free. With immigrants this translates to parents or sibling going on the title and "living" in the property so it becomes tax-free. All of these things push up the value of smaller developments sites. There is not a linear relationship between land size and value. Smaller sites will be priced higher than larger sites on a per square metre mostly as a result of tax.
For many coming into NZ from Asia they view land almost in the same league as gold. It has no immediate return, but has the necessary scarcity and is an excellent long-term store of value. Then there is relative value. On 3rd Degree this week a new resident commented that an 80 sqm apartment in Beijing would cost NZD $1m. Add to that, that in China you cannot own the land and simply have a leasehold interest. Little wonder NZ looks like extremely good value. Asians generally also have an allergic reaction to paying tax, so no stamp-duty and no capital gains tax also helps when it comes to treating land as a "store of value." For New Zealanders there is also the added incentive of tax breaks on negatively geared property. Buying a development site as a long-term hold will generally be negatively geared and generate tax losses, with a tax-free windfall in the future. Forget any argument about being in the "Property Business" that is peddled by most self-interested industry figures. This is pure and simple effective tax planning and it distorts the market values. I'm a property investor and I love property, but I still find it absurd that you can offset losses against other income and yet take the capital gain tax free.
We need to encourage density and I'm broadly speaking a fan of the Unitary Plan. BUT the urban limit is plain dumb. By getting rid of the limit we won't create massive amounts of urban sprawl. Removing this false barrier reduces land values on the fringe and that flows back into the centre because it influences the opportunity costs and trade-offs all the way through the market. The councils role in pushing up land prices is frustrating. Another interesting issue I'd like to touch on is council valuations. In the absence of other information they are used by buyers as a proxy for value. For example, "houses in Sandringham are selling about 30% above CV." CVs completely over-estimate land values. I own a piece of land in Avondale which I bought for $1.05m. At the time it had a CV of $3m. I have since spent $1m getting it ready for development, and according to my Valuer it is worth about $2.6m with a resource consent in place. Even with a resource consent I'm still not at the council value. How can council valuations be so wrong and what distortion does that create in the market? It was on the market for 2 years before I bought it and luckily I was dealing with a realistic owner - funnily enough the council. I've seen first-hand how unrealistic landowners think. Their thinking (reinforced by some Agent that is equally clueless) would go something like this: a sub-dividable site sold down the road for $1.2m which was 15% above CV therefore my land is worth $3.6m. If you want to see what I'm up to visit our web site powellstreet.co.nz
Getting rich through property
It's hard to buy a business in NZ, except a cafe, motel, shop, or a services franchise. For the most part you wont get rich running any of these business and you wont get rich working for someone else. It is not surprising that property is how most Kiwis pursue wealth creation. It has low barriers to entry and it is easy to borrow against. With property, you won't get rich by paying off the mortgage. Wealth comes from leverage and capital growth over time. I wonder if our "shared need" for property prices to increase is a major part of what fuels the system. If everyone wants higher prices, what happens?
The stories we tell each other
Property is no different to everything else and so much of what drives the market is the stories we tell each other. The key storytellers are the real estate sales agents. And they will always talk up property. The problem is we all want our house prices to go up, so we reinforce and add to the story. I'm guilty, as are you. Its not helped by Property being the only realistic tool for many to become rich and hence the proliferation of "get rich with property" seminars and coaches. Stories soon become blurred with facts and they become indistinguishable. The best example is that there is a property shortage in Auckland. If you ask anyone why house prices are going up, they will tell you because we aren't building enough houses. Drill any deeper and blank faces will look back at you. With all of the information I have I still don't understand if we have a property shortage, and if we do, then exactly what that means. I certainly don't have a staunch view on it. Stories can get in the way of facts and become key drivers of purchasing decisions. Are bubbles the product of stories getting distorted into facts? Is speculation willingly buying with no information, or is it buying when believing stories to be facts?
Too many small investors (and some bigger ones) invest in property based on its mythical development value. With the new Unitary Plan, sub-dividable land has become even more trendy. Get rich quick. Suddenly everyone is buying a project but without a clue as to the costs involved. The problem I have with much of the talk around the Unitary Plan is that most investors buy land on the basis that some developer will buy it off them for squillions. They have no intention of developing it, and will simply hold it for someone else to develop later.
Pass the Parcel
We do not have a shortage of land. We have a shortage of capable developers and too many investor who can afford to be lazy land bankers. To date it has been a game of pass the parcel. With a growing population and nobody building, the game is to buy and hold land, then pass it on to someone else who will do the same and so on. The problem is that it never becomes economic to develop the land so we end up in a cycle of pass the parcel. Back to my $2.6m piece of land. With a good story and attracting some hot money from offshore I could probably sell it for $3.6m. That's the problem. Why take the risk and develop, when you can just pass the parcel?
If I'm going to point to all of the problems then its only fair that I also point to the things I believe would solve the inefficient allocation of capital to land.
- Introduce ring-fencing of property investment losses
- Improve how we measure house sales so we have more facts (Easy and not contentious)
- More accurately calculate CV land values (Easy and not contentious)
- Drop the urban limit
- Introduce capital gains tax on land value (to fund infrastructure)
- Get rid of development contributions
- Get rid of GST on land