Reader mailbag: restrictive covenants edition

If the particular character of a neighbourhood is all that important, why don't residents protect it using covenants?

A reader emails me:

I don’t think it is Nimbyism if a neighbourhood wants to protect its own character. What is Nimbyism is denying others beyond your neighbourhood the same opportunity you had.

It seems counter intuitive to think a place like Houston which has few zoning laws gives local communities greater control to enable the protection of individual property rights by allowing those individuals to collectively agree to covenant those rights (which include the protection of special character areas like Franklin Rd) and yet not to interfere with others who may wish a different way outside that zone.

High density advocates hate the idea that Houston communities that fringe CBD areas can continue to live a lifestyle that they have agreed to and also stop others (like Dhyrberg) from coming in and destroying it.

I know that many new developments come with covenants restricting future use of the property: developers expect that residents want rules binding both themselves and their neighbours. I don't want to live in that kind of place, but in a world of heterogeneous preferences, some prefer homogeneity.

Is there anything legally that would stop residents in places like Epsom, Grey Lynn, or any of the other hotbeds of development discord, from jointly agreeing to bind themselves against future development?

Under the status quo, everyone on the street seems to have been given a property right in what anybody else does with their property even though no covenant was put in place. It's an odd conception of property rights to say that, because I bought my house with certain expectations of what my neighbours might do, I therefore am allowed to veto anything they may wish to do with it.

Imagine some street where most residents put value on the street's current character; some on the street would prefer to turn their houses to higher-density use. The current rules let the character-amenity people shout a lot and block the development; those wishing to develop have to pay off all the potential veto players in order to prevent their blocking. Shouting is cheap and, since a developer would have to pay off every potential shouter, there is incentive to pretend to care more than you really do. I'm sure much of the shouting is genuine. But we have little sense of the real dollar value of the experienced disamentiy.

An alternative framework would have those who love the neighbourhood's particular character draft up a covenant agreement and try to get all the owners to sign on. If there are neighbours who were set to re-develop instead, they'd either not sign and not be bound, or be paid by their neighbours to take on the covenant's provisions.

Coase tells us that in low transaction cost environments the two scenarios should be equivalent. Coase also tells us that all the interesting action is in the high transaction cost real world. Is it cheaper to overstate your preference against a neighbour's re-development, or to overstate your willingness to turn your house into a 3-storey set of condos to try to induce payments not to? The former is pretty easy. The latter generally takes a set of architectural and engineering drawings plus building consent applications.

I wonder whether it would be workable to do away with neighbours' ability to object to anything other than real environmental effects like shading by replacing the regime with a menu of covenant options that neighbours might wish to impose upon themselves consensually.

Thanks to my correspondent for useful discussion.

Zone wars

Auckland's battle over school zoning gives some hint as to the magnitude of the value at risk. 

Adrien de Croy, who lives with his family in a home zoned for EGGS and also within the proposed One Tree Hill College zone, understood there was significant pressure on the rolls at AGS and EGGS.

"They can't really reduce the zones unless there's an alternative in place, and [the proposed One Tree Hill College zone] basically gives them the opportunity to reduce their zone. We see it as the first step to removing us from the Auckland Grammar and EGGS zones."

Mr de Croy, whose eldest child is 7, said at this stage his main concern was for the value of their property. A real estate agent had told him a typical premium someone would pay to get into the "double Grammar zone" was about 20 per cent.

Last year the Herald reported one Mt Eden home just 750m outside the area went for $516,000 less than a house up the road, valued the same but situated 250m within the zone.

One Tree Hill College principal Nick Coughlan said he understood such concerns, but they were unfounded.

The zone, and any overlaps, was informed by the need to not divide areas and homes around contributing schools. There was no intention to realign zones in the future, Mr Coughlan said.

We can do better than this, though, to gauge the effects of school zoning. For that, we turn to Waikato's John Gibson and Geua Boe-Gibson. They've estimated the effects of school boundaries in Christchurch pre-quake. From their abstract:

School attendance boundaries are a contentious issue in New Zealand, and have been relaxed and re-imposed depending upon political sentiment. Critics contend that a supposedly egalitarian state school system becomes one of selection by mortgage, with the value of ‘free’ schools capitalized into property prices. Attendance boundaries restrict the schooling opportunity set facing a student, who typically is unable to study at nearby high-performing schools if they live outside their boundary. We relate schooling opportunity sets to sales prices of over 8000 houses in Christchurch, controlling for dwelling attributes, neighborhood characteristics and geographic accessibility to a wide range of services. Our model explains over three-quarters of the variation in prices and we use this model to predict property prices if there were no attendance boundaries. Abolishing boundaries expands most schooling opportunity sets and predicted house prices generally rise. But prices would fall in some higher income neighborhoods with highly educated residents, who are likely to oppose reform of school attendance boundaries.

Gibson and Boe-Gibson use a year's worth of house sales in Christchurch, October '04 through October '05, to check the effects of school zones on prices after accounting for land and building area, building age, materials, parking, garage, and whether there was a deck, slope, or view. I hadn't known that QV data included information on the latter three. Importantly, they link in Census meshblock data on neighbourhood ethnicity, immigrant status, education, and employment, and meshblock crime. Some of the work on school zone effects will confound "good school"  with "seen-as-desirable (ie no rednecks) neighbours".

They simulate the effects of a standard deviation increase in NCEA Level 1-3 pass rates on median house prices and find that, all else equal, having access to a school with a standard deviation better NCEA pass rate is worth between $14,300 and $19,900 for the median house. This gives a few implications.

First, the market value of policy innovations that improve school quality is very high: a policy that improved NCEA pass rates by a standard deviation is worth about $42 billion.

Second, locking poorer people into poorer schools seems a pretty bad policy. Gibson calls it "selection by mortgage", and worries it can reduce social mobility especially among minority groups.

Finally, while abolishing school zones would increase the total value of the housing stock because gains to those getting access to better schools exceed losses to those currently sitting on regulatory rents, it's unlikely to happen because those earning the rents are more effective at protecting turf. While the average goes up in value by about $25,000, houses in preferred zones drop in value by about $20,000. I expect this is an upper-bound estimate as other forms of rationing would have to come in for the better schools in the absence of mechanisms allowing them to grow, and as I'd expect that those with current access would find ways to maintain such access.

Rich people can afford to pick their preferred public schools; poor people get locked into whichever schools service poorer neighbourhoods. The problem is worse in much of North America, where schools are funded from local property taxes rather than from general revenues, ensuring that poor places can't afford good schools; New Zealand's decile funding system works to provide equitable funding across schools. But zoning still causes problems.

Gibson and Boe-Gibson conclude:

...the property market becomes the main schooling selection mechanism for New Zealand parents who are ambitious for their children. Even though schools may nominally be ‘free’, students from poorer households face more restricted schooling opportunities than do wealthier students, being constrained through the housing market.

Almost two decades have passed since New Zealand’s brief experiment with relaxing school attendance boundaries in the 1990s. The frequency of reselling houses makes it likely that most home-owners have paid a price for their dwelling that includes the expected value of access (or exclusion) from particular schools. Consequently there will be windfall gains and losses if future policy reform allows a weakening of attendance boundaries and an opening up of school enrolments. Nevertheless, the wide variation in school performance and the contribution of attendance boundaries to reducing social mobility suggests even difficult reform is worthwhile.

I would love to see a replication of this work in Wellington. In particular, I'd love to know the relative magnitudes of school zone and all-source earthquake risk on property values. Is there a bigger difference between moving from Wellington College zone to out-of-zone than from moving from a low-medium quake-risk property to one that will fall off the side of a cliff in an earthquake? I suspect so, but it would be nice to know.

Things I wish TradeMe Property could do

For reasons soon to be made clear, we've been perusing TradeMe Property's Wellington offerings. TradeMe is the country's best overall aggregator of available property listings. [Update: see here].

Here are the things that you can currently do on TradeMe Property:

• Restrict your property search by:
• Bedrooms (we want 4+);
• Number of bathrooms (we want 2+);
• Neighbourhood (we're flexible);
• Price range (likely <$800k; Wellington's way more expensive than Christchurch);
• Property type (house, apartment, section, townhouse, unit)
• You can find out, for any property:
• Zoned schools, out-of-zone schools, unzoned schools;
• Maps, property boundaries, great links through to Google Maps.

Here are some things that could easily be done, but aren't currently done:

• Chorus maintains a great map of network capability. For any property, you can see if they're on the fibre network, whether VDSL2 is available, whether ADSL2 is available, or whether you're stuck on standard ADSL. Our house at New Brighton is on VDSL2 and gets 40MB/s to the cabinet downstream, 10 MB upstream. I'd like to be able to restrict property searches to those getting at least ADSL2 and strongly prefer VDSL or fibre; a decent internet connection is worth a lot to me. Scraping that detail into TradeMe Property would be pretty easy, once Chorus's website is back up.
• Update: Vodafone has it too. Somewhere in TradeMe's back-end it should be able to just pull address details for both of these to see what's available. 
• Update: Mashblock! I'd been going through the Census's front-end, but that's cumbersome. Mashblock goes straight from address to Census meshblock and tells you the neighbourhood's demographics. There's still important Census stuff available that isn't yet on mashblock, like household composition and education, but Mashblock's a good start. And especially since the StatsNZ version is really cumbersome if you want quick stats on an address. 

Here are some things that could be done, but might be harder, and might only matter to me.

• Wellington District Council has great maps showing hazard risks. There's a combined hazard map providing all-source risk of earthquake shaking, liquifaction, tsunami, and landslide. And, you can also get it by each of those risks individually. I would like to be able to restrict my search as follows:

"Return only houses showing low all-source risk, but add to that any weatherboard or wooden house where risk is only due to earthquake shaking, because old weatherboard places fare well in shakes so long as other risks are low."

• Wellington is all valleys and hills; it's hard to tell which get any sun unless you live there. SunCalc provides sun positions at different times of day; you can also change the date to get seasonal effects. As it's overlaid onto Google Maps, you can pretty quickly see if you're going to be badly shaded by surrounding hills. It should be possible to turn that into a sun score. 

I emailed a Wellington realtor explaining what we're looking for; he laughed at me as he'd never had anybody put first priority on where the house sits on the WDC earthquake risk map. While this makes me worry about how seriously Wellingtonians take earthquake risks, it does mean that there shouldn't be particularistic price premiums on safer houses. And that's good for me. 

We started out looking at Karori, Khandallah, Johnsonville and Aro Valley; we've started looking more at Island Bay as you seem to get rather more house for the money there, and the commute in to downtown doesn't seem at all unreasonable. But I'd happily accept advice from those with better local knowledge. I will look forward to meeting far more of my Wellington readers.

Labour on Housing, RBNZ on LVR

There appears little plausible economic justification for Labour's proposed ban on foreigners' buying houses.

Let's take Seamus's logic from yesterday one step further. Recall Seamus's simple model:

Consider a very simple model of the New Zealand housing market in which there is a fixed supply of identical houses that will not change over time, and an unchanging demand. Let there be no on-going maintenance or other costs to owning a house, just the one-off capital costs. Finally, let there be a risk-free interest rate of 5%, let demanders be risk-neutral and indifferent between renting and owning for a given cost, and let rental income to a landlord be exempt from tax so that there is no tax advantage to owner-occupied housing. In this world, there would be an unchanging equilibrium rental price for housing over time, and an unchanging price of houses that would be equal to this rental price times 20.

Following on from Seamus's later tweaks to the base model, let us also change the model a bit. Imagine that demand in one year's time will double and then stay constant from then on, and that everyone knows that as of tomorrow. The process is identical to the one Seamus lays out for the case where only foreigners know that equilibrium demand doubles in a year's time given that the stock of foreign capital is large relative to the domestic market:

In this version of the model, the rental rate would continue to remain constant for a year before doubling, but foreigners would bid up the price of houses now to the point where the capital gain between now and in one-year’s time was sufficient to exactly offset the fact that current rentals are insufficient to cover the capital cost of the house.

We can get a disconnect between current rental prices and current house prices where the market expects a future increase in demand relative to supply. That rental rates have not gone up lock-step with Auckland housing prices simply isn't automatically evidence of a bubble or anything irrational. Rational, forward-looking investors could easily be looking at the current Auckland market, the current plans for expanding housing supply in Auckland, and concluding that there's no way that supply will increase quickly enough to keep up with increases in demand. We can't guarantee that this is what's happening, but we cannot simply look at the purported disconnect between rental costs and property prices and conclude BUBBLE.

Now, consider the RBNZ's proposed LVR policy. The policy restricts banks against allowing more than some percentage of new home mortgage loans to have "small" deposits. I am not sure if RBNZ has yet indicated what the thresholds for the different speed limits will be, but it's sounded like it's designed to be binding most of the time. Under what scenarios does this rule make sense?

Start with a world like Seamus's: perfectly inelastic supply, prices 20 times rental rates under his conditions. Further, there is zero chance of bank bailouts in case of property market collapse; everything would be handled under OBR where depositors might take a small(ish) haircut. Individual investors form expectations about future demand; banks form estimates of the future price paths of housing. They're both identical in this simple case. Now, suppose that a cohort of buyers knows that demand will double next year and so start bidding up the price of housing today. The banks from whom they're borrowing money check to make sure that the buyers will be able to cover the mortgage costs and that the buyers' expectations around future rental earnings aren't crazy.

In this world, LVR restrictions only make sense where bank exposure to highly leveraged property loans impose systemic unpriced risk. Even if RBNZ knows no better than do individual banks, they might want to set speed limits where loans risk pushing into leverage levels consistent with prior cascading bank failures. I'd expect that RBNZ has run plenty of stress tests and has some idea of what level of leverage could yield cascading failures for varying levels of property leverage and plausible ranges of housing market drops.

But, in this world, you only set the speed limit to bind in exceptional cases, not in normal cases. To get a rule that binds more strictly, I think you have to assume that RBNZ knows more about the future path of relative demand (either shifts in demand, or potential moves in the supply curve) than do either the banks or investors.

I wonder whether Labour's "dey turk er houses" ban-the-foreigners housing policy shares some common assumptions with RBNZ's LVR regs. Tweak Seamus's model a little bit such that these foreign investors are all just systematically wrong about the future demand path and that there are enough of them that they can manage to affect prices at the margin. Then banning them from bidding up housing where we know that they are causing a bubble by definition avoids a bubble. I do think this requires some pretty heroic assumptions about knowledge asymmetries. But they might not be all that far from the knowledge assumptions required to make sensible an LVR policy that binds in the normal rather than only in the exceptional case.

Christchurch Housing

I'd missed the Ministry of Business, Innovation and Employment's summary report on Christchurch housing when it came out a couple of months ago.*

The highlights:

• Total housing stock dropped by a net 11,500, or 6.2% of the ex ante housing stock, from 2010Q4 to 2012Q4.


• The number of private rentals as measured by tenancy bond remained constant at 39,000 during 2011 and 2012; the prior trend had increases of 1500 per year prior to 2010. 
  Demand for rentals would have increased sharply with destruction of owner-occupied homes, temporary moves by those getting repairs, and incoming construction workers. The largest drops were in tenancies of 2 to 3 bedroom homes.


• House prices in Christchurch are well above their prior 2007 peak, though Auckland's prices have ramped up by even more. But Christchurch rental prices have increased by more than Auckland. From August 2010 through February 2013, the average Christchurch weekly rent measured by new bonds lodged** increased by 31%, from $293 to $384. Auckland rental prices increased by 13% over the same period. 
• While average weekly rents remain higher in Auckland and in Wellington, the 2012 Household Income Survey has household income in Auckland at $94k, Wellington at $93k, and Canterbury at $82k.


• Rental accommodation at the bottom end of the market have been particularly hit. MBIE notes that MSD reckons $180/week about what beneficiaries can pay in rent; the proportion of private new bonds lodged in that range has halved since the quake. 
• I'm following up with MBIE for a bit more data on the overall distribution.


• Social housing units, whether provided privately as bedsits and boarding houses or publicly as Council housing or Housing NZ units, have also dropped substantially. Housing NZ was down 6% as of December 2012; I understand that the government pushed pretty hard to get the Housing NZ units sorted despite some thorny insurance issues. Christchurch Council is down 17%. The low-income tenants here served would not have an easy time finding alternative accommodation. They're being outbid for private rentals by incoming construction workers and by people seeking temporary accommodation during earthquake repairs. 
• I note that measures that could increase supply at the lower end of the market, like making it legal for private homeowners to build secondary flats into their homes, would result in fewer vulnerable tenants being displaced. 


• Holiday parks, which sometimes provide overflow temporary accommodation rather than just catering to tourists, are also overflowing. 
• I note that Council staff came close to shutting down the South Brighton holiday park when its toilet block failed an engineering code assessment; they backed down when it hit the press and instead are letting it be strengthened.  

The report also warns of a huge increase in accommodation demand set to come in 2014-2016 when an estimated 15,000-25,000 construction workers will be looking for housing at the same time as tens of thousands of home repairs create demand for short-term accommodation.

There's no way that allowing secondary flats within peoples' houses would come close to meeting the demand that's yet to come. But neither is there any reasonable reason to continue banning one of the easiest ways of getting quick temporary accommodation to market.

It will be interesting to see what will happen in 2014-2016.

* I'd linked the report here, but hadn't gone through it in depth.

 ** This will provide a better indicator of current market prices than would a measure of all existing rents: it shows what prices are faced by those coming to market.