RDP 2020-04: The Apartment Shortage 1. Introduction

Australian cities face a shortage of apartments. The severity of this shortage can be gauged by the difference between what home buyers will pay for an apartment and what it costs to supply. For example, we estimate that the average new apartment in Sydney sells for $873,000 but only costs $519,000 to supply, a difference of $355,000 or 68 per cent of costs. The wedge is 20 per cent of costs in Melbourne and 2 per cent in Brisbane. Why don't builders and developers exploit these profitable opportunities? The standard answer is that planning regulations stop them.

There are frequent media reports of people willing to pay hundreds of thousands of dollars more for the legal right to add an extra apartment to their building. For example, in 2014 a property at 661 Chapel St, South Yarra in Melbourne was sold for $20 million when it was zoned for 13 storeys. It was then rezoned for 31 storeys and sold later that year for $56 million (Lucas 2017). Loosening restrictions added $36 million in value. For more examples see Kendall and Tulip (2018, Appendix A). These anecdotes suggest that, but for planning restrictions, apartments would be readily supplied for much less than current market prices.

While observations like these are common, it is not clear how representative they are. This paper quantifies the shortage by comparing city-wide estimates of costs and prices. Kendall and Tulip (2018) conducted a similar exercise, focusing on houses, with some simple estimates for apartments. This paper takes a closer look at apartments, given that they are the focal point in planning debates. Whereas estimates of the zoning effect for houses answer the question: why is housing so expensive?; estimates for apartments are more relevant to the question: what do we do about it?

The first objective of this paper is to examine the effect of building restrictions on apartment prices in more detail, using data that Kendall and Tulip did not have. We use unpublished construction cost data from the ABS, filter CoreLogic sale price data more finely, add an extra two years of data and review other assumptions based on further consultation with the industry. This results in smaller but qualitatively similar estimates of the zoning effect in Sydney and Melbourne and significantly smaller estimates in Brisbane. A closely related objective is to examine the applicability of similar overseas research, discussed in the following section, in an Australian context. We confirm the key qualitative result of this previous research: building restrictions substantially increase the cost of housing. Consistent with this, a key contribution of this paper is to assemble and compare representative data for Australia's largest cities.

Our second objective is to examine how the shortage of apartments varies across time, location and building types. We find that, over the past decade, the excess demand for apartments has increased substantially in Sydney, fluctuated without trend in Melbourne and declined in Brisbane. In Sydney the excess demand is most severe in inner suburbs. In Melbourne and Brisbane excess demand is more dispersed. Tall buildings are a substantially less costly way of increasing supply than the ‘missing middle’ of medium density in middle-ring suburbs promoted by some planners.

Our paper only looks at the costs of land use restrictions. Policy decisions need to weigh these against benefits, which would be desirable to quantify. Pending that, we note that the literature surveyed by Ahlfeldt and Pietrostefani (2019) suggests that net externalities of urban density may be positive. Higher wages, more patent applications, less energy use and other benefits of density are found to more than offset traffic congestion, shadows, noise and other costs. Local studies, specifically Travers Morgan and Applied Economics (1991), Trubka, Newman and Bilsborough (2008) and CIE (2010), are less comprehensive, but do not point to overall results being very different in Australia. Glaeser, Gyourko and Saks (2005) specifically examine height restrictions and estimate their external costs to be small. Moreover, many observers have a sense of whether the benefits of lower density are ‘large’ or ‘small’ and these judgements can be compared with our estimates of costs.

Our results have obvious implications for housing policy and town planning. They also contribute to understanding the responsiveness of residential construction, a key parameter in the transmission of monetary policy. And they help to explain the determinants and sustainability of housing prices, which are important in financial stability policy.