RDP 2018-03: The Effect of Zoning on Housing Prices 9. Discussion

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

We estimate that zoning restrictions raise detached house prices by 73 per cent of marginal costs in Sydney, for example. We emphasise that this is not the amount that house prices would fall in the absence of zoning. As discussed in our introduction, that would require estimating supply and demand responses, which is beyond our scope. We also note that physical land costs are higher in Australian cities (particularly Sydney) than overseas. So even if zoning restrictions were relaxed, housing in Australia would remain expensive relative to cities where zoning is permissive and land is less physically scarce.

Ideally, policy with respect to zoning would reflect a weighing of the benefits and costs. Our analysis contributes to such a decision by quantifying some important costs. These should be offset against the benefits from zoning, such as offsetting the negative externalities of intensified or uncoordinated development. Gyourko and Molloy (2015) discuss the evidence on these issues and conclude that the overall efficiency losses from constraints on residential development may be large, with costs outweighing benefits by a substantial margin. Subsequent research (Albouy and Ehrlich 2017) supports this conclusion. However, both these studies note that the benefits of most forms of zoning regulations are difficult to quantify.

As Furman (2015) discusses, zoning regulations have some important effects that go beyond those we quantify. As they become more binding and contribute to increases in property prices, they represent a wealth transfer from future home buyers to current home owners (see, for example, the discussion in Lowe (2015)). They also result in higher rents as the supply of housing is constricted. Both of these factors may increase inequality. La Cava (2016) and Glaeser and Gyourko (2018) emphasise rising house values in supply constrained markets as a driver of changes in the distribution of wealth and income in the United States. Murray and Frijters (2015) argue that many of the benefits seem to accrue to those with political connections and can be dissipated in rent-seeking.

Development restrictions also reduce the responsiveness of the housing stock to changes in preferences and relative prices. This can ‘lock in’ an increasingly obsolete urban structure (Kelly, Weidmann and Walsh 2011). Cheshire, Hilber and Koster (2018) find that planning restrictions lead to a substantial misallocation of housing resources in England. Perhaps more importantly, these restrictions prevent labour from being allocated to where it is most productive. Estimates for the United States suggest these effects are large (Hseih and Moretti 2015; Glaeser and Gyourko 2018; Herkenhoff, Ohanian and Prescott 2018). Zoning restrictions reduce the elasticity of housing supply, making housing prices more responsive to changes in underlying demand. As Glaeser, Gyourko and Saiz (2008) document, this means that house prices are more variable than otherwise, with potentially negative consequences for financial and price stability.

If housing demand continues to grow, as seems likely, then existing zoning restrictions will bind more tightly and place continuing upward pressure on housing prices. Policy changes that make zoning restrictions less binding, whether directly (e.g. increasing building height limits) or indirectly, via reducing underlying demand for land in areas where restrictions are binding (e.g. improving transport infrastructure), could reduce this upward pressure on housing prices.