RDP 2011-03: Urban Structure and Housing Prices: Some Evidence from Australian Cities 1. Introduction

Housing prices in Australia have grown significantly in real terms and relative to household incomes over recent decades. Changes in housing prices, like changes in other prices, are the result of many underlying forces. There have been a number of important demand-side factors, most importantly the lower average level of nominal interest rates in the inflation-targeting period and the greater availability of credit stemming from financial deregulation (see e.g. Battellino (2009), Ellis (2006) and Richards (2008)). However, supply-side factors can also matter. It is noteworthy that while prices have risen significantly over an extended period and population growth has been quite strong, there has been no pick-up in the supply of new housing (see Figure 1). Indeed, the growth rate of the nationwide housing stock has been falling gradually over the past several decades, and in 2009 and 2010 was lower than at any time in at least the last 50 years. The corollary of the developments in housing supply is that average household size (the number of people per household) has risen in recent years, after declining gradually for at least a century.

This paper studies how some aspects of the supply and demand for housing determine the structure of cities, including density and the price of land and housing. In particular, we study the impact of the provision of transport infrastructure, land use policies such as zoning limits on housing density, and frictions that increase the cost of new housing development. We use a version of the Alonso-Muth-Mills model, calibrated to match broad features of a representative large city, to analyse the impact of these factors on the equilibrium structure of a city, the housing choices of households and the price of housing. We also examine how the equilibrium is affected by the size of the population, and in doing so show how certain policies that might initially have had only small effects could be expected to have large effects following significant growth in the population.

Overall, the theoretical results draw attention to factors that are likely to have been contributing to developments in the Australian housing market over the past decade or more. Many observers, including in the development industry, have pointed to difficulties in the construction of medium- and high-density housing close to the CBD. In the context of the model, this would be consistent with a range of factors, including a shortage of appropriately zoned land, driving up development costs. Towards the city fringe, these factors could also be weighing on the economics of new construction, with poor transport infrastructure also affecting households' willingness to buy at more distant locations. Together, to the extent that these factors have driven up the cost of new housing and reduced its supply, they could be expected to have also increased the price of the existing stock of housing.

The paper is organised as follows. The next section lays out a basic version of the Alonso-Muth-Mills model. Section 3 studies the role of some key determinants of the urban equilibrium in the context of this model. Section 4 provides some empirical evidence on the structure of the major Australian cities, including housing prices, urban density and zoning, and assesses how these relate to some predictions of the model. Section 5 concludes.