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Differential Movements in the Prices of Houses and Units in Melbourne

Differential Movements in the Prices of Houses and Units in Melbourne. Kelvin Wong University of Hong Kong. Hao Wu University of Melbourne. Objectives. Many macro studies have explored different determinants of housing price movements We try to ask a different question:

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Differential Movements in the Prices of Houses and Units in Melbourne

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  1. Differential Movements in the Prices of Houses and Units in Melbourne Kelvin Wong University of Hong Kong Hao Wu University of Melbourne

  2. Objectives • Many macro studies have explored different determinants of housing price movements • We try to ask a different question: • Do the price of houses and units move in tandem? • If not, what might explain their differential movements? • In Australia, esp. Melbourne & Sydney, development density has undergone some structural transformation • Past 20 years: Melbourne population grew by >30%; similar growth is expected to continue in next 20 years • Melbourne 2030 Plan (Melbourne @ 5million): impose Urban Growth Boundaries to promote higher density development within the city • A study still in progress, so comments are much welcome…

  3. Dwelling types • Australia Bureau of Statistics • Separate house • Semi-attached house / terrace house / townhouse • Flat / unit / apartment • Our definitions based on REIV and other studies (e.g. Kupke et al, 2011) • House: single family, low density • Stock: 68% (1996) down to 67% (2006) • Unit: multi-family, medium density • Stock: 18% (1996) up to 21% (2006)

  4. House v Unit

  5. Melbourne (inner) 2x 1.5x Source: REIV

  6. Theoretical arguments • Houses are generally more expensive – not an argument here • Can the price of houses grow faster than the price of units? • Yes, the two markets are completelysegmented • No, space is perfectly substitutable • Buyers may shift to buy units • Unit developers may become house builders • Reality: somewhere in between, because of … • transaction cost (e.g. search and moving) – short-run effect • inelastic supply (e.g. construction lag; planning control) – medium-run effect • Structural differences in demand or supply drivers?

  7. Motivated from a HK study More non-local investors (speculators), who want liquidity Better location Source: RVD

  8. Internal demand driver? 1. Local purchasing power • As real income increases, the demand for houses increases more than that for units • Move from units to houses – better quality, better neighborhood, greater control of the property • Early 1990s: income growth driven by economic recovery (e.g. Tu 2000) • Post-2000: income growth stimulated by capital inflow

  9. External demand driver? 2. Capital inflow • Immigration increases the demand for houses more than that for units • Immigration policy in favor of wealthy people who can invest substantially in local economy • Foreign investment increases the demand for houses more than that for units? • Not necessarily, because of foreign investment restrictions on landed property (e.g. houses)

  10. New factor from real option theory • Clapp, Salavei& Wong (2012) • Estimated that up to 30% of the house price can be attributed to an option premium in the US • The premium is larger for towns with higher redevelopment potential and greater house price volatility • Supply, not just demand, is also substitutable • Implication for the house-unit price gap • Consider two otherwise identical pieces of land, one with a house and the other with a higher density development (units) • The latter, having fully utilized the land, has a higher overall value (while each unit has a lower value than the house) • The house owner can realize the higher overall value if it is redeveloped into units (at some cost) • If option theory is correct, the flexibility to redevelop an existing house is valuable, and this should be translated into a higher house price (relative to unit price which carries no option value)

  11. Redevelopment in Melbourne • Evidence on redeveloping houses into units • Planning policy and home-starter subsidies encourage urban consolidation, leading to gentrification and inner city intensification • Common practice: Purchase run-down existing homes and convert them into higher density units • More recently, builders actively seek to buy suburban backyard to build units (i.e. subdivision) • Main hypothesis: A higher volatility increases the option premium embodied in house prices, hence a larger gap between house and unit prices • Volatility of unit prices • Volatility of construction costs…

  12. A reduced-form model log(net migration) log(House price / Unit price) log real income (deflated by CPI) Log(exchange rate of AUD against USD) Return volatility of property stocks listed on ASX Lagged supply of houses and units

  13. Sample & descriptive statistics • 1993-2011, quarterly data • Inner Melbourne

  14. Results for inner Melbourne N: 75, Adj. R2: 75%, DW-stat: 1.7

  15. Results for outerMelbourne N: 75, Adj. R2: 33%, DW-stat: 1.8

  16. Conclusion • Our preliminary results support the real option theory • Higher volatility increases house prices more than unit prices • Such a relationship is significant in inner Melbourne but not outer Melbourne • But we need more micro-level data for further tests: • Suburb-level: building age, planning parameters • Transaction-level: hedonic pricing + option value

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