From The Conversation.
A good rule of thumb in debates on who bears the economic cost of a policy change is to look at the positions taken by vested interests in the matter. If anyone is going to know if they bear the cost, it is those who pay. In the case of infrastructure charges on new property developments, the vocal objections from the property industry are a sure sign that they bear the economic costs.
Infrastructure charges are levied by local governments on developers of new land estates, based on an increased load on essential infrastructure services the council is responsible for.
A research paper reported in The Conversation recently claimed that property developers could pass on these charges in the price of new homes with a mark-up of 400%. The paper also claimed that these charges had the same price effects on existing homes, meaning that new home buyers ultimately bear the cost of infrastructure charges, rather than developers.
But the logic of this should be challenged and is not borne out in the results of other rigorous academic studies of infrastructure charges, which have in fact found the opposite.
The idea that costs of developer charges can be passed on through new home prices sounds intuitive. But it is based on an incorrect notion that prices are determined by costs.
In fact, developers already charge the maximum the market will bear. To not do so would be the equivalent of selling your house for half the market price, just because it only cost you that amount 10 years ago when you bought it. You wouldn’t do it, and nor would a developer.
Using a statistical analysis of a simple regression of home prices with developer charges, along with many hedonic control variables – as this study has – will find a positive correlation simply because charges are set in proportion to housing size. But that isn’t a causal relationship.
As Ian Davidoff and former academic economist (now the ALP’s shadow assistant treasurer) Andrew Leigh succinctly describe in their study on how stamp duty affects the market:
…if one were to simply regress the sale price on the tax payable on that property, the coefficient would capture both the mechanical fact that the tax amount is a function of the price, as well as any behavioural impact of taxes on prices.
It’s true that observations of this mechanical relationship have been widely interpreted as a behavioural effect in the literature on developer charges. But the best analysis does not interpret such results in this way.
A better way to observe behavioural impacts is take advantage of natural experiments, such as when a developer charge is increased in one area but not in a comparable adjacent area, then look at any subsequent price changes compared to the “control group”.
These types of natural experiments can alternatively be attempted with statistical controls, and a recent paper does just that when looking at the house price effects from additional costs imposed to finance infrastructure.
They find that not only are proper statistical controls very difficult to implement, but that prices decrease per dollar of additional infrastructure charge by somewhere in the range of $0.33 to $2.09.
This range captures the standard view that costs cannot be passed on in prices, which in the case of developer charges means that the developer or previous landowner bears the full cost of the charge, and not the home buyer. Davidoff and Leigh’s controlled results support this view on the incidence of stamp duties in Australia.
These more properly controlled results are consistent with the political actions of the property industry who oppose developer charges because they bear the full cost.
Why is all this important? Vested interests benefit from any illusion of unsettled academic debate. In the case of developer charges the property lobby can maintain an intelligent-sounding “Goldilocks” view in public debates that goes something like this: “The research is not settled. But it is likely that we don’t pay the full charge, nor do we pass it on completely in home prices. The cost is probably shared between us and the homebuyer.”
They capitalise on this apparent uncertainty by claiming that their interests are aligned with the home-buying community; a seductive “Goldilocks” view that is hard for politicians to ignore.
Author: , Economist at The University of Queensland
As a developer myself I and most of the people in the industry I know do a reverse price feasibility study is based on market demand and forecast price on completion and allowing a 30% margin generally incorrectly referred to as “profit”.
Factor in a 10% price drop on completion and a 15% cost over run and your 30% “profit” margin is gone.
Alternatively if you have not sold “off the plan” a 9 month sales period will generally wipe out your 30% “profit” margin.
I looked at doing a few projects in Sydney a few years ago and at the time between the SCC and NSW State Government government charges were $225k per lot, development cost $100 per lot, holding costs, assuming you could get a vendor to sign a contract with settlement when the project was “shovel ready” were around $50k, if you had to settle and then hold the land for the 5 years it takes to get an approval, please ignore the PR nonsense from the NSW State Government & SCC, this is real world stuff, then holding costs were around $200k and the selling price point I identified was $350k per block.