Will the government's Housing Infrastructure Fund finally make a dent in New Zealand's housing crisis? Probably not. It has elements of being a step in the right direction but, overall, it is way too tentative and doesn't solve the real problem anyway.
The underlying problem
If houses in Auckland were as affordable as they are in the Greater Tokyo Area (the world's largest metropolis and one of a handful of truly global cities) then the median house price would be in the region of $450k - $500k.
The main reason that they are actually double that price boils down to insufficient land being made available for development. What little is available has been bid up to astronomical levels reflecting the incredibly short supply. Unfortunately a speculation bubble has also formed on top of the normal price rise in response to the short supply.
Without going into all the ins and outs, any policy response to the high price of residential housing has to deal with two, inter-related problems: (i) there aren't enough dwellings to house the population of the country and (ii) speculators will keep bidding land and dwellings up out of the reach of normal people as long as they are convinced that authorities cannot or will not make it possible for enough dwellings to be built.
If building restrictions are just lines on maps then why don't councils simply allow more building? That was the theory behind Special Housing Areas. But fast-tracking permission to develop land for housing means nothing when there is no supporting infrastructure. You simply are not allowed to even start building a house in New Zealand unless you can demonstrate that basic services can be supplied.
The fact is that councils cannot find enough funding through normal channels to build enough basic infrastructure to get ahead of the demand curve for development. This is well known to the land bankers who can rely on council funding constraints when assessing the risks of land speculation.
The Housing Infrastructure Fund
Will the HIF break this log jam? Unlikely. Some of the reasons why:
Tuesday 25 July 2017
Monday 17 July 2017
Depreciation pt 1: the mechanics and revaluations
OK depreciation is a pretty dull topic. But it's not widely understood and it is a crucial component in the council funding model. We can't have a sensible discussion about the merits of Municipal Utility Districts or infrastructure bonds without a working knowledge of depreciation. This post aims to show that the mysterious world of depreciation and asset revaluation is really quite mechanical. A planned later post will discuss the "so what?" aspects of depreciation.
We are all familiar with the decline in value over time of the stuff we own. Our cars, computers, furniture etc are worth less this year than they were a year ago. In business, both private and public, this decline in asset value is formally tracked and accounted for in financial statements. So each year the value of fixed assets (cars, computers, plant) in the books is written down by some fixed percentage. Eventually, for accounting purposes, individual assets are deemed to be worthless and are no longer depreciated.
But there is a useful accounting practice that makes up for the loss of value. All private, public and not-for-profit businesses count that loss of value as an expense. As these organisations take in money they also have to pay operating expenses such as staff costs, power, insurance, raw materials and so on. Depreciation is counted as another expense except that there is no bill to pay so the money stays inside the business. That bit of cash can be put aside before any income or company taxes are calculated and paid.
For example if you buy a computer for a business for $900 that has a nominal life of three years then each year you depreciate the value of the computer by $300 and "put aside" $300 in cash. You can do whatever you like with the cash but if you did hold onto it, after three years your computer would be valued at $0 and you would have $900 in the bank. So you could go out and buy a replacement computer if you wanted to without having to put any more of your own money into the business.
Councils do the same thing with the value of their physical assets. But, because they are capital intensive industries the sums of money are comparatively eye-watering.
A simple example
Let's say a council builds a new bridge for $20m and the bridge's accounting life is 100 years. (Of course there are Roman bridges still standing after 2,000 years but for the purposes of managing money you have to draw a line somewhere).
The calculations are pretty straight forward at first. For accounting purposes the bridge will be worth $0 after 100 years so each year the council depreciates the bridge by $200,000. After one year the bridge is valued down to $19.8m and there are cash reserves of $200k. That process could continue each year for 100 years until the bridge was valued at $0 and there was $20m in cash in the bank.
That $200,000 cash still has to physically come from somewhere and it mostly comes from rates. In this example, building a new bridge automatically added $200,000 p.a. to the total rates take. If that seems a little strange I plan to clarify rating for depreciation in a later post.
Inflation and revaluation
Inflation (even super-low inflation) will savage that $20m over 100 years. The council could invest the money and chances are they could preserve its spending power. But, for a number of reasons, councils don't do that (they pretty much spend the money straight away). Instead, they revalue their assets periodically and, as a result, adjust the amount of depreciation they charge to keep in line with cost inflation.
Councils base their depreciation calculations on what it would cost to replace their assets today not what they originally spent. In the example of the bridge, after three years of owning it the council would get it revalued and recalculate the depreciation charge. The Civil Construction Price Index is currently running at about 3% p.a. (i.e. double the rate of consumer price inflation). At 3% annual price inflation the same $20m bridge would cost about $21.855m to build three years later.
Since the bridge is already three years old it only has 97 years of accounting life left, therefore the book value is set at $21.2m (97/100* replacement cost). The bridge is still going to be depreciated to a value of $0 over its remaining life so the new annual depreciation charge is 1/97 * book value or $218,545 p.a..
By revaluing the bridge every three years the council can keep lifting the depreciation charge to stay in line with current construction costs. Effectively it inflation-proofs its depreciation.
To Takeaway
Sure this stuff is as dry as dust but that is the whole point. The actual process of calculating and funding depreciation is orthodox accounting practised by private and non-private organisations all over the world. From time to time I see people convincing themselves that depreciation and revaluation is some kind of double-dipping or shady money practice. Nothing could be further from the truth.
Revaluation is a normal practice too. Listed property companies would not survive an audit if they didn't revalue their buildings every few years.
The only interesting part is what happens to the money that does collect via depreciation. And that topic is for another day.
We are all familiar with the decline in value over time of the stuff we own. Our cars, computers, furniture etc are worth less this year than they were a year ago. In business, both private and public, this decline in asset value is formally tracked and accounted for in financial statements. So each year the value of fixed assets (cars, computers, plant) in the books is written down by some fixed percentage. Eventually, for accounting purposes, individual assets are deemed to be worthless and are no longer depreciated.
But there is a useful accounting practice that makes up for the loss of value. All private, public and not-for-profit businesses count that loss of value as an expense. As these organisations take in money they also have to pay operating expenses such as staff costs, power, insurance, raw materials and so on. Depreciation is counted as another expense except that there is no bill to pay so the money stays inside the business. That bit of cash can be put aside before any income or company taxes are calculated and paid.
For example if you buy a computer for a business for $900 that has a nominal life of three years then each year you depreciate the value of the computer by $300 and "put aside" $300 in cash. You can do whatever you like with the cash but if you did hold onto it, after three years your computer would be valued at $0 and you would have $900 in the bank. So you could go out and buy a replacement computer if you wanted to without having to put any more of your own money into the business.
Councils do the same thing with the value of their physical assets. But, because they are capital intensive industries the sums of money are comparatively eye-watering.
A simple example
Let's say a council builds a new bridge for $20m and the bridge's accounting life is 100 years. (Of course there are Roman bridges still standing after 2,000 years but for the purposes of managing money you have to draw a line somewhere).
The calculations are pretty straight forward at first. For accounting purposes the bridge will be worth $0 after 100 years so each year the council depreciates the bridge by $200,000. After one year the bridge is valued down to $19.8m and there are cash reserves of $200k. That process could continue each year for 100 years until the bridge was valued at $0 and there was $20m in cash in the bank.
That $200,000 cash still has to physically come from somewhere and it mostly comes from rates. In this example, building a new bridge automatically added $200,000 p.a. to the total rates take. If that seems a little strange I plan to clarify rating for depreciation in a later post.
Inflation and revaluation
Inflation (even super-low inflation) will savage that $20m over 100 years. The council could invest the money and chances are they could preserve its spending power. But, for a number of reasons, councils don't do that (they pretty much spend the money straight away). Instead, they revalue their assets periodically and, as a result, adjust the amount of depreciation they charge to keep in line with cost inflation.
Councils base their depreciation calculations on what it would cost to replace their assets today not what they originally spent. In the example of the bridge, after three years of owning it the council would get it revalued and recalculate the depreciation charge. The Civil Construction Price Index is currently running at about 3% p.a. (i.e. double the rate of consumer price inflation). At 3% annual price inflation the same $20m bridge would cost about $21.855m to build three years later.
Since the bridge is already three years old it only has 97 years of accounting life left, therefore the book value is set at $21.2m (97/100* replacement cost). The bridge is still going to be depreciated to a value of $0 over its remaining life so the new annual depreciation charge is 1/97 * book value or $218,545 p.a..
By revaluing the bridge every three years the council can keep lifting the depreciation charge to stay in line with current construction costs. Effectively it inflation-proofs its depreciation.
To Takeaway
Sure this stuff is as dry as dust but that is the whole point. The actual process of calculating and funding depreciation is orthodox accounting practised by private and non-private organisations all over the world. From time to time I see people convincing themselves that depreciation and revaluation is some kind of double-dipping or shady money practice. Nothing could be further from the truth.
Revaluation is a normal practice too. Listed property companies would not survive an audit if they didn't revalue their buildings every few years.
The only interesting part is what happens to the money that does collect via depreciation. And that topic is for another day.
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