Rising building costs and population growth didn't drive up house prices as much as low interest rates, our distorted tax system and short land supplies, a new study has found.

Global falls in interest rates, tax and restrictions on urban land supply are the main cause of higher house prices during the last 20 years.

Recent policy changes and reforms show signs of addressing past housing and urban system issues for the future.

A housing technical working group was formed by Te Tai Ōhanga the Treasury, Te Tūāpapa Kura Kāinga the Ministry of Housing and Urban Development and Te Pūtea Matua the Reserve Bank.

That group released a housing report based on insights from the Hamilton-Waikato area.

It aimed to identify what caused the housing boom for future state decision-making.

The Treasury's Dominick Stephens, who is group chair, said factors like population growth and construction costs were seen as playing a more modest role than the other three main causative factors.

Dominick Stephens headed the group which released the report. Photo / supplied

The global decline in interest rates inevitably led to a sustained reduction in borrowing costs in New Zealand, increasing the demand to buy houses, he said.

"If land supply had been more responsive, this would have sparked a larger housing supply response, moderating any initial lift in house prices and putting downward pressure on rents. Instead, restrictions to land supply meant that much of the fall in interest rates was capitalised into, or captured by, higher urban land prices.

"Higher urban land prices led to higher house prices without increasing the incentive to build dwellings."

When land supply was restricted, changes to the tax system tend to affect the value of urban land rather than affecting dwelling supply or rents, Stephens said.

The three agencies wanted to know about the linkages between the economy, Government policy, monetary policy and the housing market, with a particular focus on social wellbeing.

"In our assessment, the main driver of house prices in New Zealand over the past 20 years has been a global decline in interest rates, in the context of restricted land supply.
House prices rising much faster than rents over the past 20 years has resulted in a dramatic increase in the price/rent ratio, or equivalently, a dramatic decline in rental yields - annual rent divided by the property's value," the report said.

House prices in the Hamilton and Waikato area rose much faster than incomes during the past 20 years but mortgage rates have approximately halved.

The net effect is that mortgage costs relative to income have decreased since 2000.

In 2020, New Zealand had the highest housing cost to disposable income ratio in the OECD. Waikato region house prices rose by 372 per cent between 2002 and 2021 and rents went up by 114 per cent, the report said.

Aerial view of the Waikato Expresway Hamilton bypass at Kay Road Bridge. Photo / supplied

The Waikato had geographic and natural constraints on housing expansion: "Highly productive soils, deep peat soils, rivers and high-risk flood zones from wetlands. Around 65 per cent of land in the Waikato is used for farming or forestry, 27 per cent is indigenous vegetation, and 1 per cent is urban. Compared to other major centres, the Waikato has fewer natural constraints. Sites of significance to Māori can also be a constraint on development and unable to be mitigated," the report found.

Tax distortions affected house prices, land prices, rents and construction costs and these have hit the Hamilton/Waikato area as much as other regions. The most important tax distortions are:

• Imputed rent - the rent owner occupiers effectively pay themselves - is not taxed, whereas other forms of income earned on investments are taxed;
• Capital gains are not often taxed, whereas other forms of income are;
• GST is charged as a lump sum when a house is built, and is charged on maintenance costs and rates, but is not charged on the flow of housing services consumed.

The first distortion increases the incentive to buy housing compared to other forms of consumption, creating an incentive for people to live in bigger or better houses than otherwise, the report said.

The first and the second distortions also increase the investment value of housing compared to other investments. Devoting resources to owner-occupied housing yields untaxed shelter in perpetuity as well as untaxed capital gain.