Higher council rates lead to higher property rents

The New Zealand Herald reported earlier this month:

Big increases in council rates may be contributing to a rent crunch in some parts of the country.

Data from CoreLogic shows the regions with the largest increase in rent since the end of the Covid freeze in 2020.

Ōakura, New Plymouth, is top of the list with an increase of 68% compared to September 2020. It is followed by Marfell, in the same area, at 67%. Westmorland, Christchurch, is third at 66% and Lower Shotover, Queenstown, at 64%.

Kiwibank economist Sabrina Delgado said there was a “very strong theme” of council rates rises being passed through to higher rents.

“Ōakura was one of the suburbs which saw an over 20% increase in council rates last year while Marfell saw a 17% increase in rates.”

In my ECONS102 class this week, in addition to covering economic welfare (as noted in yesterday's post), we covered the (rental) market for land. A couple of things make this market different from the regular markets we draw diagrams for. First, in theory, the supply of land is fixed. As Mark Twain once joked, when it comes to land, "they aren't making it anymore". However, in practice, we do make more land. Land is reclaimed from the sea, or swamps are drained, or conservation land is released. So, the supply of land isn't fixed, but it doesn't respond much to a change in rent. In other words, land supply is very inelastic. Second, we need to consider landowners who are owner-occupiers. In effect, those landowners are renting land to themselves. They aren't actually paying rent to themselves, but they still face a cost of using their land - there is an opportunity cost, because they could have rented the land to someone else, and they are giving up the rent that they could have received. Owner-occupiers would still rent land to themselves even if the rent was zero, so the supply of land is positive, even if the rent is zero.

Now, let's turn to the situation in the article, and show why increases in council rates lead to higher rents. This is shown in the diagram below. Before councils raised rates, the market is operating at equilibrium, where the supply of land SN0 meets the demand for land DN0. The equilibrium land rent is R0, and the equilibrium quantity of land rented is QN0. The increase in council rates raises the costs of landlords, shifting the supply curve up and to the left, to SN1. The new equilibrium rent is R1, and the equilibrium quantity of land rented is QN1. [*] So, the increase in council rates is passed onto tenants in the form of higher rents.

*****

[*] Now, you might wonder about the decrease in the quantity of land rented. Where does it go? Notice though that the shift upwards in the supply curve, which represents the increase in costs to landlords, is quite large (shown by the red arrow), while the decrease in quantity of land rented is small by comparison. So, there isn't much change in the quantity of land. Where does it go? Some landlords may leave land fallow, and no longer use it or rent it out. Some may be converted to conservation uses. Either way, that (small amount of) land is no longer available to rent (even to an owner-occupier themselves).