RDP 2020-04: The Apartment Shortage 6. The Cost of Building Out

6.1 Land Purchase Costs

Whereas Sections 4 and 5 assumed that extra apartments could be supplied by increasing building height, in this section we consider increasing the number of buildings. That saves on construction costs but requires extra land on which to build the structure. Valuing land is sensitive to assumptions about where extra construction might occur. For example, land tends to be expensive near the city centre and inexpensive on the outskirts. Some illustrative data are in Table 4.

Unpublished data from the Building Activity Survey covering the 2013–18 period indicate that the average new Sydney apartment is in a building comprised of 117 apartments (row 1, Table 4) and which occupies 2,397 square metres of land (row 2). That implies the average apartment uses 20 square metres of land (row 3). For reasons discussed below we do not value this land at its market price but at its opportunity cost under an alternative policy: its value if reserved for detached houses. The average Sydney house occupies 625 square metres of land and costs $1.2 million, including structure (Kendall and Tulip (2018), updated) at an (unweighted) average cost of $1,965 per square metre (rows 4, 5 and 6). This represents a simple benchmark to which we refer later. A more realistic assumption, and one consistent with estimating effects of marginal changes, is to assume that new building occurs in similar locations to recent construction. In particular, more apartments are built on relatively expensive land closer to the city centre. If we weight by apartment completions in each SA3 from 2013 to 2018, the average price of land used for detached housing increases to $4,033 per square metre.^[12] Multiplying this by the land requirement of the average apartment implies that the land for extra apartments would cost about $82,700 per apartment (final row), or $9.7 million for the representative apartment building. Similar calculations in columns 2 and 3 imply that the cost of land for replacing nearby houses with apartments of their current configuration is about $44,000 per apartment in Melbourne and $34,000 per apartment in Brisbane.

In comparison, Urbis assumes land acquisition costs of $105,000, $41,000 and $53,000 per apartment in Sydney, Melbourne and Brisbane in 2011, based on a 50-apartment building requiring 5,000 to 10,000 square metres of land and the average price of urban development land at chosen locations. In 2018 prices, this is substantially more expensive than our estimates. This partly reflects larger land area spread over fewer apartments. CIE (2011, p 36) assumes costs of $85,000, $55,000 and $72,000 in Sydney, Melbourne and Brisbane for the median apartment in 2011, but does not provide underlying details.

To value land at the average cost of detached housing would be an unrealistic description of how apartments are built under existing policy. The most likely sites for development include a large premium above other land, because their development potential is capitalised into the property value. Nevertheless, valuing land as though it were used for average detached housing is appropriate for comparing different policies. An alternative to the current policy of reserving most of our urban land for detached housing is that we build some apartments on that land. The opportunity cost of permitting more apartment buildings is the value of land when it is used for detached housing.^[13]

6.2 Finance and Margins

We assume finance and developer's margins add 10 per cent and 25 per cent respectively to the cost of land, as discussed in Section 4.3. These assumptions are larger than those of Urbis and the CIE. As previously discussed, it seems appropriate to assume risks are substantially bigger at the beginning of a project than at the end.

6.3 The Cost of Building Out

Table 5 shows the cost of building out; that is, supplying extra apartment buildings of the current size and design in nearby locations. Average construction cost estimates are discussed in Appendix A.2. We then add land acquisition costs and higher finance and margin estimates, as discussed in the previous two subsections.

Total average cost estimates, the final row, are also presented in Table 1, which shows that the cost of building out is similar but somewhat higher than the cost of building up. Average costs are larger in Sydney than in Melbourne or Brisbane. The differences between cities arise partly because land per square metre is more expensive in Sydney (Table 4). Moreover, apartment buildings tend to be shorter in Sydney, making land per apartment even more expensive.

Footnotes

For the sake of computational simplicity, this estimate ignores some small costs such as stamp duty, conveyancing and other transaction costs (about 4.5 per cent of the property value, according to Fox and Tulip (2014, Section A.5)); land tax, rates and other holding costs (about 5 per cent of property costs according to CIE (2011, p 42)) and demolition costs (about $15,000 for the average-sized house according to industry contacts and Rider Levett Bucknall (2017, p 40)). [12]

This is perhaps the most important difference between our estimate of the effect of planning restrictions and the CIE's (2010) estimate of ‘transformation benefits’ from infill development. [13]