Tuesday 19 February 2013

An offer you can't refuse

Earthquakes can cause uninsurable losses. In Christchurch, a decent proportion of those losses are being borne by those who owned vacant sections at the time of the Canterbury earthquakes. When you purchase insurance on a house, it's coupled with a mandatory payment to EQC, who provide coverage against earthquakes, landslips, floods and the like, up to $100,000 per event. But EQC doesn't cover vacant sections, and figuring out arrangements with an insurance company for getting insurance on vacant land didn't seem obvious to most owners of vacant sections.*

In theory, this shouldn't matter a ton. Because there's a potential for an uninsured loss, everyone pays a bit less for the property because of it and takes their risks. 

But suppose that, after the earthquake, the government comes in and tells you that your land is unremediable even if you think otherwise. They offer to pay you half its value as compensation. And there are hints that you'll be compelled to sell on worse terms if you refuse the offer. 

Suppose that you decided to hold out: you don't want to take the offer and want to live on your land. Council would likely stop providing services to the property even if you offered to pay more for service provision, but you could always dig a well, put in a septic tank, hire a rubbish service, and put in some solar panels: off-grid in-town. But it was a vacant section: it may be impossible to get Council permission to build anything there, even if you build a one-story wooden place on screw piles that go down a few dozen meters and pay for extensive land strengthening. But suppose you get that sorted out, somehow. Council still could forbid access to the land: the street by your house will be reclaimed for some other purpose, all the neighbours have sold out, and you may be forbidden from using government-owned land for an access lane (or from purchasing an easement for such use). If the neighbors across the street are on TC-3 land [allowed to live there, but any new building has to be on much stronger foundations], it's harder for Council to force you out by preventing access because the road will still be in use. But it seems awfully likely that they'd simply refuse to allow you to build on it, even if you had a sound engineering design. Council doesn't like things that don't fit the plan.

The earthquake imposed a lot of damage on the land. But much of the subsequent loss is consequent to policy decisions. If you don't take the red zone offer, you may well be stuck with a piece of land that policy has made unusable. And because of that risk, and the veiled threats of expropriation if you don't take the red zone offer, it's not really an offer that can be refused.

CERA maintains a land status map. A static image is below. The red zones are the ones where the government says that land repair would be prolonged and uneconomic. This is different from the downtown Red Zone where access remains forbidden due to demolition work.

The government has never quite said what it's planning on doing with the red-zoned properties it acquires. There's been talk of a park running along the banks of the Avon; it would be a wonderful amenity if provided. But I'm not sure that anyone quite believes that reasonable parts of the red zone won't eventually be fixed up and sold back for development, albeit likely with substantial constraints on foundation types and construction method. The potential value of the land if fixed up and sold off could remain fairly high, even with the LIM restrictions; that locked-up value will be awfully tempting for future governments. 

Imagine that you bought a section for your retirement home. You followed all the rules, but you didn't think to get insurance on a vacant section. You are happy to bear your own quake-losses. Post-quake, you're red-zoned and the government offers you half the land's value. You'd still prefer to stay on the section and build a redesigned house. The neighbours across the street are TC-3, so the street will continue to exist and services aren't hard. But you're very likely not allowed to do it with your own property that you still own. And then Aucklanders insult you because you didn't have insurance on a vacant section and begrudge the half-value payment offered by the government on terms that effectively cannot be refused. 

I see little compelling reason that government should be insurer of last resort for those who failed to get insurance. But what proportion of the subsequent losses have really been due to changes in permitted land use rather than the direct effects of the earthquake? The half-value offer would be more than fair if the owners could still have the reversion option of making do on their own. But what's going on feels an awful lot more like forced purchase at well below the owners' willingness to accept.

And, if the land really is unbuildable, then it's costless to offer those selling first option to repurchase should the government ever decide that the land really could be sold - at the price at which they were compelled to sell to the government plus their apportioned share of the improvements. This still has problems: suppose that you're on the side of the street used as park while those on the other side of the street get the option to repurchase and subsequently on-sell at a profit. Perhaps a more clever scheme would then pay a dividend later on based on average comparable price increases. It's not an easy thing to set up, but we're really imposing a pretty substantial potential taking on many owners of vacant sections.

Take-away note for the Aucklanders: this isn't simply the government coming in and compensating people who hadn't bought insurance. This is the government coming in, telling you your land is unusable because they have deemed it to be so (the red zone has incurred substantial damage - true, but you're also kinda forbidden from making it usable at your own cost), and telling you that they'll give you half its prior value. Sure, there's been a real reduction in the land's value because of the earthquakes. And sure, some of those wanting full compensation are likely just rent-seeking: where the real reduction in land value is more than half of its prior assessed value. But there are some folks who really seem to be undergoing a forced and poorly compensated taking here.

* Newspaper reports keep claiming it was impossible, but I see conflicting reports from Kiwiblog commenters who claim to have sorted out such insurance on their own.


  1. I don't think there has been an official announcement yet on the red zone future, however the first block of land in Kaiapoi has been cleared and grassed, so hopefully it points the way for the rest of the red zone: http://www.stuff.co.nz/the-press/news/christchurch-earthquake-2011/8154872/Grass-all-that-remains-of-neighbourhood.

    GIven that the general consensus is that residential land is not easily insurable (if it was I'd expect the standard insurers to offer packages that covered the land that is not covered by EQC) and that the government is pretty much forcing you to sell up, I can't see how the government can claim a moral hazard would exist if they paid the section holders the RV.

  2. No particular disagreement, but a big payout could discourage the emergence of that market. On the other side, I would fully expect that any insurance offered would wind up being a scam: if the government says you can't build on the land, then the insurer says they could remediate for $10k and only pays out on that basis, and the government forbids them from remediating....

  3. Hmm, that 'scam' sounds oddly familiar.....