The Australian housing market: the cost of affordabilityWednesday, August 17, 2011
Phil Chronican is ANZ’s Australian chief executive. This is an abridged version of a speech he made on the 2nd of June 2011 in Sydney.
WITHOUT question, the housing market is a core pillar of the Australian economy and our national psyche – we love property, and everything that comes with it.
The housing market has a $4.2 trillion capital value and has a unique influence over our lives, but is proving an increasing source of controversy.
As a market or industry, rarely do we stop to ask what does the ideal housing market look like. For me, it would be a market that delivers sustainable outcomes and a balance between access and affordability, financial security, returns for investors, business opportunities and employment for industry participants.
So what are we seeing today? House prices have risen significantly over the past 30 years, well in excess of inflation or income growth. In the 13 years to 1998, average house prices doubled. From 1998 to 2007, prices more than doubled again (to almost $500,000).
Since then, price growth has slightly declined. the weighted average home price in Australian capital cities fell 2.1 per cent in the March quarter, according to the Australian Bureau of Statistics.
This has been the result of many things, including removal of the first home owners grant, rising interest rates, a re-tightening of foreign investment rules and slowing population growth.
But prices, which are still very high in a historical sense, are also having an impact, particularly on affordability for new buyers. We’re seeing this play out in reduced demand such as lower auction clearance rates. This decline is affecting the banks, too, with credit growth for housing at rates lower than they have been for 30 years.
The Economist magazine sparked enormous debate recently by publishing the results of a survey that estimated Australian houses are “overvalued” by 56 per cent – the world’s highest, above that of Hong Kong.
Looking at average house prices over the past 25 years – from $100,000 to above well above $500,000 – it is reasonable to say prices are high.
The question of affordability is a little more complex as you need to take into account not just prices, but interest rates and incomes. If you look at the past 20 years, incomes have risen and interest rates have fallen. This means the average person’s effective purchasing power is much greater than it was.
The missing part of the house-price equation is the supply side. A house is a consumer good. Everything in a house, including the materials and labour embedded in it, are tradeable commodities. As such, there is no reason why they should cost any more in Australia then they do elsewhere, for anything other than short periods.
Of course you need somewhere to put a house, so it is the value of residential land that is the only real driver of house-price differentials.
Prices for inner-city residential apartments in Australia look similar to those in Hong Kong and Singapore. Does that mean we face the same issues regarding the supply of land for housing?
Obviously when you look at Australian cities, there are far greater opportunities available for medium to high-density living in inner-city areas of for lower-density living on available land on city fringes than there are in Hong Kong or Singapore.
People are paying a price for land that is many multiples of what people in the US and Europe are paying for residential land in similar-sized cities.
To an economist the issue is obvious: constraints on the supply side have artificially steepened the supply curve for residential housing. Under the status quo, the Australian housing market is clearly losing the battle to keep demand and supply in check.
At ANZ, we estimate there is a shortage of about 230,000 dwellings. Over the 20 years to 2006, the demand and supply of housing largely kept in touch. But since then, a significant gap has opened. This year there will be demand for about 20,000 more dwellings than will be completed.
The supply of housing will become even more critical in the coming years as Australia lifts its intake of skilled migrants to help fill shortages in labour market.
Responsibility for many controls relating to the supply of residential land and housing rests with governments at all levels. They include land release and zoning, planning and building approvals, infrastructure planning and costs, existing transport infrastructure.
Governments at all levels. They include land release and zoning, planning and building approvals, infrastructure planning and costs, existing transport infrastructure.
Governments have an important role to play in facilitating efficient housing outcomes. And we’ve seen what can happen when they get it wrong in the case of the first home owners grant. In practice, these grants were capitalised against house prices so quickly they did not so much benefit first home buyers but rather people selling to first home buyers.
The supply of housing is further influenced by the large proportion of government revenue that is based on property values, including capital gains tax, stamp duties and council rates. As such there is a financial disincentive for governments to make major changes.
If we’re going to continue to be a stable, growing country and we don’t want housing to become more unaffordable, supply side needs to be addressed. We have seen increases in land being released in some cities such as Melbourne in the last year, which is encouraging – however, more needs to be done. We need reform back on the agenda to address supply issues.
As a nation, we hold a significant proportion of our wealth in property. Of total household wealth, we hold about 60 per cent in real estate, compared with 25 per cent in the US.
There is no doubt that capital gains made by most people in the property market over the past 15 – 20 years have created an unsustainable perception of housing as an attractive investment vehicle.
Taking a clinical look at the merits of property as an investment option, any investment should be judged by the total cost versus the total expected return and the risks involved.
With housing you have significant upfront costs relative to other investments: capital improvement and maintenance, rezoning and development around your property.
Then there are the risks of movements in prices and interest rates. rental yields are roughly 3.5 per cent gross, before outgoings, depreciation and any periods without tenants.
Then there is the cost and inconvenience of finding tenants and collecting rents on time. and when you come to sell you have costs such as advertising and agents’ commissions plus the uncertainty of not knowing how long it will take to sell. In some parts of Australia houses are on the market for six to nine months, on average.
the only way you could make sense of housing as an investment is if the capital gains were enough to offset these disadvantages. While i expect prices to hold at near-current levels, and later continue to rise in line with growth in incomes, we are not likely to see them double and redouble any time soon. The major structural changes that occurred in the 1990s, such as the RBA’s more assertive management of inflation and interest rates and the explosion in access to credit, are not about to be repeated. So with this in mind, if you compare housing with any other form of investment it looks weak on most criteria.
But should we all get out of housing? no, of course not. Housing does need to be owned by someone, but that does not support an individual having most of his or her wealth tied up in one or two properties.
So where is the market headed? Many commentators have argued that the housing market is a bubble waiting to burst. I do not agree. Housing markets collapse when demand collapses. It is the same steep supply curve working in reverse. The worst-affected areas in the US market were those where overbuilding was the greatest.
That is not the case for Australia’s capital city housing markets. Continued population growth means we continue to have strong demand for new housing.
For the first time in more than 40 years, the number of people per household in Australia has increased over the past two years, as subdued supply and affordability limits finally bite. The price weakness is likely to continue. If interest rates continue to rise and the price of other essential services rise, we are likely to be in for a sustained period of low house-price growth, but with latent demand ready to pounce if prices come back to more reasonable levels.
What does all this mean for home buyers? It means they need to assess housing on its merits. They need to ask is it where I want to live? Will I be happy with it for 7 to 10 years? Can I afford it? If there were no capital gains for the foreseeable future, would I still be happy to buy it rather than rent? For investors it means they need to assess questions such as: is the yield sensible? What sort of capital gain do I need to achieve to make sense of the investment after all the costs?
Affordability problems have got to a point where we no longer can let market forces attend to them. What we need is a real, ideally shared, political commitment for reform and the discipline to see a long-term plan through to completion.
As part of this plan, we need to look at how we free up more affordable land and housing on our urban fringes for first time buyers, and how to support it with public infrastructure. We also need to consider how we encourage medium and high density development in high-demand areas where existing infrastructure can support further development.
Governments might want to look at whether the extent of negative gearing tax breaks are fostering an unhealthy focus on housing as an investment, thereby compounding the affordability issues.
If we do not address the structural issues now, we could face a very different outcome in the face of the next major economic downturn – we have seen in the US and Britain what can happen when demand falls sharply and excess supply becomes evident.
Remember, the primary purpose of a house is as a place to live and raise your family, not a speculative investment vehicle.