Improving housing affordability begins at home

Australia’s capital house prices rose 10% last financial year, with an even stronger rise of 15% in Sydney. While seemingly a dramatic increase, it is important to look through the short-run variability in house prices to longer-run trends. On an inflation and quality-adjusted basis, house prices in Australia have increased by around 2-3% per annum since 1970. This is enough to yield a doubling in real house prices every 30 years or so, underpinning a long-term decline in housing affordability and the home ownership rate.

Far from being an asset price ‘bubble,’ this increase in real house prices is well explained by economic fundamentals. A major influence has been the decline in global real interest rates since the early 1980s. Australia’s real mortgage interest rates have also declined, from around 10% in 1990 to around 3% today. This long-term decline has boosted asset values and, together with increased competition in housing finance, the borrowing capacity of households.

Based on Australian experience, a 1% decline in real mortgage interest rates raises real house prices by between 4-5%. Unless global real interest rates rise significantly in the future, the gains in house prices associated with this long-term decline in real interest rates are unlikely to be unwound.

Income and population growth are the other main drivers of housing demand. While these growth rates are subject to considerably short-run variability, they represent permanent changes to the overall level of demand.

Demand suppression policies are thus unlikely to improve long-run housing affordability. The central bank has little influence over real interest rates in the long-run. Tightening accessibility to housing finance might be justified on financial stability grounds, but won’t change the overall demand and supply balance in housing markets when only 37% of Australian households are owner-occupiers with a mortgage. Suppressing income and population growth or immigration in the name of housing affordability would be a perverse public policy response.

An unfortunate and increasingly common response to rising house prices has been to scapegoat some buyers, such as domestic and foreign investors. But they are no more responsible for rising house prices than the typical first homebuyer. The problem is not too much demand, but too little supply to prevent upward pressure on house prices.

In most markets, rising prices would induce new supply, containing or even lowering prices in the long-run. Unfortunately, the supply of new land and new homes in Australia is largely determined by regulation, preventing housing supply from responding quickly enough to rising prices.

Even in the long-run, Australia has not been building sufficient new homes to accommodate changes in demand.

Over the last decade, the average number of new housing lots produced in the five largest capital cities has declined by around 20%. The price of land for new homebuyers in these capitals has increased by nearly 150% over the same period. New lot sizes are getting smaller as homebuyers seek to economise on the rising cost of land.

Urban growth boundaries have ring-fenced our capital cities, while development and planning controls and taxes on new housing have made it increasingly difficult to supply affordable new housing, despite little change in real building costs.

Rather than tackling the tax and regulatory burden on new housing supply, politicians have responded with diversions designed to draw attention away from their own role in reducing housing affordability.

The House of Representatives Standing Committee on Economics inquiry into foreign investment in real estate is one such diversion. Foreign buyers of residential real estate transfer wealth to Australians, either in the form of additions to the dwelling capital stock built specifically for overseas investors or higher home prices received by Australian vendors.

To turn away these foreign wealth transfers would only serve to compound our domestic policy failures in relation to housing.

It is government policy to encourage temporary residents to come to Australia to study and work. If these temporary residents are prevented from buying new dwellings, they will enter the private rental market and increase competition in that market.

Australia already has a more restrictive policy on foreign investment in residential and other real estate than comparable economies such as the United States and the United Kingdom. 

The fact that the existing controls on foreign investment are not effectively enforced only serves to demonstrate that our politicians have enacted impractical and unworkable laws and regulations that are too costly to properly enforce.

Australia needs to become more open to foreign investment, not less, but must also free up the supply of new housing to contain upward pressure on prices.