What price a roof over their heads?

If you’re a Baby Boomer or Gen X, talk of the problems of housing affordability might be of limited personal relevance. But for the following generations of Australians, the cost of housing - both rented and ownership - has escalated to a point that our society in the future may be significantly altered.

Is there a problem?

No matter which measure you use (there are many published) it’s clear that housing costs relative to incomes have soared, especially since the late 1990s. As a multiple of average incomes, the median house price has escalated from around 4 to 5 times incomes for almost all of the post war period (or since records began) climbing rapidly in the late 1990s and continuing to climb now, reaching seven or even eight times average incomes for many capital cities.

Historic low interest rates have had only marginal impact on the affordability issue, because the size of mortgages are now so much larger, especially for first home buyers entering the market. In other words, housing was on average more affordable when interest rates were above 10 per cent or 15 per cent for the 1970s, 80s and early 90s, than when interest rates fell below 7 per cent - because houses were cheaper relative to incomes and mortgages easier to service.

Home ownership rates, especially in the generation of under 35s, are falling to historic lows, from 44 per cent a decade ago to just a third now (see here for example). This leaves many in the rental market, where rental costs relative to incomes have also climbed and eat up much higher proportions of the household budget, making saving in turn harder and the idea of building a deposit that much more elusive.

Causes now undisputed

The causes of the decline in housing affordability are now better understood. Many economists, not trained in the mechanics of supply-side housing delivery, wrongly assumed Australians’ “love affair with housing” and growing demand fed by falling interest rates was the primary cause of rising prices. But now the price pressures on the supply side created by state and local government planning policies are better understood for their role in increasing house prices. Limited new land supply (the result of artificially imposed growth boundaries), compounded by new and exorbitant levies on new housing (the combination of which can readily exceed $100,000 per dwelling), plus the high compliance costs created by labyrinthine and uncertain planning regulations, have combined to create a generational price pressure on supply that simply did not exist prior to the late 1990s (after which point, unsurprisingly, prices began to escalate relative to incomes).

As much has been acknowledged by the Reserve Bank Governor himself, who has publicly complained that our inability to create new housing supply at such a time in our economy, while house prices continue to rise, is a cause of concern that policy makers need to address.

The consequences

If the extent of the problem and the causes are now widely understood (though there remain some in denial), it’s the consequences of this generational change that are worthwhile thinking about. Home ownership has been a cornerstone of Australian economic, social and family life for generations. What happens if an entire generation finds ownership so much more costly, or entirely elusive?

The first consequence is already apparent. Our parents, and for many of us aged 40 or more, probably coped with a mortgage on a single income. Today, young couples or families entering the housing market need to rely on two incomes to service the debt. Even then, the combination of two incomes allows little comfort room - a loss of work by one member of the family can lead to immediate financial distress. This places additional pressures on young families. It’s also hardly a coincidence that the rapid escalation of child care in Australia can be roughly traced to the point where house prices started to escalate out of proportion to incomes (roughly a decade ago). What the long term social impacts of dual income families with children in child care from an early age - and pre- and post-school care for their school years - will be, only time will tell.

Deferrment of children by an entire generation is already being observed (PDF 1.88MB). To some this is a sign of a selfish generation, splurging on the here and now. To others, it’s a sign that the prospects of starting a family, and buying a home, have become financially too remote for people in their 20s, so they defer these plans until their 30s. The health risks rise in proportion to the age at which women have their first child: what consequences will this create for health care costs and prenatal care, given the supposed ideal age for having a first child is in the 20s?

At the other end of the scale, project this current generation forwards in time. The family home and real estate generally has proven the single biggest form of savings for Australians for generations. It’s been relied on to help fund retirement, and even to help fund people into aged care. If rates of home ownership decline substantially for a generation, this form of retirement savings is no longer there. Superannuation has been a revolution but for average wage and salary earners, remains largely insufficient to fund a generation of workers into retirement. Will this mean greater dependence on social welfare for the aged as a higher proportion of the current generation moves to retirement age?

The economic consequences of high housing costs are also apparent. With greater proportions of total household incomes being devoted to mortgage payments than ever before, this also means less is available for other forms of consumption, or saving. The paradox of thrift shows that reducing consumption in favour of saving has economy wide effects by decreasing demand and putting a brake on economic activity. The same surely happens if thrift occurs because housing mortgages are consuming so much economic energy that consumption elsewhere suffers.

Australians, the reports tell us, are working harder, longer and taking fewer holidays. Is that because of necessity, triggered mainly by the single biggest impact on household finances - the mortgage? The economy-wide consequences of less consumption generally, mean reduced leisure travel, less non-housing or business investment, and so on, simply because for a generation the cost of servicing the debt on the family home has become financially all consuming.

Consider this: if the combination of supply shortages, up front levies and red tape have conservatively added $100,000 to the cost of a new home, that additional cost by way of a larger mortgage is worth an extra $675 per month alone! ($100,000 at 6.5 per cent variable over 25 years). The total interest bill is over $100,000, plus the principal, over the life of the loan. If that money was directed instead into domestic consumption, would the economy be stronger and Australians more prosperous?

Limited economic growth is a further consequence that could derive from needlessly high house prices. For states like Queensland, for example, population growth has been driven not just by lifestyle seekers, but also by the lure of relatively lower cost housing and costs of living. That relative advantage has now eroded, interstate migration numbers have slowed (topped up for the present by international migrants) and - due to the slowdown in the building industry as public policy chokes new supply - new job creation has also slowed. Ironically, Queensland now trails the (more affordable) states of Tasmania and South Australia in terms of economic performance, according to this report by Commsec. (West Australia is also concerned - see here).

You could speculate forever on other possible consequences of maintaining this high price regime for housing via current public policy settings, but among the most worrying is that we are witnessing the creation of a new landed class structure in Australia. For Gen X and Baby Boomers, rising house prices have added equity to family balance sheets - which have been leveraged to acquire additional investment housing, often more than one. While this generation is building wealth through house price growth, the other generation is being denied that opportunity. They are becoming the rental generation, whose economic efforts will go in rents to the landed generation, whose wealth will rise further.

Australia has long held dear the ideal of a classless society, of equality of opportunity and ‘a fair go’. But are we now witnessing a new class structure, defined by those who own property (and quite a bit of it) and those who don’t? That this is occurring largely at the hands of Labor state governments who claim a charter of social equality, is just as worrying. And if we fail to remedy the problem now, what are the possible consequences of that new social division as we move forwards in time?