Economic factors affecting the housing market - ANZ

[Pages:2]Econom ic fact ors affect ing t he housing m arket

( Art icle based on a present at ion t o t he Aust ralian Financial Review's Housing Congress in Melbourne on Thursday 8th March 2007, and published in t he AFR's op- ed pages on Monday 12th March)

Aust ralian resident ial propert y prices have shown rem arkable resilience despit e t he end of t he boom in m ost m aj or cit ies around t hree years ago. Under t he influence of t he m ineral boom , propert y prices in Pert h, Darwin and som e ot her cent res such as Mackay have cont inued t o rise rapidly, at least up t o t he end of 2006. But in m ost parts of south- eastern Australia, with the exception of western Sydney, the stellar price increases chalked up between the m id- 1990s and the early years of this decade have not been reversed; and indeed in som e cities property prices have continued to rise, albeit at a m ore m odest rate.

To a very large ext ent , t he rise in Aust ralian propert y prices over t he past dozen or so years is the result of a num ber of favourable developm ents ( from the st andpoint of would- be hom e buyers) being `capit alized' int o prices. Forem ost am ong these is of course the dram atic decline in int erest rates as Australia transitioned from the high and volatile inflation of the 1970s and 1980s to the low and st able inflat ion we have enj oyed since t he m id- 1990s. This has been supplem ented by enhanced com petition in m ortgage m arkets which has seen m ort gage rat es fall by m ore t han t he official cash rat e. The borrowing capacit y of hom e- buyers has also been assisted by 15 years of rising real incom es ( in contrast to the decline in real incom es over m uch of the 1980s) .

The com bined effect of t hese t rends has been t o lift t he am ount which a t woearner household on average earnings can afford to borrow without debtservicing absorbing m ore than one quarter of their incom e from around $100,000 in the early 1990s to over $300,000 today. And financial innovation has m eant that this `rule of thum b' for determ ining m axim um loan sizes is a less binding constraint than it used to be.

Over t he sam e period, however, net addit ions t o t he housing st ock of about 1.25 m illion were sufficient only to absorb the increase in the num ber of households requiring accom m odation ( thanks to rising net im m igrat ion and a decline in the average num ber of people per household) .

So alt hough t he borrowing capacit y of buyers has m ore t han t rebled over t he past 15 years, there has been no net increase in t he supply of housing. I n t hese circum st ances, it is hardly surprising t hat t he price of housing has roughly doubled.

And now that the structural decline in interest rates ( between 1990 and 2002) has clearly com e to an end, and been m ore or less fully capitalized into the value of t he exist ing housing st ock, house prices are ( in general) rising at a m uch m ore subdued pace.

Suggestions that because houses are now `over- valued' relative to incom es or rents, and that therefore a `law of gravity' will inevitably result in a fall in house prices in m uch the sam e way as `over- valued' share prices inevit ably decline, ignore a fundam ental difference between shares and residential real estate.

Although equities have, over long periods of tim e, typically been at least as rewarding an investm ent as real estate, no- one has to own shares. I f shares are widely perceived to be `over- valued', enough investors will reduce their exposure to shares ( that is, sell them ) to push their prices down to levels which will eventually be perceived as `fairly' or `under- valued'.

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On t he ot her hand, we all have t o live som ewhere. And in Aust ralia, we generally prefer to live in our own dwelling rather than som eone else's, if we can.

Very few Australians are ever going to respond to being told that their property is `over- valued' by `shorting' to property m arket ? that is, by selling their residence, renting for a while and hoping to re- enter the housing m arket at a lower price. The t ransact ions cost s as well as t he personal inconvenience represent m aj or barriers t o anyone cont em plat ing doing wit h t heir house what Kerry Packer did wit h Channel Nine at Alan Bond's expense.

So when house prices do reach a level at which t he m arginal would- be buyer can no longer afford to buy, it's turnover which drops ( by 28% over the past three years) , rat her t han prices. Prices do not fall across t he board unless int erest rat es and/ or unem ploym ent st art rising by am ount s sufficient t o force som e exist ing owners to becom e sellers.

This has happened in som e pocket s, such as West ern Sydney ? where, it would appear, som e people who borrowed a very substantial proportion of their purchase price at the trough of the interest rate cycle and who m ade very little if any allowance for the possibility that rates could rise even by a percentage point or so have found them selves unable to m aintain their m ortgage com m itm ents. But these are the exception rather than the rule. And in the m ore affluent suburbs of Australia's larger cit ies, rising incom es and share values have boosted the capacity of buyers to purchase residences whose value is enhanced by their scar cit y .

Buoyed by rising im m igrat ion, `underlying dem and' for housing is now running at around 165,000 units per annum . But current levels of housing starts ( dam pened by the rises in interest rates over the past few years) im ply net expansion in the housing st ock of less t han 140,000 unit s per annum . Not surprisingly, rent al vacancy rates are declining sharply and will likely be down to around 1% in m ost cities by the end of this year ? a prospect which is certain to prom pt an accelerat ion in rents.

A key lesson for those concerned about im proving `housing affordabilit y', whether for buyers or renters, is that policies which work only on the `dem and side' of the housing m arket are doom ed to fail. Anything which puts additional cash in the hands of buyers ( such as grant s or st am p dut y concessions) or rent ers ( such as cash assistance) with a view to enabling them to buy or rent m ore expensive houses results m erely in m ore expensive houses. I nstead, policy needs to focus on increasing the supply of housing ? particularly low- cost housing ? and reducing the tim e taken to bring land and housing to m arket.

- Saul Eslake Chief Econom ist , ANZ

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