The Great Australian Dream – Literally

House price ‘plateau’ still out of reach for most

by Sarah Toohey
9 July 2012
20110528.  BRW.  Torquay. Generic Real Estate.  Property, for sale, sold, housing, growth, development, housing market, greater melbourne, home, residential, real estate, home buyer, rent, lease, land, interest rates, building.</p><br /><br /><br />
<p>Photograph by Arsineh Houspian.  +(61) 401 320 173.
Only a dream … housing prices have risen to a level that most cannot afford. Photo: Arsineh Houspian

Reading Ross Gittins’s article last week (“Houses hit affordability ceiling, the price plateau is here to stay– see below) I started to think that perhaps my dinner party crowd is a little different to his. We’re not worrying if housing is getting unaffordable; the people sitting around my table are talking about raising kids in a rental or moving out of the city. They know housing is unaffordable.

From an economist’s perspective, Gittins’s article is right, but it’s missing the context and the consequences of high housing costs in our cities. He’s right that it is logically impossible for prices to rise to a level no one could afford, but it’s not impossible for them to rise to a level that most cannot afford, and that’s what has happened in our cities over the last decade.

A recent COAG report found that only 24 per cent of properties for sale in Sydney, 48 per cent in Melbourne and 17 per cent in Brisbane were affordable to households on the lowest 60 per cent of incomes in those cities. That means, in Sydney for example, 60 per cent of households are competing for the 24 per cent of properties they can reasonably afford. That calculation is sensitive to movements in interest rates, but interest rates would have to move significantly to get those numbers in balance.

But if only 24 per cent of properties are affordable to 60 per cent of buyers in Sydney, then who is buying the unaffordable properties? Well, there are 1.7 million property investors in Australia, encouraged by negative gearing and capital gains tax exemptions to invest in housing and shelter their other income. There are also many households who’ll stretch themselves to the financial limit to get their piece of the great Australian dream, even if they might not necessarily be able to hold on to it.

Gittins is also right when he says that we’ve seen a structural shift to a lower interest rate environment, but servicing the loan isn’t the whole picture. Because households now borrow so much more, we’re actually paying banks almost twice as much in interest payments than we were back when interest rates were at 17 per cent – and it takes much longer to repay the average home loan. This has consequences. Firstly, households are now much more sensitive to changes in interest rates; one upward stroke of the RBA pen can tighten a household budget dramatically. But more subtle is the impact that paying off debt for longer will have on a household’s ability to save for retirement.

Lest I be accused of opening up some sort of intergenerational warfare here, I think that parents watching their children struggling to buy a home, and chipping in 10, 20 or 30 thousand dollars to help them do so are (clearly) poorer for this current state of affairs. Let alone those parents who simply cannot afford to make the choice to help their children out, because they rent themselves, or have their own mortgage, have no superannuation to speak of, who spent their savings on their kids’ schooling, or who might be able to help one child but not two – and definitely not three.

When property forecasters and economists gaze into the house price crystal ball, it’s abstracted from the lives of people buying and owning a home, and the decisions that people make to escape the insecurity of the rental market and the things that they go without – like trips to the dentist, or school excursions, and in extreme cases meals, to “afford” to pay the mortgage.

I sincerely hope Ross Gittins is right when he says that house prices have hit a ceiling and will stay stable, but even if they have, it doesn’t actually mean housing will suddenly be affordable. Research by NATSEM last year showed that house prices would have to remain steady for 10 years in order for incomes to catch up. If we don’t take the opportunity now to fix the structural problems in our housing market that have pushed prices up over the past decade – such as investor tax breaks and investment in affordable rental housing – we won’t fix this problem in the long term.

Sarah Toohey is campaign manager of Australians for Affordable Housing.

Houses hit affordability ceiling, the price plateau is here to stay

by Ross Gittins
July 4, 2012
'The value of your home is easily determined: it's worth what someone is willing to pay for it.'

The decade of skyrocketing values was down to a one-off, and now it’s over.

FOR years when people at dinner parties worried about houses becoming too expensive for the younger generation to afford, I used to tell them not to worry: it was logically impossible for prices to rise to a level no one could afford. Why do I remind you of this? Because it’s starting to look like I was right.

While it’s always possible for prices to be higher than particular individuals can afford, it’s impossible for them to be higher than most people can afford. 

When prices are rising, and have been for many years, it’s easy to conclude they’ll go on rising forever. Even easier to conclude – as every real estate agent encouraged us to – that house prices can only ever go in one direction.

As we’re discovering, it turns out not to be true. According to Saul Eslake, of Bank of America Merrill Lynch, Australian house prices rose by 142 per cent between 2000 and their peak in late 2010, but in the 18 months since then have fallen by a national average of about 7 per cent. (In Sydney the fall’s been 5 per cent; in Perth 9 per cent, Melbourne 11 per cent, Brisbane 12 per cent.)

There’s no shortage of people, particularly foreigners, who are convinced this increase went way beyond what the ”fundamentals” of supply and demand could justify – a bubble, in other words – and it won’t be long before the bubble bursts and prices come crashing down, as they have in the United States and various other countries.

They may prove right, but I’m with Eslake, who argues it’s unlikely. He estimates the present level of house prices is fully justified by the change over several decades of the two main factors determining the affordability of housing: household income and the level of mortgage interest rates.

The Australian median house price rose from 2.8 times average annual household disposable income in 1993 to four times in 2001. Since then it has been relatively stable. What allowed that multiple to rise so greatly was a ”structural decline” in mortgage interest rates that occurred in the 1990s with the return to low inflation and the shift to the official interest rate being set by an independent central bank rather than politicians.

We could have used that fall in interest rates to pay off our homes much faster, or to increase our spending on other things. Instead we decided to use it to borrow more and move to a better house.

Because so many of us made that choice at much the same time, we weren’t all able to move to ”better” (bigger, better appointed or better located) homes. Rather, the main thing we achieved was to bid up the prices of homes generally.

In the jargon of economists, we took that essentially once-only fall in the average level of mortgage interest rates – which Eslake estimates to have been about 4.5 percentage points – and ”capitalised” it into the value of our homes.

Eslake argues house prices aren’t likely to come crashing down because we have the income and borrowing capacity to afford the price of housing at roughly its present level, because we haven’t been building more homes than the growth in the population justifies (in fact, we’ve been building too few) and because we haven’t been borrowing against our homes to finance other consumption.

Eslake does predict, however, that house prices will rise much more modestly over the coming decade or two than they did in recent decades. Whereas they rose at the rate of 9.5 per cent a year during the noughties, he predicts rises averaging 3 or 4 per cent a year in future.

Why? Because there won’t be another, one-off, structural fall in the level of interest rates that greatly increases our capacity to borrow without increasing our monthly repayments. (Don’t confuse the Reserve Bank’s ups and downs in interest rates as it manipulates rates to manage the economy with the underlying average level of rates over a longer period.)

Without a structural shift in interest rates, house prices can’t rise much faster than household incomes are growing. The indirect flow-through to households of the ever-rising prices we were getting for our mineral exports caused household disposable income to grow at an average rate of about 7.5 per cent a year over the past decade or so.

That compares with 4.5 per cent a year during the 1990s. Now commodity prices have stopped rising and are easing back, so a more modest rate of growth is likely in coming years.

Which brings me back to where I started. The value of your home is easily determined: it’s worth what someone is willing to pay for it. The value of homes generally can be no higher than what people generally are willing and able to pay.

While it’s always possible for prices to be higher than particular individuals can afford, it’s impossible for them to be higher than most people can afford.

But it’s surprising how much flexibility there is in the system. Many parents understand that, from their privileged position as home owners, they have to assist their children to buy a home of their own.

As long as enough parents see it that way, house prices will stay roughly where they are. Were too many parents to be unwilling to help, however, house prices would have to fall. This generation sells its homes to the next generation.

I take the present small falls in house prices as a sign the limits to affordability have been reached, and won’t be exceeded.
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