Published by Cuffelinks, Thursday 5 April
Australian housing has been a good investment with prices more than doubling in real terms over the past 20 years. Since 2012, house prices have risen 50% in Melbourne and 70% in Sydney. Our recent report, Housing affordability: re-imagining the Australian dream, investigated the trends.
Prices went up the most in inner cities. People paid a premium for dwellings with good access to areas near the CBD where employment has grown fastest. And lower-priced dwellings increased in value more than higher-priced dwellings. Investors preferred lower-price property, below land tax thresholds. Shifts in migration rules skewed population growth towards younger households that typically buy cheaper housing.
The perfect storm created the price boom
Overall, prices went up because of a perfect storm of rising incomes, falling interest rates, rapid migration, tax and welfare settings that fed demand, and planning rules that restricted supply. And as with any asset, there’s always the possibility that some of the current price is purely stemming from irrational exuberance.
The key question for investors is whether the good times will roll on for housing. Investors in residential housing are counting on continued strong capital growth. Most of them are negatively geared, and that only makes sense if housing values continue to soar.
Future prices depend on many factors. Recent history can tell us a lot about what matters.
Many of the drivers of rapid housing price growth may be slowing. Household incomes rose about 30% in the 10 years to 2013. Since then, real incomes have barely moved, as Australia ran into the headwinds that have afflicted many other developed countries. Housing prices also rose because interest rates fell, but nominal and real official interest rates are now at around their lowest in Australian history. If interest rates rise, one would expect housing prices to fall.
Housing prices also rose because tax and welfare settings boosted demand. In 1999, the Commonwealth switched to taxing half of nominal capital gains rather than all of the real capital gains. Given actual capital gains and inflation rates, this increased the after-tax returns on investments like housing with higher capital returns but lower annual income returns. The capital gains on homes have never been taxed. And there are big welfare advantages to home ownership in retirement, because the means test for the age pension ignores all but the first $200,000 of the value of a home.
Migration and population growth driving prices
These tax and welfare settings may not last. Australian government budgets are challenged. Not only is the population ageing, but a declining proportion of those over 65 is paying tax. Inevitably, policy makers are starting to focus on the tax and welfare settings that provide substantially greater benefits to older Australians. The ALP has already committed to changing capital gains tax and negative gearing rules. Changing the age pension means test to include more of the value of the home might be unpopular, but it is about the only policy change that boasts a unity ticket between think tanks from the right, left, and centre. If any of these policy changes are implemented, they are likely to weigh adversely on housing prices.
Demand for housing also rose when Australia’s net migration rose substantially from about 2006. Population growth averaged 210,000 per year from 1990 to 2004, but 360,000 per year from 2005 to 2016. After dipping a little in 2014-15, net migration is now at record levels in Sydney and Melbourne. Governments can slow migration. It’s not a first-best policy option, but the discussion is becoming louder. If governments do tap the brakes on migration, then house price growth is likely to be lower.
Population growth wouldn’t have affected prices so much if supply of new housing had kept up. But while population growth jumped from about 2005, dwelling construction didn’t rise much until 2013. Reserve Bank analysis suggests that much of the price rises reflected the ‘zoning effect’ – a premium paid for planning permission to build a dwelling on the land. Their work shows that the zoning effect explains around 40% of the price of a typical detached house in Sydney or Melbourne. In 2000, before demand for housing took off, the effect was only 20% of the value of a house in Sydney, and negligible in Melbourne in Brisbane.
The zoning effect reflects political reluctance to permit enough subdivisions relative to demand. Many voters support increased density, but only in the suburb next to theirs.
These patterns are already changing, with substantially more apartments completed in 2015-2018. Sydney allowed far more 5- to 9-storey developments along major transport corridors; Melbourne allowed more high-rise in the centre of the city, and Brisbane allowed more 10- to 20-storey buildings on the edge of the CBD. Although the strategies varied, in each city these materially added to supply. As a proportion of the population, the change was greatest in Brisbane, and apartment prices there have moderated over the past 18 months.
A key issue for future prices is whether state governments and local councils continue to permit increased levels of medium- and high-density development in our major cities. The issue is intensely political. A backlash is brewing in Sydney. Local residents usually oppose increased density because of the additional pressure it tends to impose on local resources from parks to parking. But the penny is starting to drop that the failure to permit more housing means that ‘my children can’t afford to buy a house’.
The political trends that will influence housing price trends
Housing affordability has become the second most important issue on voters’ minds (after health). While other solutions (such as regional development and first-home buyer concessions) are politically popular, they won’t in fact fix the problems. If governments want to allay voter worries about affordability, they will have to permit more building. The political paradox is that improving affordability for new home-ownership implies less capital growth for investors and homeowners.
The political pressures will be more intense because it is also increasingly obvious that housing is one of the biggest causes of the widening wealth gap between high- and low-income households, and between older and younger households. Age-based voting emerged as a force in the last United Kingdom election, and there are signs that political parties are positioning themselves in Australia to respond to the increasingly different social attitudes and economic interests of older and younger generations.
And our major cities are increasingly geographically divided between: the centre and middle, with higher incomes, levels of education, and female workforce participation; and outer suburbs with fewer advantages. This is a poor economic outcome – because employers ultimately have a smaller potential workforce than otherwise, and a bad social outcome – as rich and poor live increasingly segregated lives.
To some extent, the long-run returns to housing investment depend on macro-economic conditions, particularly incomes and interest rates. As such, they aren’t so different from equity investments. But housing investments also depend a lot on policy decisions around migration, tax, and planning that will particularly affect the housing market. Housing depends, more than most investments, on the politics.