Understanding the Housing Market in Australia

Greg Jericho has recently written a great article Today the great Australian dream is owning a home loan (or two). It's worth a read but I thought I'd reproduce some of the excellent charts in the article here with some comments and end with an assessment of rising household debt.

The trends in occupancy types are clear: fewer outright owners and more renters. As Jericho notes:

Twenty years ago, 71.4% of households either owned their house outright or were paying off a mortgage; now it is down to 67.2%. Had the level of home ownership stayed the same in 2013-14 there would have been around 370,000 more households who owned their home rather than renting.

Housing costs have increased rapidly since the late-1990s, but housing costs as a percentage of incomes have remained relatively stable. This highlights the significance of low interest rates and expanded incomes during the boom. When interest rates eventually rise again, expect 'real' costs to rise as well. The graph at the end of this post shows how important lower interest rates have been generally.

More Hobartians own their own home than any other capital city. Darwin has the lowest percentage of owners.

Perth leads the number of owners with a mortgage, with Brisbane the lowest.

There are more public renters in the ACT than anywhere else followed by Adelaide. Melbourne has the lowest number of households in public housing. These figures are largely related to residual and ongoing public housing policies. Public housing has been important for the ACT since its origins and the Housing Trust in South Australia has played a significant role in the rental market.  

Darwin and Brisbane have the highest percentage of private renters and Adelaide and the ACT the least.

Jericho notes the changing nature of Australian housing, particularly the increased number of bedrooms and fewer persons per house:

Perhaps linked with the rising housing costs is also the change in the size of our houses. In 2013-14, there was a record high average number of bedrooms per household at 3.14. This meant there were 1.212 persons per bedroom – just touch below the record set in 2005-06 of 1.219. 

Nearly 45% of all households had two or more bedrooms spare – but a whopping 66% of households who had paid off their mortgage had two or more spare bedrooms, around 1.8m households. 

Such a statistic certainly gives support to those who argue one reason for shortages of housing is people staying in their family home long after the children have left and perhaps long after the need for such a big house is required.

But as Bob Birrell and David McCloskey recently noted in a report called The housing affordability crisis in Sydney and Melbourne Report One: The demographic foundations

[T]here will be enormous growth in the number of households where the householder is aged 45 or more years. Most of these will be couple households as the children leave home or single person households as one or other of the partners die or move into care. This is a consequence of population ageing. The main consequence of this ageing effect will be a large increase in the number of small households aged 45 plus who will be occupying mainly detached houses  in both Sydney and Melbourne. Every extra occupancy due to ageing means one less of the stock of detached houses in Sydney and Melbourne that will be available to younger households who are seeking a detached house, whether a resident or newly arrived migrant. 

Most industry, planning and housing industry commentators on the housing crisis neglect the significance of these demographic factors. The one outcome they do acknowledge is the likely increase in one and two person households. Most assume that this increase will create a large pool of households who, though occupying detached housing, will be interested in downsizing to a unit or apartment. Some argue that this interest will contribute to an historic switch in the preference for apartment living relative to the past preference for detached houses. The evidence cited below indicates that this is a highly unlikely. 

This report argues that the neglect and misunderstanding of these demographic factors means that the housing industry leaders, commentators and planners, do not appreciate the depth and longterm nature of the housing affordability crisis in Sydney and Melbourne. Nor do they appreciate why the recent surge in apartment approvals will not solve the problem. 

Despite assertions that negative gearing benefits all income groups, investing is done mainly by the wealthy - the top 20 per cent account for 39 percent of properties.

The owner without a mortgage, however, is dominated by the lower quintiles, reflecting the fact that many owners have retired and thus have finished earning. Remember that the more investor properties there are, the more renters there will need to be as well

The owners with a mortgage category is spread as one would expect with mortgages increasing with income.

Renting is spread fairly evenly across all income levels. 

The increase in house prices has been fuelled by increased access to credit since the 1990s. Australian house prices have (so far) avoided the sort of corrections experienced in many other advanced economies, which has reinforced the popular idea that buying a house is the best investment.

While many commentators continually worry about rising public debt, I am more concerned by rising household debt. The chart below shows that debt as a percentage of income has begun to rise once again after a period of consolidation after the GFC.

Perhaps the more important graph, however, is the one on the right, which shows just how beneficial low interest rates have been. Interest payments as a percentage of income peaked in 2007. Before the GFC, the RBA was more worried about rising cost pressures than recession.

The rapid reduction in interest rates after the crisis had a significant stimulatory effect on the economy as mortgage holders suddenly had more disposable income. It would be an interesting counterfactual to think what might have happened to house prices if the GFC had not hit. Undoubtedly interest rates would have increased further as the country boomed. This then might have had a significant dampening effect on the wider economy and the housing market in particular. It is ironic that the GFC might have saved the Australian housing market, or at least delayed its day of reckoning.

House Prices Compared

The Economist has put up an interactive graphic on house prices that allows us to compare house prices, prices against average income, prices against rents and percentage changes.

THE Economist tracks the health of housing in 26 markets around the world, encompassing a population of over 3 billion. Prices are now rising in 21 of these markets at a median pace of 4.7% a year. China’s housing market is one of only five countries in our index where prices are falling, joining Singapore and a trio of euro-zone countries—France, Greece and Italy. The government has been trying to boost the market over the past ten months which is now slowly responding. 

To assess whether house prices are at sustainable levels, we use two yardsticks. One is affordability, measured by the ratio of prices to income per person after tax. The other is the case for investing in housing, based on the ratio of house prices to rents, much as stockmarket investors look at the ratio of equity prices to earnings. If these gauges are higher than their historical averages then property is deemed overvalued; if they are lower, it is undervalued. According to our measure, property is more than 30% overvalued in six of the markets we track, notably in Australia, Britain and Canada.

By comparing particular subsets of the list of countries it allows us to contextualise Australia's experience over the last 40 years.

The house price index allows us to choose a starting point going back as far as 1970 to look at changes in house prices. In an index the starting point is given a value of 100. If we go back to 1970, house prices have risen to over 9000 on the Index for South Africa and nearly 5600 in Britain and nearly 4000 in Australia. The United States, Germany and Japan's rises have been much less significant, with Japan suffering massive falls after the rises in the 1980s.

A better indication of real changes is provided as well, which makes the changes slightly more palatable. On this basis South Africa's rises in nominal terms bounce back to reality and Britain is the stand out performer with Australia also steadily rising. In real terms, prices in Japan and Germany are roughly at the same level as they were in 1970.

If we compare this same set of countries over the past 10 years, then Sweden and Canada are the stand outs.

Comparing house prices against average income gives us a measure of how affordable house prices are. If average incomes have been increasing rapidly it would be surprising if house prices didn't increase rapidly as well. But what we see if we play with countries and dates is that houses have become significantly less affordable (overvalued) in Australia and Canada. Indeed, Australia is the standout. Japan's houses are significantly undervalued compared to the long term average of the ratio of prices to income.

Comparing house prices to rents gives us another variable to compare value. On this basis we get similar results, although Canada is now the stand out of overvaluation.

Playing with the starting date provides some interesting comparisons: Australia, Germany and Japan for example. Germany is particularly interesting for its relative stability. Ireland has had a spectacular rise and fall and is now rising again.

If we make the starting date 2007we can see how well Australia has done in comparison with many other countries, although German house prices have risen as well. Greece is a fairly bleak story. 

So what does it all mean? It means that house prices nearly everywhere have had periods of significant expansion due to increasing access to credit and greater financialisation of economies. While these are global occurrences, particular national considerations are have also been at play including regulations and incentives that encourage house speculation, such as restrictions on housing supply and negative gearing in Australia. 

According to the RBA: 

Over the past 30 years, Australian housing prices have increased on average by 7¼ per cent per year, and over the inflation-targeting period by around 7 per cent per year. However, these averages mask three distinct phases:

• During the 1980s, annual housing price inflation was high, at nearly 10 per cent on average, but so too was general price inflation. In real terms, housing price inflation during the 1980s was relatively low, at1.4 per cent per annum compared with 4.5 per cent during the period from 1990 to the mid 2000s, and 2.5 per cent over the past decade.

• The 1990s until the mid 2000s were marked by quite high housing price inflation, of 7.2 per cent per annum, on average, in nominal terms.

• Annual nominal housing price inflation over the past decade was lower than either of these periods, at a little over 5 per cent on average.

The RBA contends that "housing price growth was closely associated with changes in the debt-to-income ratio over most of the 1990s until the mid 2000s". Recent rises have been closely associated with the increased role of investors.

The two variables that seem to indicate that Australian housing on average is overpriced are prices against income and prices against rent. Both have veered significantly from their long-term averages.

Charts of the Week and Other Things

 Figures for UK

A New Sustainable Housing Boom?

Bank lending is on the increase again and the housing market is back in boom territory. My prediction  last year was that the housing market would boom and then crash. The question is how long this play will take to work itself out. Too long a delay means the prediction is almost worthless. My guess is that the boom will continue over most of 2014 before crashing in 2015 as the economy tanks due to declining demand from China and the difficulty of increasing credit as a percentage of disposable income.

From the RBA:

The renewed boom has been associated with increasing concerns about housing affordability for younger buyers. According to a report in The Australian, the wealthy account for a growing percentage of housing stock, with "the top 20 per cent of income earners owning 36 per cent of Australian homes".

Another question is whether increased home lending is 'crowding out' business lending. To answer this we would need to understand whether the problem is one of supply (the banks) or demand (small business). I'm guessing that if banks can make easy money lending for houses it decreases their willingness to lend to risky small business.

One simple solution that would help affordability and possible crowding out: get rid of negative gearing.

From Leith van Onselen at Macro Business:

While it is clear that the mining boom has ended, my conjecture is that a new housing boom is unlikely to have long legs. This view is reinforced by the high levels of household debt as a percentage of disposable income.  One possible mitigating factor could be foreign purchases of Australian houses. Although there are restrictions on foreigners buying houses in Australia, these seem to be regularly bypassed by foreign investors through a variety of means. According to Martin North:

One factor which is driving the residential property market, especially in the major centres of Sydney, Melbourne and Perth is a rise in overseas purchasers. They may be Australian residents, overseas purchasers buying property for investment through an approved development, or locals acting for overseas purchasers, who are attracted by the sustained house price growth and relative economic stability. China is often identified as a major source for potential purchasers.

The ratio of debt to income increased enormously over the 1990s and 2000s and it is hard to imagine it repeating these increases over the next 10 years. A similar level of growth would see household debt to income increase to well over 200 per cent. (Such a ratio is possible, however, as The Netherlands shows, but it does set a country up for an inevitable rebalance as debt becomes unsustainable.)

Australia has benefited from a virtuous circle as the credit boom interacted with the mining boom. This is likely to turn into a vicious circle over coming years as commodity prices, particularly iron ore prices, decline over coming years.

Australia has been lucky in the timing of various booms - credit, consumption, housing and mining - over the past 10-15 years and who knows what new factor could intervene to damn all predictions and continue the luck.

The major factor affecting Australia given our growing export dependence will be the trajectory and form of Chinese growth. A less investment intensive Chinese growth model will lead to lower demand for resources and have negative effects on Australia.

The left field factor that I think will be very important over coming years is the fossil fuel revolution that has already had significant impact in the United States, putting it on the path to energy independence.

Rising prices and new technologies have made previously economically nonviable sources of supply viable. These technologies will eventually have an impact throughout the world, lessening the prices Australia receives for gas. Increased demand increases prices, which in turn increases supply, which eventually leads to lower prices. We are approaching this stage for many of our key resources. What Australia needs is continuing and sustained demand to balance lower prices with increased export volumes.  Over the longer term, lower prices mean that further supply is less viable and the cycle begins again. However, given the sustained nature of this commodity super cycle and the massive increase in supply it has encouraged, it is likely that it will be a while before there is a new investment boom, especially given Australia's status a high cost country.

While it might seem a long shot to connect these factors to the housing market, lower prices for Australian resources, particularly gas, could lower Australian incomes and expose high levels of indebtedness.

The saving grace for households (as the chart above shows) has been low interest rates leading to a lower ratio of interest paid to disposable income. Given the low level of inflation and the uncertain prospects for the world and Australian economies, low interest rates are likely to continue for a while.

The major reason for the absence of a crash in the Australian property market has been the simple fact that we've avoided a recession and thus avoided the development of a negative spiral where increasing unemployment leads to declining demand and increased difficulty in households meeting debt repayments, which leads to further declines in spending and further declines in demand. And so on.