Bubble Trouble?

Stephen Walters considers the ongoing dilemma facing the housing market and warns against attractive but ineffective panaceas.

A perfect storm of factors has driven home prices seemingly ever-higher and out of the reach of many Australians, particularly aspiring first time buyers. The issue has become so acute that politicians have (finally) realised they have a problem. But beware policymakers offering easy solutions like a simple tweak to the tax treatment of housing as a panacea. This would help, but only a sustained boost to home construction will have a lasting impact on affordability.

It’s beyond doubt now that housing in Australia is among the most world’s expensive, in absolute terms and as a multiple of income. Sydney-siders, need to spend 12 times their household income to buy an average home – only Hong Kong’s metrics are worse. Nationally, six times income is needed for the average home – economists classify anything above four as expensive.

It is a stretch, though, to say there is a housing “bubble” in Australia. Our housing has been expensive for decades, but this does not necessarily imply inflation of a bubble. True, some over-supplied, inner city apartment markets look vulnerable, but not the broader market.

We need to be careful, too, about comparing offshore dynamics with the Australian market, particularly those in the US before the global financial crisis (GFC). There are important distinctions that make housing here more resilient than most, including our variable interest rate structure, full recourse mortgage lending, favourable tax treatment, rapid population growth, and the sustained underbuild of housing for decades. But there are excesses here creating anxiety for our policymakers.

The extent of the problem is now clear. The ratio of home ownership in Australia has slipped to a 70-year low as people give up on the “Australian dream” or delay their purchase. A number of factors are contributing to worsening house price affordability at a time of record low wages growth.

First, the Reserve Bank of Australia (RBA) has decreased interest rates to record lows, so borrowing is exceptionally cheap. The current cash rate is half the “emergency” rate that prevailed during the GFC, yet weakness in the broader economy means interest rates will remain low, encouraging demand for housing.

Second, in spite of soaring home construction since 2013, most economists believe the broader housing market remains undersupplied, meaning even higher prices.

Third, although evidence is patchy, foreign investors still see Australian housing as attractive, further inflating prices. And, of course, the age-old perception that rent is “dead money” compels people to “get into the market” no matter the price extremes.

For regulators, the affordability problem feeds directly into financial system risks. The sustained strength of the east coast housing markets has contributed to an explosion in household debt. Very few countries mirror our elevated household debt as a share of the economy, an imbalance RBA officials see as a growing risk to domestic financial stability.

So, what can be done? Reform of the Commonwealth’s tax treatment of housing would help, particularly altering the nexus between generous negative gearing provisions and the 50 per cent discount on capital gains tax liabilities. This arrangement encourages borrowing and speculation, particularly when interest rates are low.

At the state level, stamp duties on conveyances should be replaced with land taxes to encourage more productive use of housing assets. Finally, more scrutiny of foreign purchases would also be beneficial, perhaps alongside higher borrowing costs for investors.

These measures are only part of the solution. The core issue is the undersupply of housing. There have been welcome steps to change zoning laws to allow higher-density housing and to streamline construction approvals processes, but more needs to be done.

What is not helping are expanded first home owners’ grants and stamp duty concessions; if anything, these boost demand and inflate prices. Similarly, allowing first time buyers to dip into their superannuation for a deposit on a home may help facilitate a purchase, but will not address the problem of affordability.