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Housing Supply and Price
Volatility
Leith van Onselen
Chief Economist
MacroBusiness.com.au
• House prices in
Australia
experienced a
decade of
exceptionally
strong growth.
• Real prices
increased by
120% between
1996 and 2010.
Overview of Australian housing market
• Price growth was
not matched by
growth in
underlying
fundamentals.
Overview of Australian housing market
• Value of housing
stock relative to
total employee
earnings far
above historical
norms.
Overview of Australian housing market
• Value of housing
stock relative to
GDP also far
above historical
norms.
Overview of Australian housing market
• Strong growth in
home values has
made Australians
relatively
“wealthy”.
Overview of Australian housing market
• But Aussies hold a disproportionate share of their wealth in
housing, compared with other English-speaking nations.
Overview of Australian housing market
• Mortgage
affordability is
improving, but still
poor overall.
• Proportion of
household income
chewed-up by
mortgage interest
payments still 34%
higher than 1989,
when mortgage
rates peaked at
17%.
Overview of Australian housing market
• Virtually all
growth in
housing values
has come from
land price
appreciation,
with land prices
roughly doubling
relative to GDP
since the late-
1980s.
It’s all in the land
• Land price appreciation has occurred across all markets, with
Victorian values the most expensive at 2.6 times GSP as at June 2012.
It’s all in the land
• Australian vacant residential land has become prohibitively
expensive, with all markets experiencing rapid price appreciation.
It’s all in the land
• The ratio of
Australian
mortgage debt
to GDP rose
four-fold since
1990,
following
deregulation
of the financial
sector.
How did we get here?
• The share of loans channelled into housing has increased from 24% of total loans in 1990 to 59% currently.
• The rapid expansion of mortgage debt and housing values has been funded, to a large extent, by heavy offshore borrowings by Australia’s banks and is represented by a massive expansion in bank assets (mainly mortgages) relative to GDP.
How did we get here?
• The Finance & Insurance industries have grown more than twice as fast as the rest of the economy since the mid-1980s, when financial markets were deregulated.
• Finance & Insurance’s share of GDP has more than doubled to nearly 10%.
How did we get here?
• Strongly rising commodity prices have played a major role in increasing
housing values since-2004, via their positive impact on incomes. The
commodity price boom came along just as mortgage growth began to
decline, enabling house prices to remain “stronger for longer”.
How did we get here?
• The Australian Treasury estimates that 50% of Australia’s income growth over the 2000s came from the one-off terms-of-trade (commodity price) boom, whereas McKinsey estimates that 90% of Australian income growth since 2005 came from the mining boom.
How did we get here?
• The number of property investors has surged, from 696,000 in 1990 to 1.75 million in 2010. Nearly 60% of investors are baby boomers.
• Two-thirds of investors were negatively geared in 2010, losing on average $2,750 per year, or a total of -$4.8 billion. Three quarters of negatively geared investors earned less than $80,000.
How did we get here?
• Australia’s rigid urban planning system has ensured that the
increased demand has manifested in rising prices rather than
increased dwelling construction.
Dwelling construction weak
• Numerous commentators argue that Australia’s tight
housing supply means that a severe house price correction
could not occur:
• “Because Australia suffers from quite acute housing shortages we
shouldn't expect to see any significant falls in prices” (Chris Joye,
June 2010).
• “…since 2006, population growth has exceeded new supply of
dwellings… This will put a floor under housing prices and is a key
reason why we have little concern about a sharp (or large) house
price decline” (Paul Bloxham, July 2011).
Does tight supply mean prices can’t fall?
• Similar arguments were used in USA prior to bust:• “The California Building Industry Association (CBIA) continues to express alarm
over what it calls an ongoing housing crisis in Southern California… only
185,000 to 205,000 building permits will be granted this year, far short of the
240,000 new homes needed each year… The population increase, coupled with
the housing shortage, has the CBIA worried that it will be increasingly difficult
for first-time homebuyers to find a moderately priced unit“ (CBIA, 2006).
• “The valley that Las Vegas and 1.8 million residents call home is nearly built
out… At the current building pace in the USA’s fastest-growing major metro
area, available acreage will be gone in less than a decade, developers and real
estate analysts say… A scarcity of land is driving prices skyward… Developers
who 15 years ago paid less than $40,000 an acre are paying more than
$300,000 today… Developers don’t expect land prices to fall.” (USA Today,
2006).
Does tight supply mean prices can’t fall?
• Economic theory
says that when
supply is “inelastic”
(unresponsive),
increases
(decreases) in
demand causes
bigger increases
(decreases) in prices.
Does tight supply mean prices can’t fall?
SRestricted
SUnrestricted
• Empirical evidence from the US and elsewhere shows that markets with responsive land-use regulations have more affordable housing markets and experience less price volatility, as changes in demand manifest more in new construction rather than prices.
Theory supported by empirical evidence
• Growth in US house prices bore little relation to income and
population growth.
Theory supported by empirical evidence
• US markets with responsive land-use regulation remained affordable
and experienced relatively low house price volatility throughout the
bubble/bust period.
Theory supported by empirical evidence
• US markets with responsive land-use regulation never had the big
run-up in debt or the subsequent deleveraging as housing was always
abundant and affordable, and speculative demand was minimised.
Theory supported by empirical evidence
• US markets with responsive land-use regulation generally had lower
level of mortgage arrears and housing foreclosures than the supply-
restricted states.
Theory supported by empirical evidence
• In Georgia, policies
mandating lending to
the poor and under-
privileged resulted in
massive subprime
lending.
• Yet Georgia’s
delinquencies never
reached the levels of
the supply-restricted
bubble states.
Theory supported by empirical evidence
• Big demand ‘shock’
from GFC caused rate of
household formation to
plummet as individuals
increasingly opted for
group housing.
• Turned a perceived
housing shortage into a
glut.
• Meant prices were not
supported by “tight”
supply.
So what happened?
• While Australia’s restrictive
urban planning regime has
helped to drive prices
higher during the boom, it
is unlikely to save us from
price falls in the event that
there is a big shock to
demand.
• A perceived housing
shortage could easily turn
into an oversupply, just like
it did in the supply-
restricted states of the USA.
Lessons for Australia
• The UK’s housing
market has arguably
the most restrictive
land-use regime in
the world, yet
housing has
experienced four
boom/bust cycles
since the 1970s,
with price volatility a
constant feature.
Lessons for Australia
• Australia’s terms-of-trade (commodity prices), peaked in 2011 and are now declining, which will drag on incomes and employment going forward.
• Australia’s population is also ageing, with the working age population set to shrink in relative terms from now on, reducing the economy’s potential growth rate and demand for housing.
Risks to the outlook
• Severe housing correction an outside chance if Australia experiences a
mining bust – i.e. sharply lower commodity prices combined with a big
reduction in mining investment. This combination would cause sharp falls in
incomes, a big increase in unemployment, and potentially a credit squeeze.
Risks to the outlook