Do we have a housing bubble? Yes, and a huge one, if we are measuring the market from the perspective of owner-occupiers. No, if you listen to a spurious line of reasoning from the Reserve Bank or if you expect current government policies and the flood of hot money from overseas to continue indefinitely. What is clear is that the current level and trajectory of housing prices has nothing to do with the supply and demand for housing from owner-occupiers.
In a paper released a year ago but which was presented last week at the Conference of Economists in Brisbane, the Reserve Bank’s researchers looked to determine whether a bubble exists on the basis of whether it is more expensive to own a home than rent one. This is a fallacious argument.
Housing is not just another asset purchase. One of the great Australian sages, Darryl Kerrigan from the movie The Castle, sums up the Australian bias against renting well when he states that with renting you simply pay someone else’s mortgage. We want to buy a home and, as such, there is no choice to be made between renting and owning. Comparing those metrics is an academic exercise only that bears no semblance to reality.
Furthermore, the difference in housing stock between rental dwellings and those inhabited by owner-occupiers is, in most cases, stark. Landlords do not like to spend money on their property if they don’t have to because the cash flow, as opposed to the tax accounting benefits, from owning a rental property is relatively small – the average yield on a typical Melbourne detached house is about 4%. Combine this with a lack of security in their tenancy and the idea that owning and renting are equal substitutes becomes less and less plausible.
The basis of the valuation of any asset class is supply and demand. In Australia we have enough dwelling units for the number of households we have and we are building more than enough each year to maintain that over-supply. In 2001, 9.2% of all private dwellings were unoccupied at the time of the Census. By 2011, this metric had grown to 10.7%. There are a lot of reasons why a dwelling would be unoccupied on Census night, but it is clear that any housing problems we may have are the result of building the wrong type of housing, not because we don’t build enough.
The base number of new dwellings that are needed each year is about 45,000. These are the new dwellings that are needed to accommodate the increase in population. It is important to recognise that the natural increase in population is actually a net supplier of housing to the nation. Newborns don’t need a new dwelling – their parents are, with notable exceptions, already living in a home. Many people who die are the last member of their household and thus their homes become empty.
Overseas migrants do not need as many dwellings as their numbers would suggest. Students and some 457 visa holders occupy high density units while those new Australians coming in on a family reunion visa can go straight into an existing household.
The demand for housing over and above the base figure comes from lifestyle choices - university graduates who want to live on their own, couples who divorce, people moving out of shared accommodation and the like. These are all important decisions in the growth of ourselves and our communities but these all can, and have been, delayed in response to housing prices going up much faster than incomes.
The level and growth of housing prices is being driven by those people who view property solely as an investment. Domestic investors have been aided by government policies such as negative gearing and favourable capital gains treatment. This class of buyer can outbid an owner-occupier by a quarter and be no worse off at the end of the full financial year.
Overseas investors often base their purchases on the differentials between Australia and their home country metrics as well as the desire to put their money in a safe haven. Furthermore, government policy only adds to the updraft of prices due to the requirement that overseas buyers of existing properties need to tear down the current structure and build something new.
Housing is unique in that all prices in a neighbourhood get re-rated with the last transaction. When the price of the best house in the street goes up, so does mine. When investors or overseas buyers pay a premium above the reserve price, or above the expected price, then all houses on the block see their land value increase.
The RBA is wrong when it says that house prices are based on what buyers are willing to pay; it’s based on what they need to pay. Owner-occupiers are now price takers, not price setters. Our housing market is unsustainable because prices have been set by a minority of buyers whose valuations and reasons for purchasing have nothing to do with the need of providing shelter for a family.
While the final word on whether we have a bubble will be confirmed after the fact. What is clear at the moment is that the RBA’s take on the housing market is, like the old wheeze about the answers from Microsoft Help, technically adept but thoroughly useless.