Australia’s capital house prices rose 10 per cent last financial year, with an even stronger rise of 15 per cent in Sydney. While seemingly a dramatic increase, it is important to look past the short-run variability in house prices to longer-run trends.
On an inflation and quality-adjusted basis, house prices in Australia have increased by around 2 to 3 per cent per annum since 1970. This is enough to yield a doubling in real house prices every 30 years or so, underpinning a long-term decline in housing affordability and the home ownership rate.
Far from being an asset price “bubble”, this increase in house prices is explained by economic fundamentals. A major influence has been the decline in global real interest rates since the early 1980s. Australia’s real mortgage interest rates have also declined from around 10 per cent in 1990 to around 3 per cent today. This decline has boosted asset values and, with increased competition in housing finance, households’ borrowing capacity.
Based on Australian experience, a 1 per cent decline in real mortgage interest rates raises real house prices by 4 to 5 per cent. Unless global real interest rates rise significantly in the future, the gains in house prices associated with this long-term decline in real interest rates are unlikely to be unwound.
Income and population growth are the other main drivers of housing demand. While these growth rates are subject to considerable short-run variability, they represent permanent changes to demand.
Demand suppression policies are thus unlikely to improve long-run housing affordability. The central bank has little influence over real interest rates in the long run. Tightening accessibility to housing finance might be justified on financial stability grounds but won’t change the demand and supply balance in housing markets when only 37 per cent of Australian households are owner-occupiers with a mortgage. Suppressing income and population growth or immigration in the name of housing affordability would be a perverse public policy response.
An unfortunate and increasingly common response to rising house prices has been to scapegoat some buyers such as domestic and foreign investors. But they are no more responsible for rising house prices than the typical first home buyer. The problem is not too much demand but too little supply to prevent upward pressure on house prices.
In most markets, rising prices would induce new supply, containing or even lowering prices in the long run. But the supply of new land and homes in Australia is largely determined by regulation, preventing housing supply from responding quickly enough to rising prices.
Even in the long run, Australia has not been building sufficient new homes to accommodate changes in demand.
Over the past decade, the average number of new housing lots produced in the five largest capital cities has declined by about 20 per cent. The price of land for new home buyers in these capitals has increased by nearly 150 per cent over the same period. New lot sizes are getting smaller as home buyers seek to economise on the rising cost of land.
Urban growth boundaries have ring-fenced our capital cities while development and planning controls and taxes on new housing have made it increasingly difficult to supply affordable new housing, despite little change in real building costs.
Rather than tackling the tax and regulatory burden on new housing supply, politicians have responded with diversions designed to draw attention away from their own role in reducing housing affordability.
The House of Representatives Standing Committee on Economics inquiry into foreign investment in real estate is one such diversion. Foreign buyers of residential real estate transfer wealth to Australians, either in the form of additions to the dwelling capital stock built specifically for overseas investors or higher home prices received by Australian vendors.
To turn away these foreign wealth transfers would only serve to compound our domestic policy failures in relation to housing.
It is government policy to encourage temporary residents to come to Australia to study and work. If these temporary residents are prevented from buying new dwellings, they will enter the private rental market and increase competition in that market.
Australia already has a more restrictive policy on foreign investment in residential and other real estate than comparable economies such as the United States and the United Kingdom.
The fact that the controls on foreign investment are not effectively enforced only serves to demonstrate that our politicians have enacted impractical and unworkable laws and regulations that are too costly to properly enforce.
Australia needs to become more open to foreign investment, not less, but must also free up the supply of new housing to contain upward pressure on prices.
Stephen Kirchner is a research fellow at The Centre for Independent Studies.