Housing Supply and Price Volatility

Leith van Onselen Chief Economist MacroBusiness.com.au

Overview of Australian housing market

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%.

Its all in the land

Virtually all growth in housing values has come from land price appreciation, with land prices roughly doubling relative to GDP since the late1980s.

Its 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.

Its all in the land

Australian vacant residential land has become prohibitively expensive, with all markets experiencing rapid price appreciation.

How did we get here?

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 Australias 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 & Insurances 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 Australias 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.

Dwelling construction weak

Australias rigid urban planning system has ensured that the increased demand has manifested in rising prices rather than increased dwelling construction.

Does tight supply mean prices cant fall?

Numerous commentators argue that Australias 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 cant 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 USAs 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 dont expect land prices to fall. (USA Today, 2006).

Does tight supply mean prices cant fall?

SRestricted

SUnrestricted

Economic theory says that when supply is inelastic (unresponsive), increases (decreases) in demand causes bigger increases (decreases) in prices.

Theory supported by empirical evidence

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 supplyrestricted states.

Theory supported by empirical evidence

In Georgia, policies mandating lending to the poor and underprivileged resulted in massive subprime lending. Yet Georgias delinquencies never reached the levels of the supply-restricted bubble states.

So what happened?
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.

Lessons for Australia

While Australias 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 supplyrestricted states of the USA.

Lessons for Australia

The UKs 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.

Risks to the outlook

Australias terms-of-trade (commodity prices), peaked in 2011 and are now declining, which will drag on incomes and employment going forward. Australias population is also ageing, with the working age population set to shrink in relative terms from now on, reducing the economys 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.