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