Macro housing conditions - the long-term outlook for the Australian housing market

Macro Housing Conditions

The long-term outlook for the Australian housing market

• House prices in Australia experienced a decade of strong growth that was not matched by growth in underlying fundamentals.

Overview of Australian housing market

• Australian housing has become increasingly expensive relative to household incomes.


• Mortgage burden has risen despite the sharp reduction in mortgage rates.

• Aggregate mortgage payments ~50% higher today than in 1989, when mortgage rates = 17%.


• In 2011, a typical household with a mortgages spent 34% of its income on mortgage payments, up from 26% in 2001, an increase of 32%.


• Rental burden has also risen, particularly in the five years to 2011.


• But mortgage payments rose by more than rents in the decade to 2011.


• Australian housing is relatively expensive internationally.

International comparisons

• Australian housing is relatively expensive internationally.

International comparisons

• Virtually all of the 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 2.8 times GSP as at June 2011.


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


• The ratio of Australian mortgage debt to GDP rose four-fold since 1990, following deregulation of the financial sector.

How did we get here?

• Reflecting the boom in mortgage credit, annual housing finance commitments rose from around 5% of GDP in mid-1980s to a peak of 22% in 2003. They have since fallen back to 13% of GDP.


• 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.


• 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%.


• 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”.


• 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.


• 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.


• Australia’s rigid urban planning system has ensured that the increased demand has manifested in rising prices rather than increased dwelling construction.


• Australia’s terms-of-trade (commodity prices), peaked in 2011 and are now falling, 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

• Prices of iron ore – Australia’s biggest export – have collapsed on lower steel demand from China.

• Spot iron ore prices are down over -50% since peak and by more than-30% since the beginning of July. Australia’s terms-of-trade will be hit hard, subtracting from personal incomes. Further mining investments are also likely to be cancelled.


• The outlook for Australia’s terms-of-trade and mining investment is not good.

• China’s massive stimulus in the wake of the GFC has built-up too much excess capacity.

• China is, therefore, unlikely to embark on another fixed asset construction boom, meaning that demand for Australia iron ore will remain tepid.


• How low can iron ore prices go? The recent boom in iron ore prices was extreme and saw prices rise nearly ten-fold in real terms over the past decade.

• There appears to still be significant potential downside as slowing demand from China meets rising global supplies.


• Population aged 65+ is projected to explode over the next two decades.

• Baby Boomers will need to sell-down their property holdings to fund their retirements.

• The need to sell will be greatest for those whom are negatively-geared.


• In 2010, the BIS forecast that the ageing of Australia’s population would reduce real house prices by around 30% over the next 40 years, compared with what would occur under ‘neutral’ demographics (i.e. a steady age structure).


• Housing credit growth is falling, hitting fresh 35-year lows in July on both a quarterly and annual basis.

• The number of owner-occupied housing finance commitments also remains weak, tracking -11% below the five-year moving average.


• Macro-prudential controls on lending would have muted the credit cycle, for example:

• Maximum limits on loan-to-value ratios (e.g. maximum 85% LVR).

• Tighter mortgage serviceability requirements, such as:

• Loan repayments cannot consume more than 40% of after-tax household income; or

• Loan repayments cannot exceed 130% of market rent on property.

How could it have been prevented?

• Free-up supply-side bottlenecks:

• Implement more permissive urban planning:

• Create a presumption in favour of sustainable development

• Speed-up development approval times

• Eliminate artificial barriers to development, e.g. UGBs, restrictive zoning, etc

• Reduce up-front development/infrastructure charges in favour of long-term bond financing, recovered from property owners over decades

• Fund infrastructure properly via infrastructure bonds


• 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.


• Abolish negative gearing or restrict it to new builds only. It costs taxpayers in excess of $4 billion per year, inflates demand and does not add to housing supply.


• Abolish transaction taxes – stamp duties and CGT – in favour of a broad-based land values tax (LVT).

• Benefits of LVT include:

• Discourages speculation – prevents land-banking and increases competition in the land market.

• Encourages more efficient land use – increases density in order to avoid paying tax. Governments are also more likely to be pro-development in order to increase taxpayer base.

• Governments are more likely to support infrastructure provision as cost can be recovered via higher land values.

• Difficult tax to avoid and administratively simple – land ownership is well documented.

• Fairer – those with largest land holdings pay most tax.


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Macro housing conditions - the long-term outlook for the Australian housing market