Why Housing Affordability Talk Is Just Hot Air

So, suddenly its politically correct to be discussing “housing affordability”. But talk is cheap, as we discussed in a recent video blog.

The problem is the political weight from home owners, banks, and the construction industry are all wedded to ever rising prices. The number of first time buyers are relatively small, so they have little political impact. Numbers count.

In addition, the regulators go out of their way to say all is well. We have questioned their stance on a number of occasions.

States benefit from high stamp duty returns, financial institutions can swell their balance sheets, and existing tax concessions assist investors who have enjoyed amazingly strong capital growth.

Tackling supply-side issues is indeed one factor, but we suspect there will be much talk and little action to address the long-term systemic issues – this is because the majority of households (and so voters)  prefer prices to keep rising. So real political intervention is untenable, unless political leaders stand up. We think this is unlikely.

In addition, we have a diverse set of outcomes across the states, from rabid house price inflation in Sydney, to falling prices in Perth. There can be no-one size fits all solution, so the issues are complex and long term, and beyond the political cycle.

In 2014 in a submission to the Senate Inquiry on Affordable Housing we outlined a road-map to address the issue. Some of the numbers may have changed, and some aspects have been tweaked, but the trajectory remains correct:

  1. We believe that the current long term trends in housing are detrimental to Australians, and this is having a significant negative impact on the economic performance of the country.
  2. We are not in a housing bubble, but we have a chronic problem. This is because the rapid growth in prices in recent years has not kept pace with many households ability to pay, forcing significant numbers into high debt to income ratio’s, the selection of properties in less accessible and less convenient locations and the exclusion of considerable numbers from the market. In total 2.3 million households are not active in the property market at all.
  3. In addition, discretionary spending has been blotted up by higher housing costs. Households are highly leveraged today, and if interest rates were to rise, mortgage stress would become more significant.
  4. Banks have grown their balance sheets in-line with growth in demand – especially supporting high levels of investment loans, and as a result they are not adequately providing reasonable lending services to a considerable number of small and medium enterprises, who could create economic value to the country. This is influenced by the relative capital costs of housing lending versus commercial lending under the Basel rules. Lending ever more loans to households to purchase property does not create real growth, it just inflates prices.
  5. We believe there are significant supply-side issue, with at least 200,000 properties required to meet current and expected demand. A significant proportion of these should be aligned with the needs of the large number of “Want-to-Buy” households, who cannot access the market today. Today 1.2 million households are directly excluded from the market. Many of these are younger, less well-off and in rental property at the moment.
  6. Local government policies and reliance on stamp duties are part of the problem, together with planning restrictions and high development fees and charges, all leading to poor supply of affordable homes. The proportion of high-rise developments is increasing.
  7. Many First Time Buyers are only able to access the market with direct financial assistance from family or friends.  The focus of First Time Buyer incentives being aligned to new-builds is welcome, but we believe that these incentives actually lift prices, and do long term harm.
  8. In addition, we note there is considerable demand from both local and overseas investors, contending with potential First Time buyers.
  9. Ultra-low interest rates are not helping because it is stimulating demand from the investment sector, lifting the size of loans, and negatively impacting affordability. Note that the banks rightly utilize buffers to test for affordability, so low rates do not flow into greater loan availability.
  10. Negative gearing has been one of the most significant incentives for many investors, but it is widely accepted as a costly tax advantage which has pushed up prices, and driven First Time Buyers from the market.
  11. For many, property has ceased to be primarily a place to live, it is rather an investment first and foremost. This is a concerning trend. Self-Managed Super Funds are also accessing investment property, thanks to the attractive tax sheltering which exists today.

DFA recommends the consideration of the following to help address affordability and accessibility of housing in Australia.

  1. Australia should develop a strategic housing plan which guides ongoing development, be it in current centres, or expansion into new towns. Current tactical plans are not sufficient. The plan should specifically address the supply of affordable housing.
  2. Strategies should be devised to increase land supply. State governments should reduce the current high levels of access fees for new development and revise planning criteria and processes. This has the potential to create considerable economic growth.
  3. Overseas investors should not be able to access first-time buyer incentive schemes, and the Foreign Investment Review board rules should be strengthened to reduce the impact of foreign investors on the local market.
  4. The RBA should have a direct multi-segmented housing affordability metric within its measurement framework. Affordability should be targeted at trend average, not rates experienced since the debt explosion of the 2000 onwards.
  5. Macro-prudential policies should be employment to control the growth in lending. In line with the recommendations from the Bank of International Settlement debt to income servicing ratios should be employed as the policy tool of choice.
  6. Negative gearing should be tapered away and removed for new transactions.
  7. Joint equity schemes like the UK’s Help to Buy Scheme  should be considered as a tactical step to assist some of the “Want-to-Buys.”

 

Retirement will be harder for future Australians

New research by the Swinburne Institute for Social Research, shows the wealth effect of holding property, and the risks in retirement of those unable to get on the ladder. In fact, a comfortable retirement is unlikely for those renting, because they are excluded from capital growth, which makes up such a large element of household wealth.

They also show that households who invested in property in 2013 were far more highly leveraged than those from 2003, reflecting changes in tax concessions, and growing household debt.

Essentially, households have little choice but to join the property owning sector, once again highlighting why people are so desperate to join the band wagon; and the risks embedded should home prices revert to more normal level. As we said in a recent blog – all most everyone wins from ever high home prices, until the music stops.

The report examined the wealth of people aged 40 to 64 years and recent retirees.

It evaluated the degree to which households can accumulate wealth for retirement, focusing on housing, and the impact of relationships and divorce or separation.

owners-wealth

Lead researcher Dr Andrea Sharam says lone person and couple-only renters over 45 years of age tend to have little wealth.

“There are currently 425,000 people in lone person or couple households over 50 renting in Australia with this number expected to rise to 600,000 by 2030 and again to 830,000 by 2050.

“This number of impoverished older people equates to a huge increase in demand for housing assistance.”

Men and women are revealed to have different pathways into rental poverty in old age. For women the cost of care and the gender wage gap negatively affects them, while for men low educational achievement, consequential limited employment prospects and disability are factors.

“Relationship breakdown typically adversely impacts wealth with one if not both former partners often falling out of home ownership and not later recovering home ownership.

“Single mothers with young children are particularly vulnerable,” Dr Sharam says.

Policy recommendations

The report recommends a number of policy changes, including substantial community investment in social housing, and new affordable housing tenures aimed at midlife households who may not be eligible for social housing but also cannot afford full market house pricing.

“Social housing eligibility should be widened to order to cater for a broader range of incomes,” Dr Sharam says.

This would help prevent the loss of wealth associated with being a private renter and minimise the danger of retirees exhausting their resources before end of life.

The report also recommends better rights for renters, including:

  • security of tenure in residential tenancies legislation,
  • institutional investment in rental housing,
  • age-specific rental supplements, and
  • a National Rental Affordability Scheme (NRAS) type program targeted to age pensioners.

To read the full report see, Security in Retirement: The impact of housing and key critical life events.

Is The Root Cause Of High House Prices What You Think It Is?

A snapshot of data from the RBA highlights the root cause of much of the economic issues we face in Australia. Back at the turn of the millennium, banks were lending relatively more to businesses than to households. The ratio was 120%. Roll this forward to today, and the ratio has dropped to below 60%. In other words, for every dollar lent now it is much more likely to go to housing than to business. This is a crazy scenario, as we have often said, because lending to business is productive – this generates real productive growth – whilst lending for housing simply pumps up home prices, bank balance sheets and household balance sheets, but is not economically productive to all.

Lending-MixThere are many reasons why things have changed. The finance sector has been deregulated, larger companies can now access capital markets directly and so do not need to borrow from the bank, generous tax breaks (negative gearing and capital gains) have lifted the demand for loans for housing investment, and the Basel capital ratios now make it much cheaper for banks to lend against secured property compared to business. In fact the enhanced Basel ratios were introduced in the early 2000’s and this is when we see lending for housing taking off.

So how much of the mix is explained by tax breaks for investors? If we look at the ratio of home lending for owner occupation, to home lending for investment, there has been an increase. In 2000, it was around 45%, now its 55% (with a peak above 60% last year). This relative movement though is much smaller compared with the switch away from lending to business.  Something else is driving it.

RBA-Mix-HousingWe therefore argue that whilst the election focus has been on proposed cuts to negative gearing and capital gains versus a company tax cut, the root cause issue is still ignored. And it is a biggie. The international capital risk structures designed to protect depositors, is actually killing lending to business, because it makes lending for housing so much more capital efficient. Whilst recent changes have sought to lift the capital for mortgages at the margin, it is still out of kilter. As a result, banks seek to out compete for mortgages and offer discounts and other incentives to gain share, whilst lending to business is being strangled. This is exacerbated by companies being more risk adverse, using high project hurdle thresholds (despite low borrowing rates) and smaller businesses being charged relatively more – based on risk assessments which are directly linked to the Basel ratios. Our SME surveys underscore how hard it is for smaller business to get loans at a reasonable price.

The run up in house prices is a direct result of more available mortgage funding, and this in turn leaves first time buyers excluded from the market. But it is too simple to draw a straight line between negative gearing and first time buyer exclusion. The truth is much more complex.

We are not convinced that a corporate tax cut, or a further cut in interest rates will stimulate demand from the business sector. Nor will reductions in negative gearing help that much. We need to re-balance the relative attractiveness of lending to business versus lending for housing.  The only way to do this (short of major changes to the Basel ratios) is through targeted macro-prudential measures. In essence lending for housing has to be curtailed relative to lending to business. And that is a whole new box of dice!

 

House Prices On The Slide

According to the Domain House Price Report for the March Quarter, Melbourne and Hobart are the only capital cities where house prices are still rising. Sydney’s house prices fell, recording a quarter-on-quarter drop of 1.5 per cent, bringing the median down under the $1 million mark to $995,804. This 1.5 per cent drop when coupled with the 3.2 per cent fall in the December quarter, means prices have now dropped 4.7 per cent over six months. It’s an even bigger drop than Sydney experienced over 2008 during the global financial crisis, when the median dropped 4.6 per cent over the full year.

Domain-April-2016-Sydney Canberra house prices fell by 1.4 per cent after five consecutive quarters of growth.

In Perth, house prices dropped by 1.3 per cent to $579,914 over the quarter, while Adelaide recorded a 0.5 per cent drop to $491,422, and prices in Brisbane fell by 0.05 per cent to $512,809.

The report showed that house prices in Hobart surged during the March quarter, rising by 4.3 per cent to $360,212, while Melbourne house prices rose by 1.2 per cent to $726,962.

Darwin house prices dropped sharply by 4.9 per cent to $610,305.

“Weakening economic activity and growing uncertainty is impacting fragile consumer and investment sentiment, leading to falling house and unit prices in most capital cities,” Domain chief economist Andrew Wilson said.

“The outlook for house prices remains subdued, with capital city growth likely to continue to track at best just above the inflation rate for the remainder of 2016.

“The prospect of weaker house price growth, however, will be welcomed by prospective first home buyers still struggling to get into the market.”

The boom’s over, but no crash is imminent. As Dr Wilson points out, the most recent drop in Sydney is less than the one in December. So there could be an even smaller fall in June. It’s not as if there’s been any major trigger to substantiate a more significant correction, like a large rise in interest rates or a jump in unemployment.

The “deadly embrance” between housing, house prices, and bank mortgages

An interesting IMF working paper “Mitigating the Deadly Embrace in Financial Cycles: Countercyclical Buffers and Loan-to-Value Limits” examines the limitations of Basel III in the home loan market, and makes the point that the risk-weighted focus, even with enhancement, does not cut the mustard especially in a rising or falling property market. Indeed, there is a “deadly embrance” between housing, house prices, and bank mortgages which naturally leads to housing boom and bust cycles, which can be very costly for the economy and difficult for central banks to manage. They find that macroprudential measures may assist, but even then the deadly embrace remains.

The financial history of the last eight centuries is replete with devastating financial crises, mostly emanating from large increases in financial leverage.  The latest example, the Global Financial Crisis of 2008-09, saw the unwinding of a calamitous run-up in leverage by banks and households associated with the housing market. As a result, the financial supervision community has acknowledged that microprudential regulations alone are insufficient to avoid a financial crisis. They need to be accompanied by appropriate macroprudential policies to avoid the build-up of systemic risk and to weaken the effects of asset price inflation on financial intermediation and the buildup of excessive leverage in the economy.

The Basel III regulations adopted in 2010 recognize for the first time the need to include a macroprudential overlay to the traditional microprudential regulations. Beyond the requirements for capital buffers, and leverage and liquidity ratios, Basel III regulations include CCBs between 0.0 and 2.5 percent of risk-weighted assets that raise capital requirements during an upswing of the business cycle and reduce them during a downturn. The rationale is to counteract procyclical-lending behavior, and hence to restrain a buildup of systemic risk that might end in a financial crisis. Basel III regulations are silent, however, about the implementation of CCBs and their cost to the economy, leaving it to the supervisory authorities to make a judgment about the appropriate timing for increasing or lowering such buffers, based on a credit-to-GDP gap measure. This measure, however, does not distinguish between good versus bad credit expansions and is irrelevant for countries with significant dollar lending, where exchange rate fluctuations can severely distort the credit-to-GDP gap measure.

One of the limitations of Basel III regulations is that they do not focus on specific, leverage-driven markets, like the housing market, that are most susceptible to an excessive build-up of systemic risk. Many of the recent financial crises have been associated with housing bubbles fueled by over-leveraged households. With hindsight, it is unlikely that CCBs alone would have been able to avoid the Global Financial Crisis, for example.

For this reason, financial supervision authorities and the IMF have looked at additional macroprudential policies. For the housing market, three additional types of macroprudential regulations have been implemented: 1) sectoral capital surcharges through higher risk weights or loss-given-default (LGD) ratios;3 2) LTV limits; and 3) caps on debt-service to income ratios (DSTI), or loan to income ratios (LTI). Use of such macroprudential regulations has mushroomed over the last few years in both advanced economies and emerging markets. At end-2014, 23 countries used sectoral capital surcharges for the housing market, and 25 countries used LTV limits. An additional 15 countries had explicit caps on DSTI or LTI caps. The experience so far has been mixed.in a sample of 119 countries over the 2000-13 period find that, while macroprudential policies can help manage financial cycles, they work less well in busts than in booms. This result is intuitive in that macroprudential regulations are generally procyclical and can therefore be counterproductive during a bust when bank credit should expand to offset the economic downturn.

Macroprudential regulations are often directed at restraining bank credit, especially to the housing market. They do not, however, take into account the tradeoffs between mitigating the risks of a financial crisis on the one side and the cost of lower financial intermediation on the other. In addition, given that these measures are generally procyclical, they can accentuate the credit crunch during busts. More generally, an analytical foundation for analyzing these tradeoffs has been lacking. MAPMOD has been designed to help fill this analytical gap and to provide insights for the design of less procyclical macroprudential regulations.

The MAPMOD Mark II model in this paper includes an explicit housing market, in which house prices are strongly correlated with banks’ credit supply. This corresponds to the experience prior and during the Global Financial Crisis. This deadly embrace between bank mortgages, household balance sheets, and house prices can be the source of financial cycles. A corollary is that the housing market is only partially constrained by LTV limits as the additional availability of credit itself boosts house prices, and thus raises LTV limits.

The starting point of the MAPMOD framework is the factual observation that, in contrast to the loanable funds model, banks do not wait for additional deposits before increasing their lending. Instead, they determine their lending to the economy based on their expectations of future profits, conditional on the economic outlook and their regulatory capital. They then fund their lending portfolio out of their existing deposit base, or by resorting to wholesale funding and debt instruments. Banks actively seek new opportunities for profitable lending independently of the size or growth of their deposit base—unless constrained by specific regulations.

In MAPMOD, Mark II, we extend the original model by introducing an explicit housing market. We use the modular features of the model to analyze partial equilibrium simulations for banks, households, and the housing market, before turning to general equilibrium results. This incremental approach sheds light on the intuition behind the model and simulation results.

The housing market is characterized by liquidity-constrained households that require financing to buy houses. A house is an asset that provides a stream of housing services to households. The value of a house to each household is the net present value of the future stream of housing services that it provides plus any capital gain/loss associated with future changes in house prices. We define the fundamental house price households are willing to pay to buy a house the price that is consistent with the expected income/productivity increases in the economy. If prices go above the fundamental house price reflecting excessive leverage, we refer to this as an inflated house price. The supply of houses for sale in the market is assumed to be fixed each period. House prices are determined by matching buyers and sellers in a recursive equilibrium with expected house prices taken as given. We abstract from many real-world complications such as neighborhood externalities, geographical location, square footage or other forms of heterogeneity.

Bank financing plays a critical role in the determination of house prices in the model. If banks provide a larger amount of mortgages on an expectation of higher household income in the future, demand for housing will go up, thus inflating house prices. Conversely, if banks reduce their loan exposure to the housing market, demand for houses in the economy will be reduced, leading to a slump in house prices. House prices therefore move with the credit cycle in MAPMOD, Mark II, just as in the real world.

Nonperforming loans and foreclosures in the housing market occur when households are faced with an idiosyncratic, or economy-wide, shock that affects their current LTV or LTI characteristics. Banks will seek to reduce the likelihood of losses by requiring a sufficiently high LTV ratio to cover the cost of foreclosure. But they will not be able to diversify away the systemic risk of a general fall in house prices in the economy. Securitization of mortgages in MAPMOD is not allowed. And even if banks were able to securitize mortgages, other agents in the economy would need to carry the systemic risk of a sharp fall in house prices. At the economy-wide level, the systemic risk associated with the housing market is therefore not diversifiable. The evidence from the Global Financial Crisis on securitization and credit default swaps confirms that this is the case, regardless of who holds mortgage-backed securities.

This paper presented a new version of MAPMOD (Mark II) to study the effectiveness of macroprudential regulations. We extend the original MAPMOD by explicitly modeling the housing market. We show how lending to the housing market, house prices, and household demand for housing are intertwined in the model in a what we call a deadly embrace. Without macroprudential policies, this naturally leads to housing boom and bust cycles. Moreover, leverage-driven cycles have historically been very costly for the economy, as shown most recently by the Global Financial Crisis of 2008–09.

Macroprudential policies have a key role to play to limit this deadly embrace. The use of LTV limits for mortgages in this regard is ineffective, as these limits are highly procyclical, and hold back the recovery in a bust. LTV limits that are based on a moving average of historical house prices can considerably reduce their procyclicality. We considered a 5 year moving average, but the length of the moving average used should probably vary based on the specific circumstances of each housing market.

CCBs may not be an effective regulatory tool against credit cycles that affect the housing market in particular, as banks may respond to higher/lower regulatory capital buffers by reducing/increasing lending to other sectors of the economy.

A combination of LTV limits based on a moving average and CCBs may effectively loosen the deadly embrace. This is because such LTV limits would attenuate the housing market credit cycle, while CCBs would moderate the overall credit cycle. Other macroprudential policies, like DSTI and LTI caps, may also be useful in this respect, depending on the specifics of the financial landscape in each country. It is, however, important to recognize that all these macroprudential policies come at a cost of dampening both good and bad credit cycles. The cost of reduced financial intermediation should be taken into account when designing macroprudential policies.

Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

 

Sydney Home Prices Take A Dive

The Residential Property Price Index (RPPI) for Sydney fell 1.6 per cent in the December quarter 2015 following positive quarterly growth over the last three years, according to figures released today by the Australian Bureau of Statistics (ABS).  Sydney established house prices fell 2.1 per cent and attached dwellings prices fell 0.8 per cent in the December quarter 2015. Annually, Sydney residential property prices rose 13.9 per cent.

Dec-2015-Price-Movements
In other capital cities in the December quarter 2015, the RPPI rose in Melbourne (+1.6 per cent), Brisbane (+1.6 per cent), Adelaide (+0.9 per cent), Canberra (+2.8 per cent), Perth (+0.5 per cent) and Hobart (+2.5 per cent) and fell in Darwin (-1.8 per cent ).

For the weighted average of the eight capital cities, the RPPI rose 0.2 per cent in the December quarter 2015 and rose 8.7 per cent over the previous year.

The total value of Australia’s 9.6 million residential dwellings increased $31.6 billion to $5.9 trillion. The mean price of dwellings in Australia is now $612,100.

Report calls for review of tax exemptions on family home

From Australian Broker.

The capital gains tax (CGT) will be cast into the spotlight with a new proposal to tax profits on the sale of houses over $2 million to be released by the Australia Institute.

According to The Australian Financial Review (AFR) the report by the Australia Institute, to be released today, will show that low-income households receive almost no benefit from the capital gains tax exemption, which was estimated at $46 billion in 2015-16 and is forecast to be worth $189 billion by 2020.

As such, the report argues for the removal of the exemption for homes worth $2 million or more. Modelling in the report shows removing the capital gains tax exemption for these homes would boost the budget by $12 billion over four years.

According to the AFR, Australia Institute executive director Ben Oquist said the 50% capital gains tax discount should also be looked at.

“While super tax concessions are often talked about, it’s clear capital gains tax needs reform,” he said.

“The discount and exemption are costing the budget tens of billions of dollars and while many other areas of tax reform would require compensation for the less well off, such as raising the GST, limiting or reducing the discount or exemption would affect only the very wealthy, be good for the economy and potentially be a multi-billion-dollar budget boost.”

The report claims the capital gains tax exemption on the main residence costs the federal budget more than defence, education or Medicare. It is also a big factor in housing affordability in Australia.

“Reducing the concession is likely to have a positive impact by reducing distortions in the economy,” the report says, according to the AFR.

“At present the exemption encourages over capitalisation in main residences since any increase in their value is tax free. This has the effect of pushing up the value of housing and therefore making that housing less affordable.”

Last year fewer than 1% of owner-occupied house sales were for $2 million or more, the AFR reported.

Sydney’s Capital Growth Boom is Over

From Mortgage Professional Australia. New report shows Sydney’s capital growth boom is over, economist says

A prominent economist believes a report released today confirms that Sydney’s house price boom has come to an end.

According to the latest Domain House Price Growth report, Sydney’s median house price grew by only 3.2% over the September quarter, the slowest rate of quarterly growth since March 2014.

According to the report the median price for a house in Sydney is $1,032,433, while the median unit price is now $673,182 after it grew at just 1.5% over the quarter – well down on the 7.4% growth seen during the June quarter.

“It’s still a good result for owners in Sydney, but I think it’s clear now that the boom in price growth we’ve been seeing is receding,” Domain Group senior economist Dr Andrew Wilson said.

“House price growth over the September quarter was well below what we saw in June, it’s actually less than half than the June quarter growth and it looks like growth will be lower again over the December quarter,” Dr Wilson said.

Dr Wilson said there have been a number of signs recently that have been pointing to slowdown in price growth.

“We’ve seen a sharp decline in auction clearance rates recently which is a pretty good forward indicator and also we’re starting to see interest rate increases that will offset any decreases by the RBA,” Dr Wilson said.

“Look, prices will continue to grow and it’s quite rational to say they will be higher this time next year, but it’s not going to be at the same level we’ve seen in recent years as a lot of the energy that came from the February and May rate cuts has now washed through the market and people simply don’t have the capacity to keep buying.”

In Melbourne, a similar slowing of capital growth rates appears to be occurring.

The Melbourne median house price increased by 2.8% over the September quarter, pushing the median house price above $700,000 for the first time, but that level of growth is well below the 6% recorded over then June quarter.

While investors can no longer expect the same strong levels of capital growth they have been experiencing in Sydney and Melbourne, Dr Wilson said there was also some worry for Brisbane, which has been touted by many as the next investment hotspot.

“Brisbane has been disappointing, it was predicted to grow just behind Melbourne but that’s just not happening.

“It’s doing nothing like it was predicted, growth looks like it could be below last year’s level and it’s just really going sideways with no direction or momentum.”

Does Trading Down Trump Trading Up?

As we continue to look over the results of the latest household surveys, as captured in the recently released Property Imperative report to September 2015, we look at households who are wanted to trade up and trade down. These are important segments of the market because they have reason to transact, and access to funding if they decide to trade. In fact they tend to underpin the market, and the balance between the two tell us something about demand and supply, and also which sectors are more likely to be on the up.

So looking first at those seeking to trade up, our survey identified about 1,077,000 households who are considering buying a larger property. Most (91%) are owner occupied. Of these households 12% are expecting to transact within the next 12 months, whilst 64% of households expect house prices to rise in this period.

DFA-Sept-UpTraders
The main reasons for these households to transact are as a property investment (40%), to obtain more space (33%), because of a job move (12%) and for a life-style change (12%). Many of these households will require further finance (72%) and a quarter will consider using a mortgage broker (22%), whilst 33% of these households are actively saving to facilitate a transaction. We note that prospective future capital gains rated most strongly, the view of property as an investment continues to drive behaviour. We also note that the majority of up-traders are seeking houses rather than apartments. Given the focus on owner occupied finance now, lenders and brokers would do well to consider their strategies to assist this market segment.

Turning to down-traders, more than 1.25 million households are considering selling and buying a smaller property. These households tend to be older, and with higher net worth. Of these 71% are considering an owner occupied property, and 29% an investment property. Of these 670,000 currently have no mortgage and own the property outright. Many will not need bank finance to transact. Some however may seek investment finance.

DFA-Sept-Down-Traders

Around 24% of these households expect house prices to rise over the next year, whilst 51% expect to transact within 12 months, 9% will consider using a mortgage broker and 9% will need to borrow more. Households will transact to facilitate increased convenience (30%), to release capital for retirement (28%), because of unemployment (7%) or because of illness or death of a spouse (9%).  Down traders tend to be seeking smaller more convenient property, are more likely to go for an apartment with good access to central facilities, such as shops and healthcare, and some may, as part of a wealth management strategy be seeking to release capital (as they have seen significant upside in recent times) and opt for an investment property (sometime with negative gearing).

But, if we put these two segments together, there are about 765,000 households looking to trade in the next year. Of these, nearly 80% are down traders. We think this will have an impact on the supply and demand footprint in the market, with smaller property being supported by the high number of down traders, and poor supply, whilst those with larger places, and wanting to sell may find a lack of buyers and a saturated market, so price differentials will moderate, with continue growth in the middle market, but more sluggish growth, or even a fall at the top end. This could well also distort prices in specific geographic areas.  In other words, down traders may have to give a little on the price they get to sell their current place, and pay more for their next property, because of the higher level of demand. Up-traders will find good supply of property if they choose to transact, and will be able to negotiate hard on price.

Next time we look at the investment sector.

Long-run Trends in Housing Price Growth

The RBA in their latest edition of The Bulletin has included an article examining the factors driving long-run trends in Australian housing price growth over the past three decades. They look at factors like supply, inflation and population growth.

However the glaring omission in our view is the direct impact easier credit and capital ratios have had on bank lending. Without the credit boom we could not have had a house price boom. Whilst they do point out that price to income ratios are high (but more static), we think this is a function of income growth, and is directly connected with the current level at which banks are willing to lend.

During the 1980s, housing prices grew broadly in line with general price inflation in the economy. The period from the 1990s until the mid 2000s saw relatively strong housing price growth associated with a significant increase in the debt-to-income ratio of Australian households. Since the mid 2000s, strong population growth has played an increasing role in explaining housing price growth.

Over the past 30 years, Australian housing prices have increased on average by 7¼ per cent per year, and over the inflation-targeting period by around 7 per cent per year However, these averages mask three distinct phases:

  1. During the 1980s, annual housing price inflation was high, at nearly 10 per cent on average, but so too was general price inflation. In real terms, housing price inflation during the 1980s was relatively low, at 1.4 per cent per annum compared with 4.5 per cent during the period from 1990 to the mid 2000s, and 2.5 per cent over the past decade.
  2. The 1990s until the mid 2000s were marked by quite high housing price inflation, of 7.2 per cent per annum, on average, in nominal terms.
  3. Annual nominal housing price inflation over the past decade was lower than either of these periods, at a little over 5 per cent on average.

They note that housing price growth, has outstripped the rate of inflation in other prices in the economy including inflation in the cost of new dwellings. They posit a range of drivers, for example population growth….

House-Prices-RBA-1Price to income and household debt to income ratios have never been higher than they are now. Part of this is explained by freeing up the financial system, so finance was easier to get.  The increased access to credit by Australian households over this period can be seen in the steady increase of the ratio of household debt to income. A similar trend is observed in the dwelling price-to-income ratio. While deregulation and disinflation were largely complete by the mid 1990s, the adjustment of the economy to the new steady state took well over a decade. These adjustments appear to have largely run their course, with the household debt-to-income ratio fluctuating around 150 per cent over the past decade.

House-Prices-RBA-2Finally supply did not keep up with demand. When compared with the range of underlying demand estimates, completions suggest that, over much of the past decade, the supply side has been slow, or unable, to respond to the significant increases in underlying demand (based on estimates of underlying average household size, rather than actual household size). More recently, the gap between underlying demand for and supply of new dwellings in Australia looks to have become smaller. Much of the aggregate gap was accounted for by developments in New South Wales. Underlying demand-supply gaps in Queensland and Western Australia also look to have contributed to the aggregate gap, although the estimates of underlying demand on a state level are subject to even larger uncertainty than those at the national level.

House-Prices-RBA-3They conclude that during the 1980s, housing price inflation broadly followed general price inflation in the economy, which was relatively high and
volatile. Following the financial deregulation of the mid 1980s and disinflation of the early 1990s, cheaper and easier access to finance underpinned a secular increase in households’ debt-to-income ratio that was closely associated with high housing price inflation from the early 1990s until the mid 2000s. The past decade saw a stabilisation of debt-to-income levels, but also a prolonged period of strong population growth – underpinned by high immigration – and smaller household sizes that led to increases in underlying demand exceeding the supply of new dwellings.

Looking ahead, they say it seems unlikely that there will be a return to the rather extreme conditions of the earlier episode when significant increases in household debt supported high housing price growth. Nonetheless, protracted periods of changes in population growth that are not met by adjustments in dwelling supply could lead to periods of sizeable changes in housing price growth. One important factor for housing price growth is the ability of the supply of new dwellings to respond to changes in demand. The significance of this is made clear by the recent increases in
higher-density housing and lower growth of those prices relative to prices of detached houses, whose supply has been less responsive.

We think the generous capital adequacy ratios and the banks fixation to lend on property however is the root cause. We think they should have looked harder at credit supply, and capital ratios in the context of bank profitability.