Why is housing so unaffordable?

August 17, 2007

The August 8 announcement of the Reserve Bank board's decision to raise official interest rates by a further 0.25% focused renewed media attention on the non-affordability of housing. The interest rate rise — the fifth since the 2004 election and the ninth since 2002 — increased mortgage repayments for home owners with average mortgages by $50 a week, placing extra pressure on already stretched budgets.

PM John Howard's response was predictable. Interest rates "will always be lower under us than under a Labor government", he told the media, referring to 17% interest rates under former Labor treasurer Paul Keating.

The Labor "opposition" promises more-of-the-same "fiscal conservatism" to help maintain "downward pressure" on interest rates. But when it comes to directly tackling the issue of housing affordability, neither party has much to offer.

The cost of buying a house increased by 310% between 1986 and 2005, according to the Australian Bureau of Statistics. Over the same period, inflation (as measured by the Consumer Price Index) increased by 91%, while average wages increased by 128%. Therefore, the rate of the average house price compared to the average wage increased from 6:1 in 1986 to 9:1 by 2005.

In the early years of this decade, while interest rates remained relatively low by historical standards (an official rate of below 6% for much of that time), the impact of rising house prices on mortgagees was somewhat muted. Many people felt they were getting wealthier, as their primary asset (their house) rapidly appreciated in value. The increase in official interest rates, particularly since 2004, coupled with ever rising prices for housing, has meant that housing stress — when more than 30% of household income is spent on housing costs — has increased dramatically. Options for first home buyers to enter the housing market have also been further limited.

Writing in the Sydney Morning Herald on July 11, economics editor Ross Gittens laid the blame for increased housing prices squarely on home buyers. Arguing that low interest rates on the back of lower inflation gave buyers the option of borrowing more money, he claimed that the increase in housing prices was the result of owner-occupiers buying bigger and better houses. "People didn't have to react to the increase in their borrowing power by borrowing more, but many of them did", he wrote. "They decided it was the perfect opportunity to do what they'd long wished they could afford to do: trade up to a better house. And because so many people had the same idea at pretty much the same time, the main thing they achieved was to bid up the prices of essentially the same bunch of houses."

Gittens' argument reflects much of the mainstream media discussion, which argues that the problem is personal greed and easy finance. Buyers want too much, get themselves into too much debt, and with the (inevitable) interest rate rise, fall into trouble and it all comes crashing down. It's an easy refrain and one that gets governments, banks and speculators off the hook.

A second argument places the blame on the supply side. "The biggest reason why housing is so expensive for young people now is there is not a large enough supply of land", Howard said on July 3. Housing developers are only too happy to echo this claim, blaming rising housing prices on the refusal of state governments to release land for housing developments and their insistence that developers pay at least part of the cost for basic infrastructure, as well as the cost of council red-tape.

The argument that limited supply is causing house prices to skyrocket is unconvincing. Even the ALP, in its New Directions for Affordable Housing paper released in June, admits that there is a surplus of land zoned for housing development, "with over 150,000 housing lots approved for residential development sitting idle". The release of extra lots on the outskirts of cities without adequate infrastructure or public transport will not solve the problem.

One issue that few in the mainstream media and neither of the major political parties are willing to address is the role of speculation in the housing affordability crisis. The Centre for Independent Studies, in its autumn 2005 edition of Policy, argued that the housing boom that resulted in an inflation of house prices between 1997 and 2004 was an international phenomenon. However, "average prices [in Australia] rose by 110% compared with an 18 country average rise of just 65%". House prices rose so much more in Australia, the CIS argued, because the Australian tax system encourages speculation in housing, which massively adds to the demand for housing and pushes up prices.

Negative gearing and capital gains tax concessions provided through the federal tax system make speculative investment in housing a very attractive option. Negative gearing allows investors in housing to offset their losses (any excess paid in repairs/maintenance and interest on loans, over income from rent) against other income, being in fact a government-funded subsidy for investment in housing. This subsidy is then often ploughed back into the system, allowing the investor to pay more for investment property, pushing up the price.

At the other end of the equation, the Howard government introduced a 50% concession for capital gains tax in 1999, meaning that the first half of any capital gain (profit) made in buying and subsequently selling an investment house became tax free. In a market that was already on the rise, this change fuelled speculative investment in housing, forcing prices up significantly.

This tax regime has forced the price of houses to rise and replaced first home buyers with speculators in the market. In the 18 years from 1985 until 2003, according to the federal treasury, investors' share of the housing market increased from less than 15% to 45%, while between 1996 and 2007, first home buyers' share decreased from 21.8% to 17.5%.

Federal Labor, in its New Directions document, offers to consider a range of marginal reforms that will not challenge underlying problems. Labor's options include the establishment of a federal pool of money to offset developers' infrastructure costs for the building of new housing estates. The money would only be paid to developers if the full cost of the saving is passed onto buyers.

New Directions also canvasses the possibility of establishing a government-administered account, where lower-income workers might be able to salary-sacrifice a portion of their wage to save a deposit (not much use for those without sufficient surplus to save at all). A third option canvassed is the provision of a shared equity scheme, whereby the government might loan up to 25% of the cost of a house, interest free, to be repaid at a later date. This last option, based on a British example, is not seriously explored.

Ultimately, if the purchase of private housing is to be made more affordable for working people, a massive overhaul in the tax system will be needed. Concessions that make it attractive to speculate in the private housing market must be abolished, reducing demand for residential housing and allowing prices to fall.

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