It has taken a long time but the Reserve Bank is finally talking some sense about Australia’s $5.2 trillion housing market. Although elevated house prices have made many Australians fabulously wealthy (on paper at least), deputy governor Philip Lowe says “the main impact of higher land prices is not really to increase our national wealth, but to change the distribution of that wealth”.
Lowe gave an interesting speech last night on the national balance sheet, which included a detailed discussion of land prices and their implications for monetary policy.
According to the ABS, the total value of Australia’s assets as at the end of June 2014 was around $12.5 trillion, or around $500,000 for each person living in Australia. After adjusting for net foreign liabilities, net wealth was estimated at around $10 trillion.
Land is by far Australia’s largest asset class, accounting for 34 per cent of the value of our national assets, while non-dwelling construction accounts for a further 18 per cent. Both dwellings and overseas financial assets account for a little under 15 per cent of national assets.
What the data show is that dwelling prices are largely determined by the land itself rather than the value of the bricks and mortar. The value of the dwelling component has actually increased at a relatively modest pace over the past couple of decades and possesses few of the boom-bust qualities that characterise the value of land.
The figures raise an important question: have we become wealthier as a nation simply because the value of our land has increased?
As Lowe notes, “the answer would clearly be yes if this increase was because we had discovered more land”. It would also be yes if the rise in land prices was driven by a significant increase in the productivity of our agricultural land.
Unfortunately, our land supply is fixed and the higher value of rural land accounts for just 5 per cent of the increase in Australia’s land value since the late 1980s.
The two main factors behind the sharp rise in land prices are fairly well-worn turf. The first is the combination of financial liberalisation and low inflation during the 1980s and early 1990s. Many Australians took advantage of more favourable lending conditions to buy a better property than they previously could afford.
This is possible for an individual but collectively we can’t all buy better properties. As a result, the main impact of increased borrowing capacity was to push up land and dwelling prices.
The second factor was “the combination of strong population growth and the structural difficulties of increasing the effective supply of residential land”. Our population has increased by 40 per cent (or seven million people) since 1989 and housing supply has struggled to keep up.
Housing supply faces a number of challenges, which include the “developing land on the urban fringe and … rezoning land close to city centres for urban infill”. Underinvestment in transportation infrastructure certainly hasn’t helped, which has increased the effective demand for inner-city living.
Many readers might ask why this really matters. Regardless of the reason, the sharp rise in land prices has awarded significant capital gains to many Australians and left them better off.
“The complication here comes from the fact that Australians are both owners of housing assets and consumers of housing services,” Lowe said. “We don’t just own housing and the land on which it is built, but we also live in that housing, and on that land.”
To some degree, the housing market can be viewed as a zero-sum game. If I benefit via higher house prices, then there is someone on the other side of the equation who has lost out via being forced to borrow more or pay higher rents.
“From the perspective of society as a whole, much of what is gained on the one hand is lost on the other,” Lowe said. “There are windfall gains from higher land prices but everyone pays more for housing services.”
The rise in land prices also has an important distributional element. Lowe says the distribution effects have two dimensions.
The first is cross-sectional, “with the existing owners of dwellings receiving capital gains when land prices rise”. The second is “the distribution of wealth across generations, with the current owners of dwellings earning capital gains but future generations paying higher housing costs”.
It is unclear what effect these distributional issues will have on social and economic outcomes, other than to say they will certainly have some effect. According to Lowe, “how the intergenerational distribution ultimately plays out will depend critically upon the extent to which the gains that have accrued to the current generation are passed on to the next generation”.
So far there is some evidence that a rising share of parents are helping their children purchase a property. This can be direct (through putting money towards their housing deposit) or indirect (allowing their children to stay at home for longer and save more).
As explained by Lowe, “if this type of intergenerational assistance does become more common, then fewer parents will be able to use their capital gains … to boost their own consumption”. As a result, the wealth effect arising from recent price gains will presumably be lower than the gains experienced throughout the 1990s and early 2000s.
However, “if it turns out that today’s generation use their capital gains to increase their own spending, then they will have less ability to help their children”. This is a clear concern given ‘baby boomers’ are typically asset rich but cash poor and many will be forced to downsize or sell off their investment properties to maintain their living standards. If this scenario eventuates, then the next generation of property owners will be poorly placed to pay existing prices, which points towards a structural shift toward lower house prices.
This speech by Lowe corroborates much of what I have been saying about the Australian housing market over the past couple of years. Rising land prices have been hugely beneficial for certain segments of the Australian population but it is time that our collective thinking evolved so that we recognised that high land prices add little to Australia’s productive capacity and, in aggregate, has achieved little more than raise inequality.