With residential construction rising at a rapid pace, and APRA putting downward pressure on investor lending, the housing market could be poised for a change in fortune.
The IMF has released a detailed analysis of Australia’s housing market, encompassing everything from house prices and housing supply to financial stability and lending standards.
International comparisons of housing data are fraught with difficulty. Finding comparison data is challenging, particularly with regards to house prices or income data, and there are often country-specific reasons for housing developments.
Nevertheless, taken at face value the data suggests that Australia has some of the most expensive property in the world. Real house price growth has greatly exceeded real GDP per capita over the past two decades -- before then the two tracked each other fairly closely -- as banking deregulation led to an unprecedented rise in household debt.
Growth of this nature has been fairly widespread among a number of OECD countries. Over the past two decades, real house prices have increased more rapidly in Great Britain and in Sweden; New Zealand isn’t far behind. There is however a big disconnect between Australia and the likes of the US or even the OECD average.
As a consequence the house price to income ratio -- a rough proxy for housing affordability -- has skyrocketed. It has been argued that housing is a superior good -- that households spend proportionately more on housing as their income rises -- but there is little evidence that this is the case over the past decade. Despite relatively strong income growth over that period, the house price-to-income ratio has fluctuated around a relatively stable mean.
Most of the argument in favour of housing as a ‘superior good’ hypothesis should be attributed to a combination of banking deregulation and the capital gains tax discount introduced in 1999. Housing multiples were relatively stable both before and after these decisions but initially rose rapidly as the market adjusted to new structural parameters.
House prices, as a share of household disposable income, have increased by 50 per cent in Australia over the past two decades. By comparison, housing multiples across the OECD are largely unchanged after falling from their pre-crisis peak.
Household debt, as a share of nominal GDP, has increased rapidly over the past quarter century. The ratio sits well above the OECD average and is much higher than other countries that have experienced a similar level of price growth.
The IMF also assesses house prices against the average for two housing multiples over the past quarter century. Based on these measures, they conclude that the market is potentially 20 per cent overvalued.
I don’t particularly like this approach to house price valuation. First, it assumes that the market was in equilibrium at the starting point (in this case 1990). Second, it reflects a purely cyclical assessment that ignores structural shifts.
Housing is expensive in Australia but there has also been no shortage of Australians who have been more than happy to pay a significant premium to buy residential property. My argument has never been about over or undervaluation rather than whether existing valuations are sustainable when faced with structural change.
There is also an argument that the housing market has been driven primarily by a lack of supply. Recent research by the Reserve Bank, for example, indicated that inadequate supply has supported house price growth over the past decade and does a better job of explaining the variation in recent growth than household debt.
Inadequate housing supply doesn’t preclude prices from falling. Fixed supply places upward pressure on prices but also means that prices respond more rapidly to changes in demand -- in both a positive and negative direction.
With housing construction currently at record levels, stimulated by low interest rates, we are beginning to see the supply gap close and provide less support to property prices. If the states ever take steps towards reducing the complexity of the planning process or improving the provision and funding of infrastructure then supply issues would cease to be a material driver of price growth.
This discussion of the housing market has important implications for the Australian economy as a whole. It has been well documented that the housing market represents a systemic risk for the financial system and the Australian economy. It is less well documented that high land and property prices undermine the business sector by reducing competiveness and increasing inequality.
That the IMF dedicated so much time to breaking down the issue -- based on its work with authorities such as the RBA and APRA and federal Treasury -- highlights the extent to which the housing market has hijacked the economic and political debate in Australia.
This is a debate that we need to have and it will remain that way until state and federal governments step up to the plate and begin to push for structural reform to housing supply and the tax system. Addressing these issues is smart policy from an economic perspective and would ultimately lead to stronger economic growth over the medium term. Whether a Turnbull or Labor government can sell the public on the benefits of such reform is an entirely different matter.