Some home truths about housing’s new bubble

In previous bubbles immigration was an important driver of rising house prices, particularly investment by residents born in China.

Perhaps it’s a reflection of how old I am, but when I read about rapidly rising house prices, I ­simply think: here we go again, another housing bubble.

In some cities, recent house price rises have paralleled those that occurred in the late 1980s (when inflation generally was high). There are suggestions that house prices could rise by nearly 20 per cent in this year alone in some areas. While these periods of rapid house price rises essentially come down to the forces of supply and demand, albeit with varying quantities of irrational exuberance, the precise details of these housing bubbles are not the same.

In the early 2000s, for instance, it was clearly the case that investor demand was a significant factor driving up house ­prices, in part because of the changes made to the capital gains tax regime at the time. In the current context, investors have been largely out of the ­market and the demand is coming from owner occupiers, particularly first-home buyers.

Those earlier housing bubbles also occurred when interest rates were much higher than now, but there was also reasonable real wage growth. Inflation had the effect of reducing the real value of mortgages, but there is no doubt the burden of very high interest rates — close to 20 per cent — adversely affected many households in the late 1980s and early 1990s.

Today, the situation is very different. It’s possible to secure a fixed-interest mortgage with a rate of less than 2 per cent. This means that, for any given household income, a large debt can be serviced before it becomes a struggle for the household.

It’s also why measuring housing affordability using house price-to-income ratios is no longer reliable. To be sure, a house price-to-income ratio of 10 to 1 sounds scary — it’s actually higher in Sydney and Melbourne — but the more accurate indicator now is the ratio of mortgage payments to household income.

Of course, there is circularity to the process: the lower mortgage rates are, the higher the price a potential home buyer can bid, given a reasonable deposit in hand. In other words, the low interest rate policy pursued by the Reserve Bank has the effect of pushing up housing and other asset prices. This much is accepted by the RBA, but it is seen as the inevitable corollary of using low interest rates to stimulate the economy, particularly by encouraging business investment, as well as to nudge inflation up within the target band of 2 to 3 per cent per annum. (Mind you, it has to be said that the bank is failing on both fronts.)

So let’s return to the basic forces of supply and demand. The theory is very clear that ultimately house prices are determined by supply. But as Maynard Keynes reminded us, in the long run, we are all dead. So we should also be interested in what happens to house prices in the short- to medium-term and the impact of demand factors. Nonetheless, it’s worth bearing in mind that restrictions on supply — land ­release for new homes, in particular — will push up prices if demand is outstripping the availability of homes for purchase.

To be sure, housing markets are complicated because people have strong preferences about where they want to live. Many desirable areas are effectively built out, short of the intrusion of high-rise and in-fill developments to which many residents object.

What emerges in these well-located suburbs is something that economists call Ricardian rents — the return to a scarce, irreplaceable resource. Releasing more land in Penrith won’t affect the price of houses in Mosman; releasing more land in Pakenham won’t affect the price of houses in Toorak.

When it comes to the current housing bubble, there are some very interesting features that contrast with previous bubbles. The first is that population growth is currently very low, with net immigration actually detracting from the total population over the past 12 months. In previous bubbles — particularly in the middle of last decade — immigration was an important driver of rising house prices, particularly investment by residents born in China.

The second feature, mentioned above, is the relative absence of investors in the current housing market compared with owner occupiers. This is reflected in the much stronger demand for standalone houses rather than apartments.

In February of this year, owner-occupier loans made up more than three-quarters of all home loans approved. There were more than 16,000 first-home buyer loans approved in that month, compared with under 7000 in February 2015.

While rates of home ownership have been falling for some time, particularly among those aged under 34 years, there is a strong possibility that rates of ownership will now start to rise if the involvement of first-home buyers continues.

To be sure, first-home buyers have been assisted by various federal and state government ­initiatives, including the HomeBuilder program, the First Home Loan Deposit Scheme (which removes the need for mortgage insurance) and various stamp duty concessions.

There is also the Bank of Mum and Dad, the role of which has actually been enhanced by rising house prices. With home-owning parents sitting on large capital gains, many of them find themselves able to help their children get into the housing market with gifts or loans, which particularly assist potential buyers bridge the deposit gap. It is ­estimated that the average value of these gifts/loans is now close to $90,000.

Needless to say, not everyone is able to call on generous parents and there is now a real challenge of finding affordable rental accommodation in many areas. With the relative absence of investors in the market — it actually goes back three or four years, in part because of new rules implemented by the Australian Prudential Regulation Authority — it is possible that the near-term housing affordability problem will be borne more by renters than potential buyers.

Investment in new public housing could ease the strain for renters at the margin, but the scale of new public housing is unlikely to make life easier for most renters. Once house prices have risen, there’s a serious policy dilemma for governments. For those in the market, particularly recent purchasers, there’s a lot riding on prices not falling. It’s a stock and flow problem: there are more home owners than ­potential purchasers.

For this reason, neither the federal or state governments are likely to introduce any policies, such as new housing taxes, that could push prices down significantly. The situation is in contrast with New Zealand, where a new raft of taxes on investors has been introduced to counter very rapidly escalating house prices. Investors are about 40 per cent of the market there.

Even so, there are reasons to think that these initiatives won’t succeed, particularly given the tight restrictions around land release, particularly in Auckland. Renters in New Zealand could end up having an even rougher time than here.