OLIVER FRANKEL. House prices are not necessarily correlated with changes in supply and demand29/12/2017
A recent research report, Regional Housing Supply and Demand in Australia, by the ANU’s Centre for Social Research and Methods, has reignited the debate about the relationship between house prices and imbalances in the supply of and demand for housing.
Few would dispute that steeply rising prices in some of our largest cities have made homeownership much less affordable in recent years. This has been exacerbated by slow wage growth. Many disagree however on the causes of such rapid price growth, and on what is to be done to improve affordability. The Federal and NSW governments put the blame firmly on inadequate supply. Doubt thrown on this causality by the ANU Report is one of the reasons it has sparked such interest.
Purpose and key findings of the Report
The purpose of the ANU study is two-fold: First to analyse the gap between demand and supply and second to measure the correlation between price changes and supply gaps (or surpluses). The results on both counts will surprise many.
The study estimates that between 2001 and 2017 there was an aggregate oversupply of some 164,000 dwellings (both private and non-private), much of which was in our capital cities, particularly inner-city areas.
The most ‘over-supplied’ regions include the inner-city areas of Brisbane, Sydney and Melbourne. Inner-city Sydney, for instance, had an aggregate surplus of around 6,000 dwellings, or 5% of stock. Much of the oversupply is due to new unit developments, of which the Report suggests a significant number may remain vacant.
The Report acknowledges that the picture is a mixed one, and that other parts of Sydney were under-supplied over the period, particularly the middle and outer rings.
Lead author Ben Phillips, writing in the Sydney Morning Herald, reports, perhaps surprisingly, that: “We don’t find a strong relationship between a housing shortage or surplus and movements in house prices at the regional level. There are plenty of regions throughout the country with a surplus of dwelling stock that have enjoyed strong house price growth and plenty that have not.”
UNSW Professor Hal Pawson, writing recently in The Conversation, sees the ANU study as having “blown yet another hole” in the “sacred claim” that “fixing housing affordability is simply a matter of boosting housing supply”. He refers to the “continuing seductive appeal of the common-sense claim that rising prices reflect gross shortage”.
The Report acknowledges that regions which are over-supplied may still be unaffordable and vice versa.
Encouraging to see a more granular analysis of supply and demand imbalances
What is unusual about the ANU analysis is its granular level focus on supply and demand, and price correlation. A total of 340 separate regions are analysed, enabling the researchers to show that the housing market can behave quite differently, across even a single city.
Using underlying demand to measure supply gaps may lead to misleading conclusions
The ANU study focuses exclusively on what demographers refer to as “underlying” demand. This is a concept concerned mainly with changes in population and other demographic variables (notably household sizes). It takes no direct account of actual or “effective” demand in the housing market – the demand economists typically focus on – which probably has a more direct impact on prices. Any implications that might therefore be drawn from a supply gap based on underlying demand may be misleading.
Two simple examples illustrate the point:
First, foreign investment is probably largely invisible in terms of underlying demand, yet is highly relevant in the market in the context of price pressure.
Second, as the Grattan Institute’s John Daley and Brendan Coates note, focusing on underlying demand ignores “how rising prices and worsening affordability pushed people into larger households than they would have chosen” (e.g. due to adult children remaining at home for longer), and therefore may overstate actual demand.
Including unoccupied dwellings may dramatically skew results
One of the Report’s key assumptions is that increases in supply (available to meet increased demand) include all unoccupied residences. An unspecified and potentially large proportion of them could comprise homes not in fact available for purchase, such as second or holiday homes, or homes deliberately left vacant by foreign investors. Counting them towards a surplus may therefore skew the results.
For these reasons, the Report concludes by acknowledging that the real surplus may be somewhere between 32,000 and 164,000 dwellings – a big range.
Grattan Institute’s different slant on the supply gap and its correlation with prices
Challenging the ANU analysis, Daley and Coates argue that the supply of housing has in fact lagged demand in recent years, pointing to the fact that NSW built 0.8 dwellings for every extra person throughout the 1990s, but only 0.4 dwellings per extra person during the last 8 years.
“Development at today’s record rates is the bare minimum needed to meet the estimated 725,000 additional homes required in Sydney over the next 20 years, given projected population growth”, they say.
They conclude that this is hard to square with a housing “surplus”, but agree that it is all about assumptions, such as household sizes. Acknowledging the reduction in household sizes from an average of 3.6 people in 1961 to 2.6 in 2001 (the start of the ANU study period), they note that household sizes have flat-lined since then.
Daley and Coates argue that boosting housing supply will ease prices, albeit only slowly, recognising that even at current record levels of new supply, only some 2% is added to existing stock each year. They nevertheless conclude that “housing would be a very strange market if a sustained increase in supply over several years did not make prices materially lower than otherwise”.
How long such increased supply might need to be sustained for, and by how much, in order to make a material difference, is a moot point. Any assumption that the development industry would continue to build at high rates in the face of a price plateau or gradual reduction is also surely questionable.
As Daley and Coates themselves acknowledge, our cities are not delivering the type of housing – by location and density – that our residents say they want.
In short, there are too few semi-detached houses, town houses and apartments in the middle and outer ring suburbs of Sydney and Melbourne. The Grattan Institute authors attribute this to poor planning policy and the strength of vested interests (aka NIMBYism) in those suburbs.
Many factors other than undersupply can explain steep price rises
If under-supply is not the main culprit behind the relentless rise in house prices, as implied by the ANU analysis, what other explanations are there?
Ben Phillips cautions against likening housing to standard consumer items (like bananas), acknowledging that the market may behave quite differently, for a variety of reasons, including those listed below.
As many commentators have noted, influential factors include: tax incentives for investors (particularly negative gearing and the 50% CGT discount); other property taxes such as stamp duty and land tax; government incentives aimed at first-home buyers; general economic sentiment; speculation regarding the prospect of capital gains; the level of interest rates and the ease of access to mortgage lending; unemployment; wage growth; local planning constraints; local access to jobs, local access to infrastructure and services, the level of foreign investment; exclusion of the family home from the age pension asset test. Many of these factors themselves have an effect on either supply or demand.
The successive interest rate reductions seen since the late 1990s, together with relatively easy access to mortgage credit, have undoubtedly been highly significant. These have allowed borrowers to borrow at very much higher levels than before, and to service those debts cheaply – so long as interest rates remain low. The resulting record levels of household debt are now acknowledged by APRA and the RBA to be a major risk to the financial system, particularly if interest rates rise materially or prices fall significantly.
Demand side policy options
The ANU study and the Grattan Institute both acknowledge (as do many other commentators, including this author) the need to examine demand side measures in addressing rapidly rising house prices, including via tax reform. The sacred cow of negative gearing, and its turbo-charger, the 50% CGT discount, are clearly within their sights. It is high time we discouraged investors from treating housing as a speculative commodity.
Despite some limitations arising from its scope and some of its assumptions, the ANU Report is a welcome challenge to those who argue that making housing more affordable is simply a matter of increasing supply. In the face of continuing population growth, maximising housebuilding must of course feature in the policy mix. But policy should be based on a more sophisticated understanding of what additional housing is needed and where. The analysis must be both high level, and also reflect a granular understanding of where gaps exist and are likely to arise.
The challenge of housing affordability for aspiring first home buyers will not be easily solved, even if we do see a slowing down of house price rises. At least in most parts of Sydney and Melbourne, prices are already far out of reach, even for middle income earners.
Most lower income renters too face a daunting hurdle of affordability, just to keep a roof over their heads, let alone save for home ownership. The position of those for whom government-supported social and affordable housing is the only realistic option is a growing problem that urgently calls for Federal government policy leadership
The debate sparked by the ANU Report reinforces more than ever the need for evidence based decision making in this area, as advocated in a recent article by this author and Professor Hal Pawson, in which we called for reinstatement (and reinvigoration) of a body like the former National Housing Supply Council.
Oliver Frankel is a former corporate finance and M&A lawyer, who has spent the second half of his career in finance, investment and management. Most recently, he has taken a strong interest in how to address the affordable housing crisis.