Bubble bubble, toil and trouble

Apologies for distorting Shakespeare’s Macbeth, but recent talk of a housing ‘bubble’ in Australia is increasingly reminiscent of Soothsayers with bubbling cauldrons of economic brew.  While dire warnings of impending doom are taking things too far, there are good reasons to be concerned about housing dysfunction in Australia.

The definition of a market bubble is where prices trade at high volumes and at prices which are detached from intrinsic value. We usually only spot a bubble after the event – when prices drop sharply. Australia’s housing markets may be dysfunctional and structurally distorted by taxes and regulation, but to suggest they are in a ‘bubble’ is a simplistic observation based mainly on some recent positive movements in the established house markets of Sydney and Melbourne. 

One of my main complaints with many economists and much of the media is that they treat Australia’s housing market as a single product, equally subject to the laws of supply and demand. Apart from obvious geographic differences, there are very large differences between the established housing markets (trading of second hand homes in established areas) and new housing development. Few commentators, policy makers or reporters seem to understand the significant impact on input prices for new housing of things like complex planning regulations, the long lead times on new supply, the distortions to supply imposed by urban growth boundaries, the differential tax treatments on new supply through the GST and the per-dwelling infrastructure levies - none of which apply to established housing.

This weight of this regulatory and tax burden has largely been created by various state and local governments from the late 1990s onwards. It’s had a dramatic impact on new housing construction, pushing our rate of new dwelling supply per thousand of population to a thirty year low. Anyone looking at this depressing graph would be hard pressed to be talking about a ‘bubble’ in the Australian housing market:

While new taxes and regulation have succeeded in pushing the new housing market to a 30 year low in terms of new supply, the same can’t be said for the established housing market which has largely been left untouched by regulatory or tax creep for decades. It would be political suicide for a government of any persuasion to tamper with taxes or regulation of existing housing. (Somehow though, the same political caution hasn’t been felt in terms of new housing).

So the performance of the established housing market has been in stark contrast to the new housing market. And it is graphs like this which have ‘bubble’ proponents staring deep into their cauldrons:

The latter shows that established house prices in major centres have risen dramatically, relative to measures of economic growth and to average incomes. Does this constitute a bubble?

Certainly, for people on average incomes, entering the housing market via the established house market, especially in inner city or mid ring areas where supply of vacant land has been all but exhausted, can now be prohibitive.  Supply is constrained because established areas are built out. More people wanting to live in these areas means rising demand relative to supply, and when economic conditions permit (as they do now) prices rise.

With median house prices (based as they are on the sale of established houses) hovering around the $500,000 mark in many cities, you would ideally need a combined household income of $100,000 for this to be anything like affordable. $150,000 would be better. Having said that, there are enough families with two incomes bringing in over $100,000 per annum so that housing at this level is still accessible for some. But if your combined household income is less than $70,000 per annum, you’d be pretty much locked out of many housing opportunities in established areas. And there are also plenty of families and individuals who fit that description today.

So while I don’t see a ‘bubble’ I do see a structural problem which needs to be addressed. And that problem is that where once Australian cities offered a ‘pressure valve’ via low cost, entry level housing on the urban outskirts, the price advantage of this option has now been removed by public policy changes.

The arrival of Urban Growth Boundaries (UGBs) in the late 1990s to early 2000s created an immediate shortage of low cost land for new housing. Market pressure built up within these artificial boundaries and vacant land prices shot up, while lot sizes fell – a double whammy. The GST - which applies only to new housing - added 10% to the cost of a new home, and infrastructure levies compounded the problem, adding in many cases $30,000 to $50,000 per dwelling. Soon enough, we reached the point where between a third and 40% of the cost of a new home could be attributed to new policy initiatives delivered via our planning regulators and Treasuries.

Remember, the actual building cost of detached housing has remained largely unchanged for decades – at around $1000 to $1200 per square metre. But the land cost on which that house sits has skyrocketed, as have taxes on new housing, as has the regulatory compliance cost. So the new house and land option, which was once a low cost pressure valve accessible to young families and low to moderate income groups, quickly became just as expensive as established housing in inner city and middle ring areas. Little wonder the rate of new supply collapsed so quickly.

Look again at the graph above. The market distortion took hold in the early 2000s. It doesn’t matter whose graphs or analysis you use, it was around this time that prices for housing started to move well out of sync with incomes or measures of economic activity. It was also around this time that State Governments were busy extolling the virtues of growth boundaries to ‘contain sprawl’ and plan for ‘sustainable futures.’ It was around this same time that State and Local Governments latched onto the idea of per lot infrastructure levies on new housing as a means of raising revenues. It was around this time that the GST arrived, applying as it did only to new housing. It was a triple whammy effect that has so distorted housing markets that there are virtually no low-cost entry-level options left. The pressure continues to build on existing house prices while the new building market continues to suffer. That pressure isn’t coming from first home buyers, but from people already in the market: upgraders and investors. It’s also coming from overseas buyers, and (worryingly) from geared Self-Managed Super Funds.

Talk of an Australian housing market ‘bubble’ is too simplistic but appeals to media appetites for ‘boom’ and ‘bust’ scenarios. The real story behind Australian housing markets is more complex. For those prepared to invest some time looking into it, the signs of markets distorted by inequitable regulatory and tax measures are immediately apparent, particularly as they apply to new supply.