A National Scandal: Wildly Inflated ... How to Slay Them? Introduction

A National Scandal: Wildly Inflated Residential Property Values, and
How to Slay Them?
Introduction
th
In 2010, both The Economist (2010) and the 7 Annual International Housing Affordability Survey
(Demographia, 2011) claimed Australian housing markets are some of the least affordable in the world, with
the former suggesting house prices were overvalued by 63.2 percent – the most of any country – and the
latter stating that five of the world’s six least affordable housing markets were located in Australia. As such,
there is much contemporary debate in Australia about whether the country’s 5 major housing markets
(Sydney, Melbourne, Brisbane, Adelaide and Perth) are in the midst of an asset price bubble that is destined
– like all such bubbles – to burst and damage the lives of many residents, or just reflect solid market
fundamentals relating primarily to the balance of supply and demand for different classes of residential
property. There is also debate as to whether a housing bubble, should it exist widely, can be corrected
slowly and with little long-term disruption, or whether deflation might be rapid and economically destabilising
for Australia’s financial system, as occurred in the United States at the start of the current global financial
crisis.
More importantly, debate is also hampered by weak theoretical conceptualisation of the processes shaping
housing prices, market bubbles, and the affordability of residential real estate. Only if we examine closely
these processes, will we be in a position to clarify whether bubble conditions currently exist and, should that
be the case, whether they are likely to deflate slowly with a minimum of disruption. Since problem definition
is conceivably the most crucial step in any empirical analysis, it is surprising that both academic analysis
and media commentary have failed to tackle the concept of housing bubbles and define the exceedingly
complex processes shaping housing prices. So, rather than attempting to identify the extent of any current
housing bubble, we take a step back and analyse the processes shaping residential prices. Also, we cannot
do this adequately without reflecting on the nature of economic uncertainty. Following recent work by
Sorensen (2011) and its on-going refinement, one might legitimately conclude that the form and extent of a
housing bubble is extremely difficult to define. Instead, we might merely be able to conclude that Australia’s
housing prices tend to be excessive in several market segments, an outcome caused not by irrational
exuberance on the part of the purchasers of real estate, but by mal-functioning internal market processes.
We start, then, by analysing the dynamic processes shaping housing prices in our cities, emphasising in
particular their highly complex and uncertain nature. This, in turn, leads us to identify what appear to be
gross inefficiencies in Australia’s housing markets. Thirdly we consider the notion of economic bubbles in
general and how the concept might apply to housing prices. Two important themes here are whether
housing bubbles typically result from complexity, inefficiency, or aberrant behaviour on the part of would-be
or existing homeowners or their investor counterparts. Finally, such analysis could suggest a raft of policy
reforms to better constrain the boom and bust cycles in housing prices that typically create rafts and winners
and losers from home ownership. We will leave it to others to decide quantitatively whether bubble
conditions really exist or are an illusion, or indeed are ultimately unmeasurable.
The Dynamics of Housing Markets
House supply in one year comprises the stock of existing homes, which is usually over 98% of the total, and
the flow of new accommodation on to the market. In a country like Australia, whose population grew > 2% in
2010, the relative proportion of flow (F) to stock (S) is crucial in shaping overall market prices. Where F >
household growth (HG), market prices for homes will tend to ease, ceteris paribus, and vice versa if F < HG.
So, flow is an important balancing item in housing markets.
The Production of New Housing Goods (Flow)
The production of new housing goods has two distinctive inputs: site and structure. In Australia, which is
significantly different to many countries, the production of housing lots and the construction of homes are
often in the hands of separate businesses. These, in turn, respond to the slightly different operating systems
show in Figures 1 and 2. Table 1 enlarges on the sub-factors factors contributing to each of the major
headings in the two diagrams and a quick tally of the entries shows over 60 variables in play, all potentially
affecting the supply-demand for, balance for housing, and therefore its price. Similar considerations
influence the prices of existing homes and/or the redevelopment of existing urban fabric. Both Figures 1 and
2 contain multiple feed-back loops and to some extent land and housing components are mutually
substitutable.
Figure 1: Factors Influencing the Price of Subdivided Land
Supply of Raw Land
Household Profile
Third Party (regulator etc.)
Developer Actions
Economic Settings
Household Income and
demand - supply
Funding System
Demand
Supply
Quality of Subdivision
Land Price
Economic Settings
Source: the authors
Figure 2: Factors Influencing the Price of House Construction
Economic Settings
Behavioural Issues
Third Party (regulator
etc.) Actions
Developer Actions
Household Income and
Expenditure
Decision to Invest in
Housing Goods
Demand f or
Housing Goods
demand - supply
interaction
Quality of Construction
Economic Settings
Source: the authors
Price of
Housing
Goods
Supply of
Housing Goods
For example, would-be owners can opt for less land and larger structures – as with McMansions – or the
reverse for those seeking environmental quality. Where the cost of subdivided land rises faster than
construction costs, as happened over much of the last decade, aspiring owners will tend to opt for some
combination of smaller lots and smaller dwellings according to taste.
In the short run, flow is inelastic while demand often moves sharply up or down depending on the rate of
immigration or rises and falls in consumer sentiment. New supply usually lags demand because of inherent
delays in development approval and construction. The normal market response to rising demand is for
house prices across the entire market (S + F) to increase until sufficient new supply enters the market, at
which point real prices typically decline to previous levels (Mayer and Somerville, 2000).
Additional Market Considerations
Property markets are entangled in a raft of other dynamic, and often inter-connected, processes. We identify
nine of these below:
1
At the time of purchase, the quantity and quality of housing goods sought by households tends to be
a residual within their operating budgets after (a) the purchase of goods and services and (b) savings, are
subtracted from income (see Figure 3). Once a household has committed to purchase, mortgage
repayments become a fixed element in the equation and living expenses or savings adjust downwards to
any reduction income. The initial residual is highly susceptible to upward spikes in household outlays,
occasioned by unexpected rises in, say, transport, energy, and other infrastructure costs. The downward
impact on house prices is fast, especially so in fringe locations where transport comprises a larger share of
the budget than elsewhere in out cities. Likewise, the current need for households to increase savings rates
and pay down debt looks like capping bid prices for homes for several years, as occurred throughout much
of the 1990s in response to Australia’s 1990-01 recession. The Reserve Bank’s tightening of interest rates
throughout much of 2010, increased government fees and charges, higher taxes, or general inflation in
household goods will also tend to depress household residuals available for house purchase. Note that
many of these processes will be spatially variable.
2
Demand for housing, and therefore prices, is also influenced significantly by non owner-occupiers,
and especially (a) investors in rental housing; and (b) second-home owners. Demand in both these sectors
is highly unstable, but they follow different imperatives. Investment in rental accommodation is particularly
susceptible to rental income, which is in turn affected by demand-supply conditions in the sector; prices of
real estate in general; borrowing costs; and the taxation regime including the treatment of negative gearing.
Sometimes these circumstances conspire to work with the broader housing market co-cyclically and
therefore accentuate booms and busts. On other occasions, especially where would-be owners cannot enter
the housing market, rental demand and therefore rental income surges, encouraging investors in the sector.
Second- (or trophy-) home demand is largely co-cyclical, surging in feel-good times, but rapidly dumped
when economic conditions get tough as the large number of coastal properties on the market attests. This
tends to compound housing cycles. Demand for both investment and trophy homes is also affected by
market conditions for such alternative investments as commodities, shares and bonds, fine art, boats and
aircraft, or collectables, not to mention their respective tax treatments.
3
The cycle of house price rises and falls is strongly skewed, as shown in Figure 4. Notice, in
particular, that share markets fall heavily when they hit a bump, whereas house prices can rise quite quickly,
but often then tend to fall slowly over a long period. This contrasting symmetry is easily explained. First,
shares are highly liquid and can easily be bought and sold at a moment’s notice. Housing is often horribly
illiquid, which means that buyers are sometimes trapped for the long term, and homeowners are often
unwilling to sell at a loss into a declining market, especially if they are not under immediate financial
pressure to do so. Secondly, the cost of buying and selling real estate is massively higher than trading in
shares – typically between 3 and 6 times higher according to methods used. However, most home owners
fail realise that slowly sinking house prices – by say 2% a year – over a five year period when inflation is
running at perhaps 3%, will trash real house prices by nearly 25% while the owner is not looking. Thirdly, the
fast run-up of house prices in the early stages of an upswing is often, as we suggested above, caused by
delayed supply.
4
Governments often subsidise selected types of household to shoehorn them into home ownership at
times of steely rising prices. First home owner assistance is a case in point, and has several malign effects
on house prices. Such schemes accelerate rising house prices by inducing further demand
Figure 3: Housing Outlays to Household Budget
Housing Outlays to Total Budget
-
Household
Budget
-
Price of Other
Goods /
Services
Savings
=
Housing
Outlays
(residual)
Trade-offs Between
Housing and Other Expenses
Source: the authors
Figure 4: Cyclical Price Fluctuations
in Housing and Stocks or Shares
Real (inflation adjusted) Price ($)
Stock &
Share
Prices
Real
Estate
Prices
0
Time (years)
5
10
Source: The Authors
against often sluggish housing supply. Indeed the price increases triggered by the subsidy will rise roughly
to the level of the subsidy provided. This leads to the bizarre situation where early entrants to the scheme
get a free meal ticket, while late entrants take a financial hair-cut as house prices for the target group take a
dive when the scheme expires. Such absurd outcomes only make sense to politicians seeking votes.
5
Governments have had another interestingly perverse impact on house prices generally over recent
decades. The adoption of a user pays regime for the infrastructure required by new fringe dwellers has
meant that land prices have accelerated steeply ahead of house construction costs. Instead of funding much
of this infrastructure through 3-part tariffs, where the whole community pays for urban expansion (i.e.
community rating), those costs are now borne largely by new and often young homeowners. Existing
residents, meanwhile, receive a financial bonus by paying cheaper 2-part tariffs. The much more expensive
land coming on to the market flowed rapidly through to existing owners. This second financial bonus
occurred because their homes suddenly became a lot more attractive to buyers compared with new land
release areas. Thus, the wealthy get richer and the younger new homebuyers are slugged with additional
heavy outlays.
6
Another important dynamic of property markets is the heterogeneity of both stock and flow
properties. Table 2 lists 9 dimensions. This table suggests that we are not looking at one housing market,
but a multitude, and that the cyclical rise and fall in house prices in each market segment will probably be
asynchronous. Some segments will doubtless have either excess or deficient housing stock. The former’s
prices may be considerably softer than the latter’s, but the extent of price differentials will depend on buyers’
inclination to move between segments – a process of substitution and trade-off. The extent to which market
segmentation constitutes a problem for housing markets also depends partly on two issues: (a) how far
conservative communities and/or developers can conspire to enforce their Weltanschauung and restrict
additional supplies to their preferred housing type, and (b) the diversity and pace of emergence of social
change. The latter includes delayed retirement; longer life expectancy; rising immigration; later marriage;
and possible continued decline in average household size. These two dimensions could create major
discordance between housing supply and demand, with associated residential price implications.
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This raises another important issue affecting house prices. Housing spaces often conceal
considerable inbuilt substitution possibilities, so that expected housing needs calculated by planners or
developers may simply not emerge. Again, the options are myriad. Young people unable to buy suitable
accommodation at a price they can afford may simply remain at home longer than they previously expected
or wanted. Parents can move in with their children and create multi-generational households. Various kinds
of group household can emerge unheralded. Oldies can downsize their accommodation, releasing space for
larger households while they generate new lifestyles and the means to enjoy them. Some single properties
can also be split into to two or more smaller units. Indeed, conventional economics can be almost
suspended in some conditions. Long ago, Hirsch (1977) raised the notion of positional goods, and it is clear
that in some of Australia’s higher priced residential markets, demand curves for housing are inverted: the
higher the price, the more the demand. But equally obviously, economic issues revolving supply and
demand interactions and the resulting price effects are critical to most players in the housing market.
8
Over the years, household capacity to pay for homes has been altered significantly by the loan
periods offered to aspiring homeowners. For example, the steady move from 20 year to 30 mortgages has
enabled households to borrow larger sums of money than previously, potentially pushing up house prices.
The ever-increasing numbers of dual income families has had a similar effect, as has the ability of
increasingly wealthy parents to bankroll partially their children’s dream of home ownership. It is not therefore
surprising that Australian Bureau of Statistics (ABS) time-series data on monthly household expenditures
shows little change in the proportion of gross incomes spent on housing costs for all households in the
capital cities from 1995-2008 (Figure 5). Sydney and Adelaide show marginal growth in this index;
Melbourne, Brisbane, Hobart, and Canberra all experienced no net change; and two cities, Perth and
Darwin, showed a slight net decrease. This evidence suggests housing prices have not outgrown household
incomes, which some believe to be a major indicator of inflated housing markets. Table 4 throws completely
different light on the subject. Australia’s households are now immensely in debt, and the culprit is housing
debt. The explanation for this difference, we suggest, is the extension in the terms of mortgages. Housing
outlays as a proportion of incomes have remained fairly flat; but households have raised mortgage duration
by 50% and total repayments even more.
9
Everything discussed so far suggests that different kinds of household may well have very different
housing experiences, which in turn affects supply-demand interactions and outlays on accommodation.
Some like the poor and unemployed, the young, and single-income families or those in large households are
largely excluded from home ownership. Those on dual professional incomes, the Yuppie households, on the
other hand have no problems paying off a mortgage, especially over longer time periods. In between is a
constellation of household circumstances sometimes affected by such considerations as the ability of
parents to subsidise their offspring with grants or a portion of the monthly repayments. Those forced into the
private rental sector, the number itself affected by the supply of social housing, will in turn affect landlord’s
profitability and their demand for housing spaces.
In conclusion, the forces shaping housing markets and house prices are numerically large, heavily
interconnected, dynamic individually and collectively, variable between both types of housing and types of
household, operating at a confused private-public interface. Let’s just say at this stage that some
communities have extensive power to manipulate market processes, via typical planning systems, to their
own ends and at the expense of other segments in the housing market. NIMBY, LULU, or BANANA
outcomes are deeply etched into regulatory systems. And even if they did not exist, politicians have rigged
the game in other ways. People, for instance, do not like paying infrastructure fees and charges and, since
existing homeowners of purchasers are in a large majority, why not cut their charges and load them on to
the minority of home aspirants who exercise little voting power? Moving from three-part tariffs to two-part
tariffs can achieve this.
Table 2: Heterogeneity of Housing Stock Feature Indicative Range 1 Style Single dwelling units; Row housing; Apartments; Retirement Villages; Integrated developments; Gated communities 2 Density High, medium, or low 3 Amenity Specialist rooms (e.g. home theatre, billiard, children’s play area, garage space, numbers of bedrooms and their facilities like en suites, facilities for the handicapped) 4 Size Large through to small 5 Accessibility To specific facilities like the CBD, educational and medical facilities, shopping centres, sporting venues, clubs, restaurants OR To specific transport types (public or private; land or air) 6 Quality of Design Heritage, Art Deco, Federation, Modernist, Avant Garde 7 Quality of Construction High through to low 8 Social Amenity Cosmopolitan, Gender preference, Age groups, Social class, Ethnic groups 9 Environmental Quality Water views, parkland, air quality, minimal noise, pace of life Source: The Authors Percent Figure 5: Housing Costs as a Propor@on of Income 24 22 20 18 16 14 12 10 8 6 4 Sydney Melbourne Brisbane Adelaide Perth Hobart Darwin 1995 1996 1997 1998 2000 2001 2003 2004 2006 2008 Year Source: Australia Bureau of Sta@s@cs Canberra Land and Housing Market Inefficiencies
At the heart of any economic analysis is the notion of efficiency. Efficient markets equilibrate supply and
demand fast and are sufficiently competitive to the extent that the prices of goods and services should
approximate their cost of production plus a normal profit margin. Costs include not only the inputs of capital
and raw materials, but also labour and training, rents, research and development, innovation and
opportunity costs. Normal profit levels expected by producers vary between industry sectors according to
their riskiness, and the supply of new housing is sufficiently competitive among a large array of producers,
large and small, for normal profits to prevail most of the time. That said, housing supply is more risky than
many other industry sectors because demand fluctuates markedly and long lead times frequently mean that
supply enters the market during down-turns in the business – consumer demand cycle. In other ways,
housing markets operate like those for most other goods. In the long run, the level of housing production
should approximate the level demand for new housing. This generally equates to the number of new
households entering a given market. Housing is also a “normal” good, whereby the amount of housing
“consumed” is generally a function of income - households typically increases the size and/or quality of their
dwelling as incomes increase.
However, in many ways housing markets are relatively unique when compared other to other goods, and the
previous discussion reveals numerous inefficiencies in housing markets summarised in Table 5. We have
classified these in three ways. The first, supply constipation, provides a considerable list of reasons why
additional supplies of housing suitable to consumer – both homeowners and tenants – needs are often not
provided in a timely way. Note that the difficulty lies largely in infrastructure supply and regulatory
imperfection rather than developer deficiency, suggesting a considerable scope for public sector reform. The
second, artificially inflated demand, simple notes that Australians probably sink far too much capital in
residential real estate rather than alternative investment outlets because of a range of subsidies to home
ownership and mantras surrounding home ownership. Their reduction or removal could go some way to
reducing demand – supply imbalances. Finally, the extremely high cost of residential property transactions,
when compared with share-market trades, reduces the speed with which market signals operate. The total
cost of share transactions is usually < 1% of the purchase amount, while in housing the usual amount is 5
times that. We argue supply uncertainty and inefficiencies are perhaps most important with respect to high
housing prices in Australia, and discuss in more detail below.
Housing Booms and Housing Bubbles
We now turn to the question of whether Australia’s house price movements over the last decade were in
bubble territory or simply reflect usual supply – demand interactions between households and developers in
a highly regulated production system. We should also remember the stock / flow problem mentioned earlier.
Economists generally acknowledge that prices exceeding this cost-plus normal profit formulation are
excessive and indicate a suboptimal market. Monopolistic and oligopolistic markets typically enable
producers to charge higher consumer prices and earn super-normal returns. Housing markets are inevitably
cyclical (Mankiw, 1989; Case 1992; and Ortalo-Magné and Rady, 1999) partly because, in the short run,
supply is inelastic or difficult to ramp up, as we have seen. House prices will typically increase as extra
demand is revealed until sufficient new supply can come onto the market, and then prices and new
construction should fall back to previous levels (Mayer and Somerville, 2000). The problem for housing is
that a rise in, say population growth from 1% per annum to 2% can effectively double the demand for new
housing. Supply blockages will automatically tend to raise price quite sharply under such conditions. From a
policy and empirical perspective, what is important in recognizing housing bubbles is whether rising prices
are a result of economic fundamentals such as those just described, or because of other less rational
factors.
The term “housing bubble” is often used in popular media without a clear understanding of what
distinguishes booming prices from bubble prices. This lack of understanding also exists in academic circles,
and became more apparent with the crash of the US housing market and subsequent flurry of scholarly
papers seeking to explain the “bubble.” As such, we will attempt to draw a definitions based on more
objective scholarly works developed before the most recent housing market collapse in the US. Housing
market booms and busts are quite natural for the reasons mentioned above. The size, length, and severity
of house price increases and declines have varied over the past 100 years, and not all (or even many)
crashes in the developed world can be attributed to bubbles. Many crashes occurred because of more
fundamental drivers, such as excessive homeowner subsidies, distorted mortgage markets, overly restrictive
land use regulation, developer speculation, and unsound monetary policy, and in general have followed
almost every housing boom on record.
Conceptually speaking, there is clear line between boom and bubble. The commonly accepted definition of a
market bubble is price appreciation of an asset is high only because investors speculate future appreciation
will be high, and disregard fundamental economic drivers (Stiglitz, 1990; Case and Shiller, 2003; and
Himmelberg, Mayer, and Sinai, 2005). Specifically, Himmelberg, Mayer, and Sinai (2005) apply this
definition to housing markets, who “think of a housing bubble as being driven by home buyers who are
willing to pay inflated prices for houses today because they expect unrealistically high housing appreciation
in the future.”
As mentioned above, appreciating housing prices are not necessarily an indicator of an emerging bubble.
Himmelber, Mayer, and Sinai (2005) suggest four reasons why this is so: (1) the price of a house is not
indicative of the cost of owning a house, (2) rising housing prices say nothing about whether housing is
overvalued, (3) differences in expected price appreciation and tax rates can lead to significant regional
variation in house prices relative to rents, and (4) interest rates and expected changes in regional
fundamentals greatly affect the sensitivity of house prices. Points (3) and (4) are of special importance
because expectations of price increases alone are not causes of bubbles – only if expectations are rooted in
current and past price appreciations. For example, if expected price appreciations reflecting anticipation of
decreasing household size, increasing populations, increasing incomes, or decreasing interest rates, then
expected price appreciations are rooted in fundamental economic determinants. Even if these expectations
are exaggerated or miscalculated, a bubble will not likely emerge because “irrational exuberance” among
buyers is lacking (Shiller, 2008).
Case and Shiller (2003) poignantly describe that during housing bubbles “homebuyers think that a home that
they would normally consider too expensive for them is now an acceptable purchase because they will be
compensated by significant further price increases,” and that “first-time homebuyers may…worry…that if
they do not buy now, they will not be able to afford a home later.” Shiller (2008) makes an intriguing
argument that bubbles are inherently a psychological phenomenon, where societal beliefs of ever-increasing
house prices grip public sentiment, and that these sentiments reflect serious “irrationality” in the market.
On Uncertainty
To us, housing markets look like one of the most uncertain economic systems imaginable. Myriads of
players on the demand side, with diverse and often rapidly changing housing needs and abilities to pay for
them, are competing for residential accommodation. Such conditions also exist on the supply side, except
that the interactions of actors are far more confused and often contradictory. The supply side is a whole of
society venture, with a conflicting mixture of parties representing private, government, and community
interests, each of whom has different motives, agendas, time frames, access to power, and conceptions of
the ideal living environment in various states of development. To make matters worse for all these supply
and demand participants, governments and the wider community have virtually no power to control the
changing technologies that ultimately shape urban life. Sorensen (2011) identifies 11 separate dimensions
of uncertainty, all recognisable in our cities and all interconnected so that it difficult to explain events or
observations in complex systems like those considered in this paper. The ultimate implication of this logic is
that it may be difficult to say whether property markets have experienced bubble conditions or normal
market uncertainty.
So, given the above, the question remains: are Australian house prices in bubble territory, or are they within
the range of normal expectations? The focus of this paper is not on quantitatively identifying housing bubble
in Australia. Rather, our aim to develop a concise qualitative narrative on the potential emergence and
causes of bubbles in Australian markets. We begin by suggesting that different types of bubbles may exist in
different markets. While the scholarly literature above defines bubbles as scenarios where buyers are
irrationally paying higher prices for homes because of unreasonable expectations of future price increases, it
is plausible that irrationality may emerge for reasons other than misplaced exuberance. Rather, in hindsight
what appear to be irrational decisions of homebuyers may simply be completely be rational decisions based
on increasing uncertainty in housing markets. As such, we distinguish the housing bubbles in Australia into
two types: irrational bubbles, marked by excessive and misplaced exuberance about house price
appreciation, and uncertainty bubbles, marked by more rational decisions reflecting uncertainty in both the
development process and future economic and political decisions. The distinction is important for policy
makers because irrational bubbles likely arises because of peculiar social-psychological phenomenon,
which can be difficult or impossible to address with policy, while planners and policy makers can more
tangibly address many factors associated with uncertainty bubbles. In the remained we focus on the extent
to which the latter may be driving residential markets in Australia, and suggest a myriad of ways that public
policy makers may decrease uncertainty.
Figure 6: House Price Index for Homes, 1993-­‐2010 25 Index 20 ADL Houses 15 BNE Houses 10 MEL Houses PER Houses 5 0 1993q1 SYD Houses 1996q1 1999q1 2002q1 2005q1 2008q1 Quarter Source: Residex Figure 7: House Price Index for Units, 1993-­‐2010 25 Index 20 ADL Units 15 BNE Units 10 MEL Units PER Units 5 SYD Units 0 1993q1 1996q1 1999q1 2002q1 Quarter Source: Residex 2005q1 2008q1 Housing markets are inherently rife with uncertainty. This is because of “natural” inefficiencies that arise in
both the demand and supply of housing (Mankiw, 1989; Case 1992; and Ortalo-Magné and Rady, 1999). As
such, prices are volatile in the short-run, so we should expect a natural range of real house price
fluctuations. These natural fluctuations result from asynchronous movements of demand and supply, but
also exogenous (or sometime endogenous) changes in government policies. Thus, short-run uncertainty
exists as to whether and when new supply can match increases in household demand. Households may
respond to this supply uncertainty by more quickly purchasing homes in an attempt to preemptively avoid
future unaffordability, and thus are more likely to bid and borrow higher amounts for housing than would
otherwise occur with less uncertainty of supply.
However, uncertainty also exists in government policy. In Australia, the major capital cities are dominated by
a “plentitude, plethora, and plague” of land use regulations (Bunker, 2008; Hamnett and Kellett, 2007).
These plans arguably increase uncertainty of the development process, as the development approval
process can depend upon consent from a variety of government agencies. Furthermore, government
interest in enforcement of the various planning policies waxes and wanes with different elected parties
(Gleeson and Coiacetto, 2007). Thus, uncertainly arises not only because of “natural” asynchronous shifts in
demand and supply, but also from rapid and often contradictory changes in federal, state, and local land use
regulations. This uncertainty may ultimately reduce the long-term supply of new homes and lead to supply
induced inflations of prices. (Mayer and Somerville, 2000).
However, there is no reason to believe that all housing markets segments experience similar conditions
simultaneously with respect to uncertainty. This is because the costs of the two primary components of
residential property prices - land and construction – move independently from one another. Thus, housing
types that utilize these inputs in different proportions would experience different price effects as each cost
changes. For example, a restriction on land supply would disproportionally affect housing types that are land
intensive, such as single-family detached dwellings. Recent evidence from McLaughlin (2011) suggests
such policies may indeed reduce new single-family supply in Australian capital cities. On the other hand, the
price effects on smaller, less land intensive multifamily units would be substantially lower. This latter point is
perhaps heightened by concurrent adoption of policies designed to increase the supply of multifamily units.
In Australia, adoption of policies promoting mixed-used medium density and transit oriented developments
has been quite common, especially in states with metropolitan-wide land restrictions (Hamnett and Kellett,
2007). However with the emergence of groups such as Save Our Suburbs, local resistance to densification
may greatly add to future uncertainty of the supply of both types of housing.
Descriptive evidence of house prices suggests such differentiated price effects may be occurring in
Australian cities as a result of the various land use policies. Figures 6 and 7 show the Residex capital city
quarterly price index for houses and units between 1993 and 2010, respectively. While the general trend of
price movements has been upward, especially for Sydney, Melbourne, and Brisbane, the trajectory has
been much steeper for single-family homes than for multifamily units. With the exception of Adelaide, price
appreciation of single-family homes has outpaced that of multifamily units. Thus, uncertainty bubbles, if they
exist, are much more likely for detached dwellings, although the data suggests attached units have
experienced similar, but less pronounced trajectories.
To add credence to our argument that uncertainty may be driving a housing market bubble in Australia, the
most recent empirical work on housing bubbles in Australia suggests only housing markets in Sydney and
Perth experienced bubbles over the past 15 years (Jiang, Song, Liu, 2011). Using price deviations from
predicted influences of economic fundamentals, the authors find prices in the many of the other cities –
Melbourne, Brisbane, Hobart, and Canberra – were actually undervalued from 1995-2008, and that only
prices in Adelaide and Darwin followed market fundamentals.
Still, Australian households are experiencing higher levels of house price stress. Figure 8 displays the
median multiple – which is the ratio of mdeian house price to median income - for Australian capital cities
from 1981-2009. The story is essentially the same for each city: in the 1980s, median house prices ranged
from approximately three to five times median incomes, but by 2009 the multiple range was between six and
nine. Thus, even if most markets in Australia are not technically experiencing irrational bubbles, it is
apparent that more than just increases in median incomes have been driving house price growth in
Australian cities.
Median Mul@ple Figure 8: Median Mul@ple for Australian Capital Ci@es 10 9 8 7 6 5 4 3 2 1 0 Sydney Melbourne Brisbane Adelaide Perth Hobart 1981 1986 1991 1996 2001 2006 Year Source: Demogrpahia, 2011; ABS, REIA 2009 Canberra Policy Recommendations and Concluding Comments
The foregoing discussion suggests a range public policy reforms designed to reduce excessive oscillations
in property prices and increase housing affordability, especially for lower income households. We identify
four such arenas, starting with improved infrastructure management for both greenfields development and
urban renewal. Rather than play catch-up most of the time, our cities need integrated and well-coordinated
infrastructure supply in advance of anticipated population growth. In the interests of social equity, we
advocate funding the necessary works on a city-wide basis using three-part tariffs that include a component
for system extension in addition to those covering recurrent and maintenance costs. This should reduce
dramatically the current user-pays charges levied against new residential allotments at the urban fringe and
reducing the cost of housing for entry level home owners, the households least able to afford high land
costs. This strategy should also accelerate regeneration of the existing urban fabric to higher residential
densities.
Our second reform agenda focuses on the culture of urban planning, which has become excessively
th
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concerned with regulatory minutiae and less so with the imaginative agendas of the 19 and early 20
centuries. One such task is to encourage and embolden developers and architects to invent new forms of
entry level housing for currently disadvantaged groups, especially single-person, young, and low income
households. Such developments are needed close to public transport nodes and major employment centres,
whether CBD or regional, and individual units are likely to be small scale. That will not matter much if
developments are amenity rich either on-site or in the immediate neighbourhood. We have no preference for
either owner-occupier or rental accommodation. This kind of development is also crucial if our major cities
are to accommodate within existing urban footprints a large proportion (perhaps 80%) of likely population
increase over the next 40 years.
Central to the second agenda, is the need to gain rapid community acceptance for innovative medium to
high density urban forms. This undoubtedly means lessening the power of NIMBY sentiments, although still
respecting people’s right to comment critically on proposed developments. There are few proposals that do
not benefit from community consultation. We see two important strategies in this regard. First, obstructionist
NIMBY sentiments are often assisted by local government fragmentation, whereby councillors, elected or
those standing for office, are forced to pander to defensive community sentiment. The logical antidote is, of
course, amalgamation of councils into larger units less amenable to local capture, and maybe a city the size
of Sydney should have a maximum of 4 local government jurisdictions. Secondly, we advocate revising the
power of heritage protection arrangements along the lines recommended by the Productivity Commission
(2006). Parts of our cities have been placed off-limits to significant redevelopment, and often at unfair cost to
existing residents. While acknowledging the importance retention of important heritage items to link society
to inspirational elements of its past, we should actively facilitate future aspirations. The clash of the two will
often require mutual compromise, which is sometimes difficult with existing provisions.
Finally, we would like to see property ownership toppled from its position as Australia’s premier sporting
event. This is cemented by a large raft of subsidies that privilege home ownership compared with other
asset classes and these privileges, including the absence of Capital Gains Tax on owner-occupied housing
(inflation adjusted) and Negative Gearing on rental housing, are hugely socially regressive. Most of the
benefits accrue to the top one-third of households by income. Their removal, along with iniquitous first
homeowner schemes, would go a long way to lopping our infatuation with home ownership and real estate
assets more generally. Simultaneously, our ability as a nation to allocate housing resources appropriately to
various stages in the human life cycle is compromised by the extraordinary costs, in terms of estate agent
and legal fees or government stamp duties, of switching homes. Reductions in those fees and charges
should increase the flexibility of Australia’s existing housing stock to meet demand. Another important
reform would be to cap the typical mortgage repayment term to 25 years to (i) save households a lifetime of
repayments and a mass of additional interest charges to banks or other financial institutions and (ii) stave off
possible term increases to 35 or 40 years which is where we may be heading.
What potentially stands in the way of this agenda? Well, the 70% of households currently owning real estate
are likely to be irate at diminished opportunities for making a large tax-free capital gain on their home
purchase. Worse still for them, our agenda could well increase their annual infrastructure charges, and mute
NIMY protest opportunities against developments incompatible with their Weltanschauung. And the
politicians who would have to amend laws and regulations would be inescapably captive to such interests,
who have massively more electoral power than those marginalised by current arrangements. Nor would
State Governments take kindly to losing the valuable source of non-GST income provided by stamp duties
on the transfer of residential property. On the other hand, the Australian Government could generate a fiscal
windfall from the extension of Capital Gains Tax to owner-occupied residences, though the complexities
entailed in calculating gains would probably require only levying tax on properties valued above some
threshold amount, perhaps AU$500,000. The elimination of Negative Gearing would be simpler to handle
administratively, but liable to community antipathy of the kind accompanying an earlier attempt by the
Hawke Government in 1985. So, it would be wise not hold our breath for too long awaiting the outcomes we
advocate. It looks like reform is only possible at the margin, so entrenched is the religion of owner-occupied
housing in Australian society.
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