Can housing really be affordable and unaffordable at the same time?

The latest affordability index by the Adelaide Bank and Real Estate Institute of Australia has once again flooded the real estate headlines with the jolly news that housing is growing ever more affordable.  

This pre Christmas gift of optimism from the newly updated affordability studies commissioned by the financial and real estate sectors, comes with a host of commentary – usually from those with a vested interest – who happily advise aspiring home owners that ‘they’ve never had it so good’ – in other words, to paraphrase Terry Ryder’s thoughts, first home buyers should ‘put up, or shut up.’  

Of course, it wouldn’t be half as palatable if it didn’t come accompanied with the seeming contradiction that not only is it more affordable than it’s been in the last decade (according to the HIA-Commonwealth Bank affordability index), it’s also substantially more expensive than its ever been. Yes, housing is only item than can be both affordable and unaffordable at the same time.  Work that one out Einstein.  

In fact, according to Residex, median prices in both Sydney and Melbourne have already exceeded their historical highs, ‘nudging’ $750,000 in Sydney and $600,000 in Melbourne - additionally, Perth has also reached its previous peak of 2008, with a median price of $521,000.  

RP Data’s dwelling price index shows a year to date increase of 14.3% in Sydney, 6.4% in Melbourne and 9.7% in Perth.  For home buyers, the benefit derived from lower lending rates has been all but offset by the inflationary pressure placed on prices.  

Rarely is it mentioned that housing affordability and the cost of servicing a mortgage are two separate entities.  

Mortgage rates are set up with different structures dependant on circumstance, and subject to interest rate changes influenced by the macro environment.  

To take out a 25 year mortgage requires the expectation of secure employment in a terrain where frequent job changes or part time work are becoming a norm.  

They may influence house prices through a cycle, but they do not take away the fact that home prices now – even with lower lending rates – require longer terms to pay down, with the interest over the duration of that period adding considerably to the capital cost.  

In fact I couldn’t put it any better than current governor of the Bank of England - Mark Carney, when he warns;  

“Think about the mortgage you are taking on, the debts you are taking on…You are taking at least a 25-year mortgage, maybe a 30-year mortgage.  Are you going to be able to service that mortgage five years from now, 10 years from now, if interest rates are higher? Or are you counting, even subconsciously, on the price of your house keeping going up and if something happens an ability to sell it quickly and not facing the consequences of not being able to pay?"

Carney’s cautionary words pre-empt the Bank of England’s decision to scale back its inflationary Funding for Lending Scheme amidst fears of a rapid escalation of house prices in the south-eastern regions of the country.  

From next year funding for lending will only be available for business loans -not mortgages – and if the banking sector’s concerned about signs of frothiness in an industry in which it’s heavily invested, so should we also be.  

The Bank of England governor is not alone. Central banks in Sweden, Hong Kong, Norway, New Zealand, Canada and Switzerland (to name but a few) have all adopted macro prudential measures to buffer against the associated risks of a boom/bust investor lead recovery in a post GFC environment - highlighting the importance of keeping lending standards robust – all, that is,  except Australia.  

Having weathered the impact of the GFC a little more effectively than others – the RBA seem to think we live in some magic faraway tree, effectively doing little more than wagging a cautionary finger to a sector which for the duration of the year, have outstripped owner-occupier lending with well over a third of all new loans on interest only terms and roughly the same proportion with LVRs of over 8%.  

In other words, there are still over a third of all loans in which the principle is not being reduced – with 37.3% lent on these terms for the September quarter alone.  

In NSW, investment lending is at record highs, making up over 50% of the market and although many use the well worn argument that the unwanted boom is predominant ‘only in Sydney’ – let’s not forget, Sydney is not some nether land off the coast of Tasmania. What happens in our biggest capital, with the largest and most diverse economy in Australia, inevitably impacts us all.  

Historically, this sector is more sensitive to interest rate changes with a tendency to wax and wain pro cyclically with market movements, exaggerating both gains and falls.  A housing recovery built on the back of small mum and dad investors pouring their money predominantly into negatively geared established dwellings – especially considering our current levels of private debt to income ratios - is not ideal for the long term the stability of our housing market, or house prices.  

The common Aussie term ‘spruiking’ - which APRA warns against in the self-managed super sector, is not only a contributing aspect of what inspires our culture to see property as the undiversified road map for building wealth for retirement – it is also part and parcel of what has kept our property prices high by both local and international standards.  Yet the risks associated with spruiking in SMSFs is simply the tip of a much larger iceberg.  

Having worked in many aspects of the housing industry, I have seen first hand the type of material that’s presented at seminars not just from those who receive under the table commissions from developers, but also from advocates working as independent advisors for either the seller or buyer.  

It really isn’t unusual to see slides presented at seminars with straight lines charting the difference between investing in properties that supposedly “grow” at steady 5% per annum, compared to those that grow at 10%, using historical median data as ‘evidence’ that future returns can replicate those achieved in the past, without any distinction of how such data is correlated or the difference between individual “house prices” and “median values.”  

This information borders on financial advice and comes with no mention of risk or the type of rigorous analysis, which you would reasonably expect when choosing to invest in a single asset.  

Another widely used industry favourite is the statement;  

“FACT: fewer than 5% of properties are investment grade”  

A myth if ever there was one.  Perhaps the well-known companies that use this as an advertising tool, would like to point to the person who researched every property in Australia to correlate such a statistic? Maybe we could also ask for a comprehensive definition of what ‘investment grade’ really is – because I guarantee there would be no shortage of differing opinions from industry ‘experts.’  

This endless promotion of residential property, with rows of investment magazines lining newsagency shelves, promoting subjective ‘hotspots,’ or as I pointed out a few weeks ago, agencies cold calling households, and sending ‘advisors’ round to ‘educate’ and encourage inexperienced investors to negatively gear against their principle place of residence, is toxic.  

Article continues on next page. Please click below.

Meanwhile, the RBA continue to sit on their hands, not wanting to pull a regulatory lever, instead warning investors to employ caution, hoping they will fall into line like a bunch of good school kids. However, whilst macro prudential tools may assist in ensuring banking lending standards remain robust – can they have any long-term sustainable or lasting impact on property prices?  

In a recent research paper by BIS (Bank for International Settlements), entitled “Can non-interest rate policies stabilise housing markets?”, evidence was gathered from 57 countries spanning more than three decades, investigating the effectiveness of nine non-interest rate policy and macro prudential tools on restraining credit growth and house prices.  

The analysis used a new dataset going as far back as 1980, making it the most comprehensive study to date in terms of both scope and time span.  

The paper concluded that whilst reductions in the maximum LTV (loan to value) ratio can restrain demand, its effects can be partially or wholly offset by a rising market enabling the investor to borrow more, therefore, changes in the maximum DSTI (debt service to income) ratio were assessed to be more substantial.  

But importantly;  

“Only tax changes affecting the cost of buying a house, which bear directly on the user cost, have any measurable effect on prices” and,  

“None of the policies designed to affect either the supply of or the demand for credit has a discernible impact on house prices.”

The study puts this down to the ‘can buys’ still outnumbering the growing pool of credit constrained ‘can’t buys’ – stressing that the importance of housing supply was not explicitly considered. Therefore if we want to lower house prices or put in place policies to aid affordability, we need to look outside the limited powers of the RBA alone.  

As has been proven time and time again, intermittently stoking at the bottom end of the market with FHB grants and incentives does little more than provide a short term happy pill for vendors, as the price multiplier effect ripples across the rest of the housing terrain, stimulating both an inflationary and volatile environment.  

Instead, we need to focus on the real problem in Australia – and it’s not property prices, it’s land prices - as economist Leith Van Onselen effectively points out when he analyses the difference between commercial and rural land compared to residential land values, and building costs.  

“Whilst commercial and rural prices have remained relatively stable over the last 24 years relative to GDP, residential prices have skyrocketed.”  

In other words, the cost of residential fringe land, which without constraint, should be close to its ‘raw’ value, is not cheap at all – and it’s all down to ineffective urban planning policy.  

As I (and others) have pointed out previously, even within a wide expansive boundary as mooted in Melbourne’s new urban growth strategy, the government limits land use until they have gone through a lengthy process of mapping out areas for infrastructure known as a ‘Precinct Structure Plan’ (PSP) – it is a slow laborious process and as soon as you restrict the supply of anything, scarcity inevitably inflates values.  

Larger developers are not slow to purchase swathes of acreage prior to rezoning, and then once PSPs have been finalised, drip feed it onto the market. Not only do government bodies have little understanding of how released plots respond to consumer demand, they have no policy in place to deter the practice. It’s therefore a failure.  

Furthermore, facilitation of infrastructure is currently financed via hefty development overlays, which are passed onto the buyer rather than initiatives such as bond financing, where residents pay back proportionally over a lengthy period of time, as was the case historically.  

We must remove these barriers with effective policy and let land prices revert back to normal levels to reflect a real price closer to commercial values.  

Without doing so, we can’t gain a true indicator of the trade-off buyers are prepared to make between price and distance. Currently, the average price of a newly built house and land package is around $400,000, this is not serviceable on the single median wage, and therefore can hardly be deemed affordable.  

Get the land supply, price, and infrastructure equation right and I suspect there would be no lack of demand from genuine aspiring home buyers.  Only when this is done, can we have a truly transparent debate on first home buyers’ willingness to spread over the land.