For better housing affordability, try the premier, not the PM

People have been complaining about the unaffordability of houses for as long as I’ve been a journalist. In all that time, governments have professed great concern, while doing nothing of consequence. But I suspect their insouciance can’t last much longer.

Over the years, the prices of houses and apartments have risen much faster that household incomes have risen, gradually lowering the proportion of Australians able to afford a home of their own.

So the problem keeps getting worse and, with interest rates having risen so far so fast, as well as renters now feeling so much pain, it wouldn’t surprise me if, in coming federal and state elections, many younger voters – and some of their parents – were really steamed up about the issue.

If so, both Labor and the Liberals will be vulnerable to minor parties offering solutions – sensible or otherwise. But what could the major parties do to reduce the problem?

Well, nothing that some people wouldn’t vigorously object to. That’s why the political duopoly has done so little for so long.

The unending rise in house prices has been caused by various factors – some under the control of the federal government, some controlled by the states.

If prices keep rising, this suggests that demand is outstripping supply. In general, the feds have more direct influence over the demand for housing, whereas the states have more direct influence over the supply of them.

It’s wrong to assume that all the problems are coming from either the demand side or the supply side. But, of late, economists have been focusing on the supply side, which points the finger at state governments.

At first blush, if house prices are high and rising, this suggests not enough houses are being built. That’s probably true at present, with immigrants coming faster than we’re building new dwellings for them to live in.

But, over the decades, supply has eventually caught up with demand, so that doesn’t explain why prices have been rising for ages.

And, if it was just a matter of building enough houses to accommodate the growing population, cities would just keep spreading out for ever. That would be expensive – with all the extra transport and infrastructure you’d have to build – and not everyone wants to live that far out from the CBD.

So, the real supply issue is not that we should be building enough houses, it’s building enough housing where people want to live. And the truth is that many people want to live closer in.

As the NSW Productivity Commission explains in a new report, state planning systems make it “difficult to build enough new homes where people want to live – close to jobs, transport, schools and other amenities”.

“Instead, the system encourages urban sprawl, forcing people into longer and longer commutes. These policies increase inequality, especially for low and middle-income workers.”

Guess what happens if governments don’t allow enough homes to be built where people want to live? The prices of homes in, or nearer to, the most desirable areas get bid up relative to prices out in the boondocks, forcing up the median price.

As Australia’s population has grown so rapidly over the decades, the populations of Sydney, Melbourne and the other state capitals have increased greatly, but done so mainly by spreading out.

This has made housing more expensive, as people have had to pay more to live in the closer-in, more desirable parts of the city. Inevitably, it’s the better-off who get the best spots and the less well-paid who have to live further out, where the amenity is less.

Everyone’s paying more for their housing, but the well-off pay a smaller proportion of their income than those in the middle and at the bottom. This pushes families to compromise on where they live – further from family, friends and jobs.

The NSW Productivity Commission report says poor housing affordability brings four disadvantages to individual families and the community. It leaves families with less to spend on other things. It reduces the productivity of the nation’s labour because so many people who want to work can’t afford to live near their best employment prospects.

It adds to environmental damage because more workers live further from city centres and endure long, polluting commutes to their jobs.

And it reduces people’s quality of life because so much of our cities’ populations end up too far from the beach, sports arenas, big entertainment venues and other amenities.

So, what can state governments do to reduce these costs and make our lives better?

We should build more new homes in areas closer to the city’s centre. “These areas offer both the richest collection of job opportunities, and a supply of already-built infrastructure and other amenities whose capacity can be leveraged and expanded,” the report says.

What we need to do is build up, not out, and achieve more “infill” of unused or underutilised land close in.

Specifically, the report says, we need three changes. First, raise average apartment heights in suburbs close to the CBD (and to job opportunities).

Second, allow more development around transport hubs, such as train stations, and take advantage of our existing infrastructure capacity.

And third, encourage more townhouses and other medium-density development, and allow more dual-occupancy uses such as granny flats, where higher density is not an option.

The report argues that, even if the new supply of homes targets the high end of town, building more housing closer to the CBD, “downward filtering” means affordability improves everywhere.

The new, more expensive homes near the centre will be occupied by high-income families. But they will leave behind high-quality homes that middle-income families can move to, leaving their homes to be occupied by lower-income families.

NSW Productivity Commissioner Peter Achterstraat says that “if you believe, as I do, that today’s kids deserve the same shot at the Australian dream that my generation had, we need to change our planning system and build near existing infrastructure to make room for them”.

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Beware of pedlars of supply-side solutions to home affordability

One thing you can be sure of is that if house prices are soaring, governments will be holding inquiries into it. Unfortunately, the other thing you can be sure of is that nothing will come of those inquiries.

Why? Because their purpose is to express the government’s deep concern about the worsening affordability of homeownership – its heart-felt sympathy for young people struggling to buy their first home – not to tackle the problem.

Why? Because policy decisions made by governments – federal and state – over many years have rigged the housing market in favour of people who already own their homes and against those who’d like to own.

Why? Because the number of voting homeowners far exceeds the number of voting would-be homeowners. The established homeowners – and the industries that benefit from the rigged market, such as property developers and real estate agents – get shirty if they think their privileges are threatened.

Labor summoned its courage and promised to act against negative gearing and the deep discount of capital gains tax in the 2016 and 2019 federal elections but, since its shock defeat in 2019, its courage has deserted it.

Speaking of housing inquiries, as we speak Treasurer Josh Frydenberg has a parliamentary committee inquiring into “housing affordability and supply”. As its terms of reference make clear, it’s not actually about housing affordability, but really about blaming rocketing house prices on inadequate supply rather than excessive demand.

Why? Because, with a federal election fast approaching, its real motivation is to shift the blame for increasingly unaffordable house prices away from the feds and on to the states. Whereas most of the policies promoting demand for homeownership are under the influence of the federal government, most of the policies affecting the adequacy of the supply of homes are influenced by the state governments and their creature, local government.

When I wrote about the causes of rocketing house prices last week, I knew I was leaving myself open to attack because I focused solely on factors adding to demand and didn’t get to supply factors before I ran out of space.

True, no analysis of change in any market price is adequate if it doesn’t examine both sides of the market. So let me make amends.

In simple economic theory, if the price of some item rises, the reason should be that demand has outstripped supply. Let supply catch up and the price should return to where it was. If the demand for homes rises by 100, build 100 more homes and the price should be unchanged.

But such thinking is grossly oversimplified – especially when applied to something as complex as the housing market. For a start, the simple model is designed to analyse markets for “commodities” – simple consumer goods or services you buy and soon eat or use up.

Homes, however, are assets that last for decades and have a resale value. Most of that value resides in the land on which the home is built, and the land goes on forever.

This means a home is both a consumption good – it provides its owner or tenant with somewhere to live – and an investment good, which should at least hold its value over time and probably increase in value.

As the Reserve Bank’s submission to the latest inquiry has pointed out, the growth in the number of homes has pretty much kept up with population growth in recent decades, meaning a shortage of places to live can’t explain rising house prices.

In any case, the price of buying a home is an unreliable guide to the price of finding somewhere to live since there are two reasons for buying a home: as a place to live and as an investment (a good place to park your wealth).

The better guide to the cost of finding somewhere to live comes not from the price of houses and units but from the price of renting. And the figures show that (with the possible exception of Sydney), the cost of renting in capital cities has risen only a little faster than other consumer prices.

This fits with our earlier finding that the number of homes has kept pace with population growth. And it leaves little support for the widely aired claims of people from conservative think tanks that house prices have risen because state and local government planning and zoning regulations are limiting the release of land for housing development or the growth of medium and high-density housing.

This argument has been debunked by Dr Cameron Murray of the University of Sydney. Being based on mere modelling, it fails to take account of the empirical fact that zoning regulations have been eased in recent years, specifically to ensure that home building keeps up with population growth.

This has happened over many people’s objections to the growth in high-density housing. But, unless we want our capital cities to keep sprawling outward forever, more high-rise housing is an inevitable consequence of business’s demand for – and almost every economist’s support for – rapid population growth.

All this suggests it’s the strong demand for home ownership, not any inadequacy in the supply of homes that’s driving prices up so rapidly. But what, and why? I think house prices are rising strongly because federal government decisions have made housing more attractive as an investment.

They’ve made home ownership more favourably taxed than other forms of investment, such as shares, art and antiques, or fixed-interest investments. This has always been true, but it’s become more so, first, with the Hawke government’s introduction of a capital gains tax in 1985, while exempting the family home.

But the biggest change came with the Howard government’s move in 1999 from taxing only real capital gains to taxing the full nominal gain but at only half your marginal tax rate. The popularity of negatively geared property investment took off from that time.

Ask yourself this: if the number of homes is pretty much keeping up with growth in the number of households, what happens when some homeowners decide they’d like to own more than one home, maybe many more? They use their superior borrowing-power to outbid the other home owners, existing and would-be.

The supply of land for housing is limited, but not fixed. That’s because cities can sprawl, or you can pack more households onto to the same bit of land by building up. But both solutions add to costs.

The simple demand-versus-supply model assumes the “commodity” in question is “homogeneous” – all the same. But with houses and units, it would be closer to the truth to say every home is different. Even two houses of the same design are different if they’re in different suburbs.

And some homes are in prime positions – on the harbour, near the beach, closer to town. The cheaper it becomes to borrow, the more people will bid prices higher to get the fabulous place they want.

The more governments use high immigration to increase the size of cities, the more competition there is to buy a detached house, and the more people will pay to get a place that’s close to the CBD.

Ever-rising house prices is a demand story more than a supply story.

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What's making homes hard to afford and what we could do

There aren't many material aspirations Australians hold dearer than owning their own home - but dear is the word. There are few greater areas of policy failure.

The rate of home ownership, of which we were once so proud, has been falling slowly for decades. And as the last high home-owning generations start popping off, it will fall much faster.

We've been debating this issue for years, while it's just got worse. Yet we have a better handle on the causes of the problem, and what needs to be done, than ever.

Let me see if I can pull a lot of the elements together and give you the big picture.

Don't let anyone tell you the younger generation would be happy to stay renting forever. Nuh.

And while the hurdle of owning a home and a mortgage seems almost insurmountable to the young, jumping it is just the start of our property ambition. Most people want to keep moving up to a bigger and better home. Every promotion we get makes us wonder whether we can afford a better place.

This preoccupation with the quality of our housing is the first part of the reason house prices have risen so high: ever growing demand.

Don't forget that our newly built houses are much grander than they were even 10 years ago. And most older houses have been renovated and extended to make them better.

When two-income families became common people thought "great, now we can afford a bigger mortgage on a better place".

When we got on top of inflation in the early 1990s and interest rates fell so far, people could have paid off their mortgage faster, or bought a boat, but more people said "great, now we can afford a bigger mortgage on a better place".

Trouble is, you can't satisfy increased demand for better houses – particularly better-located houses - by building more places on the outskirts of the city. And when a lot of people decide to move to a better place at the same time, the main thing they do is bid up the prices of existing houses.

One change in recent decades is the growth of the services sector and the knowledge economy (more workers knowing how to do things; fewer workers making things), which means many of the jobs have gravitated to the CBD and nearby suburbs.

So the meaning of "position" has changed from good views to "proximity" to the centre. In theory, the amount of land within 10 kilometres of the GPO is fixed. In practice, factories and warehouses can be moved further out, while detached houses can be replaced by townhouses and low-rise or high-rise units.

Even so, in every city, property prices have risen more the closer homes are to the centre.

Another source of increased demand for housing is our high population growth, caused by our policy of high immigration.

Then there's foreigners' investment in our housing, though this isn't as big a cause of higher prices as many imagine because – in principle but not always practice - foreigners are only supposed to buy newly built or "off-the-plan" homes. That is, create their own supply.

Another source of greater demand is Paul Keating's introduction of capital gains tax in 1985 and John Howard's introduction of a 50 per cent discount on the tax in 1999. This has made owner-occupied homes (which are exempt from the tax) and, thanks to negative gearing, rented-out homes, more attractive as a form of investment, relative to shares.

So house prices are higher partly because we've acquired a second motive for home-ownership: not just the security and freedom of owning the home you live in, but also the prospect of homes becoming much more valuable over time.

Of course, increased demand leads to higher prices only if supply fails to keep up. And that's where our governments – state and federal – have failed us.

It's better now, but for ages state governments failed to do enough to permit the building of more homes on the edge of cities. We got more immigrant families, but not more homes to put them in.

Worse, state governments have allowed people in inner and middle-ring suburbs and their councils to resist the pressure for more medium-density housing – more units – from people wanting to live closer to where the jobs and facilities are.

Just last week the Reserve Bank published estimates that this resistance to higher density had added more than $300,000 to the average Melbourne house price and almost $500,000 to the Sydney price, over the past two decades.

So, who pushed housing prices so high? We did. Who failed to do what was needed to counter the increase? Our governments.

The feds failed to limit the growth in demand (by limiting immigration and fixing the tax system), while the states did too little to increase supply (by discouraging the building of new homes on the outskirts and by permitting a first-in-best-dressed mentality by people in inner and middle-ring suburbs).

Why are they allowing the proportion of home owners to decline? Because most things they could do to genuinely help first home buyers would come at the expense of existing home owners, who have more votes than the youngsters.

If young people and their parents don't like that, the answer's more pressure at the ballot box. Wheels that squeak more.

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