Don’t Kill Australia’s Housing Recovery by Pulling the Wrong Levers

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Tuesday, October 21st, 2014
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There is a lot of talk about housing property bubbles and the risk of a major pricing correction.

The Reserve Bank is rightly concerned that for some borrowers, exposure to residential property has more downside than up. The current House of Representatives Inquiry into the impact of foreign investors adds to the mix as the upper end of the Sydney, Melbourne and Brisbane markets sets new price points which are dragging the rest of the market up.

Many of the voices getting coverage in the mainstream media have self-interest at heart, so it’s difficult to filter out what is real and what is not. When you start to hear major developers talking of what’s needed to create more affordable housing, it’s time to wonder whether we are hearing from wolves in sheep’s clothing. The submissions to Kelly O’Dwyer’s Economics Committee’s Enquiry into Foreign Investment in Real Estate [1] make for interesting reading. Submission 11 by the Urban Taskforce Australia makes a lot of the investment pipeline but makes no mention of the resultant retail prices and their impact on local affordability.

Treasurer Joe Hockey is also front and centre, downplaying the risk of a property bubble and trying to avoid the need to at least fine tune the rules applying to negative gearing. All this while, he is trying to encourage the states to recycle assets and plough huge new investment into expensive infrastructure projects. Hockey seems possessed with this agenda while at the same time claiming a commitment to pursuing better value for money outcomes than his failed opposition predecessors.

Negative gearing was initially intended to help stimulate investment in affordable private rental housing. At first, it did a pretty good job, but this housing supply measure is costing the budget big time, so it does need some refinement. Here are a few realities that should be considered ahead of shaping that refinement:

  • Housing for the first time in Australia’s housing history is seeing more consents for multi-unit residential development than for stand-alone homes [2]. This is the new reality.
  • Traditional residential builders of stand-alone homes and more recently attached dwellings or town house styled housing have been by far the most efficient suppliers of Australia’s housing stock. The retail house and land package price of this stock is circa $2,500 per square metre.
  • Traditional residential builders are not at the forefront of the multi-unit housing market evolution. Their normally low capital business models and a reticence to expose themselves to unions have contained expansion into this permanent change to housing supply.
  • Developers and builders of multi-unit residential developments more than four storeys in height have mostly come from the non-traditional residential construction market. These general contractors bring with them construction practices and procurement models that make it hard to compete with the traditional residential or volume housing market retail prices.
  • Non-traditional residential builders are the main employers of unionised workforces, which essentially dominate the over-four-storey construction market in Australia. The bottom end retail prices of multi-unit residential in this space starts at approximately $6,000 per square metre.
  • Larger developers who dominate public policy advocacy and media are not competitive in the smaller-scale multi-unit market. They generally operate in the eight-storey-plus market with many developments shooting past 20 and 30 storeys. The typical retail cost of this product starts at $12,000 per square metre and is rapidly finding its way to $15,000 and $20,000 per square metre.  Some recent sales of off the plan residential have exceeded these prices.
  • Australian housing has become more affluent over the last 20 years. Houses have become bigger, with the average exceeding 200 square metres, while their inclusions became more sophisticated. Recent trends see both housing and land size shrinking in response to the realities of household income and new land supply utilization. Depending on household composition, new dwellings are meeting mainstream household requirements at well under 150 square metres.
  • Dwelling size in the multi-unit market can be as small as 45 square metres, but most new two bedroom stock is in the 80 to 100 square metre range. At $10,000 per square metre and above, the maths are pretty simple. The result is that, when combined with finance and owner outgoings, this stock is beyond the capacity of typical Australian households. It’s the investor and overseas hotspot.
  • The surge in new high rise multi-unit residential development in Australia’s capital cities (where off-the-plan prices exceed $12,000 per square metre) are now being taken up by a small but relatively wealthy down-sizing baby boomer cohort who have enjoyed the negative gearing and capital gains tax advantages over the last 20 years, but increasingly by those on very high incomes who are able to leverage investments into this asset class or overseas buyers.
  • These buyers set the market momentum for prices across the board, but there are signs that upon completion the value of new stock in the higher end multi-residential market is falling by nine to 20 per cent from the paid retail price as increasing stock and vacancy rates drive lower rents and as a result ramp up the negative gearing subsidy to wealthy investors.
  • As a result, these properties will become less liquid in the event that the top end of the market comes off the boil. It’s possible – as has been the case in the past – that the biggest hit to residential prices will be in the higher priced new stock. Purchasers of this stock, however, are or should be more sophisticated than ordinary home buyers just trying to achieve housing certainty within their own means. Hopefully they have an eye on their Loan Value Ratios.
  • One developer was recently reported as having claimed that the current retail price surge of multi-unit residential was here to stay and that baby boomer parents should be leveraging their own homes to help their kids into housing. It seemed like a self-serving, self-interested perspective that is very detached from the economic realities of most retiring or unemployed households. Hopefully Kelly O’Dwyer’s Review gave this little consideration.
multi-res

The first time in Australia’s history where multi-residential development exceeds stand-alone homes

With all that said, what may be a better approach to designing more helpful housing levers which can both sustain the current housing supply momentum and put some downward pressure on the price setting pace of the high end, high density multi-unit housing sector?

Why not return to the originating principles of what negative gearing and other similarly minded housing concessions were intended to deliver? Why not put a cap on the value of property prices that can qualify for negative gearing at $10,000 per square metre in major cities and $8,000 per square metre in regional centres?

This makes good sense on a wide range of fronts. It would:

  • Direct more effort to ways of delivering more affordable mainstream housing;
  • Shield future commonwealth budgets from the impact of badly performing residential investment (negative gearing) and capital loss;
  • Refocus state government agencies currently using inflated property values to drive unrealistic and often over scaled residential developments to sell the crown silver;
  • Challenge the traditional residential housing market to come up with a modern version of their build to order housing supply model for the smaller scaled multi-unit residential sector;
  • Create a new multi-housing affordability index for purchase and rental. This should incorporate the cost of repayments, strata out-goings and insurance for high LVR mortgages;
  • Challenge the construction industry to address its out of control costs which are currently shielded by taxation subsidised residential investment and record low interest rates;
  • Reposition the residential investment asset class to sit more prudently in the mix of other investment choices. In doing so, it would make the dealings of investment advisors more transparent and accountable than they are in the current market where unscrupulous property investment packaging will again destroy the hard won savings of many;
  • Create a clearly visible overseas residential asset class which recognises the sovereign benefits of Australian property ownership and make sure owners of this property make a fair economic contribution accordingly, just as they do elsewhere; and
  • Acknowledge that the current heat in the market created by overseas investors’ marches to a different beat to that of the domestic economy. The period that record high prices continue to be created for development consented high-rise multi-unit sites is unknown, but an early indicator may be that these projects no longer stack up for local developers.

These considerations may assist to help moderate the debate and choices facing the O’Dwyer Review, FIRB, the RBA and the Treasurer in electing which levers to pull to introduce at least a moderately soft landing for new investment in residential property. Critically, the current momentum in Australia’s mainstream residential market must not be disrupted by applying out of date interventions that could harm the economy and stop new residential investment in its traces.

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