In classic economics, prices are determined by supply and demand.
To make anything more affordable, you cool demand and/or boost supply.
In housing, the supply side of this argument is often pushed by property industry lobby groups, who talk about planning reform and other measures as a ‘supply-side response’ to Australia’s crisis in affordable housing.
Others are joining in. In its Housing Affordability: Re-imagining the Australian Dream report, the Grattan Institute says lifting annual housing completions by 50,000 would deliver house prices which were between five and 20 per cent lower compared with prices if new home production were to remain at current levels.
As well as several measures to curb demand, Grattan wants supply-side measures such as encouragement of greater density in inner and middle-ring suburbs, housing targets for local councils, greenfield land releases, value capture mechanisms, property tax reform, improved tenancy laws and better transport connections.
Grattan are not alone. Early in March, the Reserve Bank of Australia estimated that zoning regulations were adding 73, 69, 54 and 42 per cent to prices of detached houses in Sydney, Melbourne, Perth and Brisbane respectively.
That has drawn a response from academics. In a joint article published on The Conversation, five leading academics declared that Australia’s failure to deliver an effective policy for affordable housing is being fuelled by ‘flawed analysis.’ Those who blame the lack of affordability on zoning have produced little hard evidence to show that this is a systematic regulatory constraint, they said.
The current run-up in dwelling values had occurred despite record levels of supply resulting from a sustained upturn in new dwelling construction from 2012 onward. Planning reform – whilst worthy – is not in and of itself an affordable housing strategy.
The researchers include University of Sydney social economist and urban planner Professor Peter Phibbs, University of Sydney Professor of Urban and Regional Planning Nicole Gurran, University of NSW director, City Futures Research Centre Bill Randolph; Curtain University Professor of Economics Rachel Ong and Australian Housing and Urban Research Institute (AHURI) director Dr Stephen Rowley.
Part of the problem, they argue, is that new supply is typically directed toward the middle and upper end of the market. Indeed, a study which Ong co-authored for AHURI last year found that less than six per cent of all new houses approved for construction were aimed within the bottom four (out of 10) pricing deciles. More than three quarters (78.4 per cent) were aimed at the top four deciles.
As for arguments that new supply coming in at the middle and higher end of the market will have a ‘filter-down’ effect, the researchers point to historical American research conducted in 1960 which they say casts doubt on the degree of filtering in America. No evidence to suggest that new housing supply was filtering down in Australia exists, they say.
Moreover, they cite research performance by economist and Mosman Council Mayor Peter Abelson which suggests that a one per cent rise in the overall level of housing stock would cause prices to fall by only three per cent (current annual completions are about 1.1 per cent of the housing stock).
Rather than planning and supply-side measures, they suggest interventions to boost housing supply at the low-income end of the market. This includes through more affordable rental in the private market (through investment driven by large institutions), greater investment in community housing and the adoption of policies on inclusionary zoning.
So is the ‘supply-side’ argument a con?
According to Phibbs, more supply is always welcome, but its impact is often overestimated.
He says housing differs from other markets. In housing, much of the traded stock consists of established homes rather than new builds. Even in a good year where new home construction is strong, you add at most around two per cent to the overall housing stock. Whilst handy, this will not in and of itself have a large impact upon prices.
Moreover, whereas rising prices for most goods and services would see demand fall, Phibbs says this is not the case with housing as capital appreciation encourages demand from investors who fear missing out. Accordingly, whilst the market does respond to rising prices with more supply, this may not lead to any substantial correction in prices.
According to Phibbs, evidence of supply’s limited impact can be seen through recent years, where prices in places such as Sydney have skyrocketed despite record new supply hitting the market. Moreover, he points to aforementioned work of Addison as evidence of these limitations.
Rather than relying upon new supply, he says action is needed elsewhere. First, with much of the growth in housing values attributed to extremely low interest rates Australia, he said, could look at other ways of stabilising our economy besides maintaining interest rate settings at these levels. More could be done to increase supply at the lower end of the market, such as inclusionary zoning and more community housing investment.
He says many would-be first home buyers no longer believe the idea that new supply on its own will make housing more affordable.
“If I was a 25-year-old person, I would probably throw myself off a cliff,” he said. “People just say more supply and everyone’s been saying that. But they have been watching those two curves (supply and prices) go up next to each other and they are not believing it.
“It’s not that you wouldn’t do it, but if that’s your number one strategy and in a market in which house prices in Sydney go up 70 per cent (over five years), you end up with a five per cent reduction (lower end of Grattan estimates), it’s useful but it’s not fixing the problem.”
Grattan Institute director John Daley disagrees.
Whilst he acknowledges the price surge in Sydney despite large supply additions, he says this can be attributed to high migration levels which have driven demand. Without the growth in supply additions, the increases would have been even stronger.
Further he said, changes in the rate of new construction affect the flow of new housing supply rather than the stock of supply. Indeed, changing the flow at which new supply comes onto the market does not have a large immediate impact upon the overall stock of new housing available. Thus, price impacts from any alteration in the flow of new housing creation would only have a limited impact upon overall housing stock (and therefore, price) in any one given year.
At any rate, Daley says, evidence of a price impact is happening. In Brisbane, which saw a large stock increase over recent years, capital growth has slowed and rents are falling. In Sydney, house price growth has slowed following two years of high completion levels.
Daley also takes issue with claims about new supply being concentrated in higher segments of the market and an absence of a trickle down effect. On the first point, he says the methodology behind the AHURI report is flawed as report authors failed to weight local government areas according to the existing number of dwellings in each local government areas when working out the deciles for their study.
Applying the correct weightings and re-running the numbers for 2016/17 (the AHURI data study used data up to 2013/14 – the most recent available at the time), he says Grattan’s analysis showed that two-thirds of all new detached housing is constructed within the cheapest half of all suburbs – albeit with apartments being concentrated in higher priced segments.
As for the trickle-down effect, he says the reason there is no evidence in Australia is because we are not collecting the correct evidence. He is also critical of the academics’ reference to evidence as far back as 1960 in regard to the US. In its report, Grattan documents multiple sources of more recent evidence it says proves that filtering does in fact happen. In 2014, for instance, a Syracuse University urban economics professor found that US housing ‘filters’ by roughly 1.9 per cent in any given year. Thus by the time it is 50 years old, a home is typically occupied by households whose income is about 60 per cent lower compared with the home’s first occupant.
As for the academics’ focus on intervention to boost housing at the lower end of the market, Daley says governments nowadays do not have the resources to intervene on anything near the scale that the academics are talking about. Even during the 1960s and 1970s when governments were more heavily involved in public housing provision, he says much of this was commercially orientated. Nowadays, he says, there has been a realisation that housing by and large is more efficiently delivered through the private sector.
Renowned economist Saul Eslake offers a different perspective.
Starting from basic economic principles, Eslake says the deterioration in housing affordability over the past quarter-century is the result of the rate of growth in demand for housing (driven by population growth and the growing popularity of housing as an asset) exceeding that in new housing supply.
From there, he says that all else being equal (including holding the rate of demand growth steady) any increase in the rate of supply would result in a more modest rate of increase in dwelling price growth than would otherwise be the case. If the growth in supply was such that it outstripped demand growth, house prices could potentially contract.
In reality, however, he says the situation is more nuanced. To truly impact affordability, new housing needs to be in the right location and of the right type.
Traditionally, he said, much new housing has centred around urban fringes. As these move further away from major activity centres, they become less relevant those needing to live within reasonable access of employment opportunities.
On housing types, he says the high-rise apartments around which most of the construction boom has centred are irrelevant to those wishing to raise families in traditional detached dwellings.
Indeed, the rate of new construction of detached housing has barely shifted at all, he notes.
Finally, there is transport. On this score, Eslake says housing on urban fringes which might otherwise be irrelevant on account of their lack of accessibility to employment centres may become accessible and thus relevant where appropriate road and/or rail assets are put in place.
“To say that an increase in supply will improve housing affordability – once you get past that simplistic high-level framework, you need to qualify it by saying that the housing is in the right place, number two, that the housing is of the right type and number three, an important dimension of housing policy is transport policy,” Eslake says.
As to what should be done, Eslake says that whilst it is well and good to understand the reasons behind the deterioration in affordability (mainly cheap finance and population growth), solutions are not as simple as reversing these factors. Monetary policy settings, for example, do impact affordability but also have wider implications for the economy. So too do population and migration policies.
Rather, he would like to see an end to tax concessions as well as first-home-buyer incentive schemes. He would like greater measures to increase community housing provisions (he is a board member of the not-for-profit organisation Housing Choices Australia). This could be done especially through the transfer of title as well as management of government owned properties to community housing providers, who could subsequently use this title as security for loans to build more housing.
Housing Industry Association senior economist Shane Garrett says the importance of supply should not be underestimated. Whilst it was true that cities such as Sydney and Melbourne have seen a run up in prices which has coincided with record volumes of new supply, Garrett says the appreciation would have been more significant still were it not for the record supply additions. Furthermore, Garrett points out that in 2017, price growth in the rental market registered its weakest level on record since 1993 – a phenomenon he attributes largely to growth in rental market supply following several years of strong building activity.
“A lot of people who have seen what has happened in Sydney and Melbourne over the past five years will say ‘come on, you know – prices have gone up hugely (even at a time of large supply additions).’” Garrett said.
“The likelihood is that they would have gone up even more had it not been for all of the new apartments and homes built over recent years.”
As well as supply-side reforms, however, Garrett would also like to see a reduction in the taxation burden on new homes. In particular, he says stamp duty should be abolished or at least heavily curtailed.
Any moves to boost social and public housing for those on low incomes would also be welcome.
In traditional economics, boosting supply makes prices more affordable.
How much impact this has on housing is an interesting debate.