Leading members of academia and industry believe the government's focus on supply expansions as the primary means of improving home affordability is misplaced due to the distinctive economic behaviour of housing markets.

According to conventional economic wisdom, increasing the supply of a given good or commodity should serve as a surefire means of bring down prices and shoring up affordability.

This mode of thinking has guided much policy formation directed at raising the affordability of housing in Australia, where sustained price gains in our leading cities have put a standard home beyond the reach of even middle-income families.

Many experts contend, however, that relying primarily on supply increases as a panacea for housing affordability is a fundamentally flawed approach. Their argument is that real estate is fundamentally different from other goods and services produced by the economy, which causes markets for homes to behave very differently from those for commodities.

Leading members of Australian academia and industry recently issued an open letter to the NSW Government, urging it to alter its housing affordability policies and expand its strategy to focus on more than just supply-related measures.

The letter said that while the government has successfully facilitated increases to housing supply in NSW, the strategy is “clearly not working,” with prices still rising in tandem with supply.

The authors of the letter include Wendy Hayhurst, chief executive of the NSW Federation of Housing Associations; Katherine McKernan, chief executive of Homelessness NSW; professor Peter Phibbs, chairman of urban and regional planning and policy at the University of Sydney; Professor Bill Randolph, City Futures director at UNSW, and Dr. Tim Williams, chief executive of the Committee for Sydney.

Phibbs explained the three main reasons why increases to supply are not a panacea for the dilemma of poor home affordability in Australia’s urban centres.

The first reason lies in the fact that houses aren’t just standard goods or commodities – they’re also assets that serve as durable investments for purchasers. This means the relationship between prices and demand differs completely from that which governs other goods and services, and can lead to market behaviour which appears at first blush counter-intuitive.

“If the prices of other commodities goes up, you tend to consume less of them,” said Phibbs. “If the price of bananas goes up, people switch to other goods.

“The key difference with the housing is that it’s an asset market, so when prices go up, particularly in the investor segment, people become more attracted to the product. You don’t see the same change in demand as a result of price changes – you in fact get the opposite effect because it’s a durable investment good.

“People aren’t as interested in buying when the prices are flat or going down – it’s when prices go up that people want to get into the market.”

This means increases to housing supply can have only a limited impact, because the expanded stock simply draws more demand from investors eager to capitalise upon buoyant market conditions.

Another key difference between housing and other economic goods and services lies in the fact that only a very small percentage of total supply is produced in a given year, with the vast majority consisting of established stock.

While in other commodities markets almost 100 per cent of supply is produced each year, in the housing market this figure is only one or two per cent.

Prices, however, are driven by the aggregate market in total – there are no separate markets for new and established housing.

“If we could produce enough houses it obviously would have a significant impact on price, but if the best we can do is one or two per cent, it’s hard to drive down the market,” said Phibbs.

While the first two reasons are standard characteristics of housing economies in any jurisdiction, a third reason outlined by Phibbs makes the Australian market distinct from other countries such as the US.

This is Australia’s procurement model on housing, which focuses more on pre-selling as opposed to the development of spec housing that is built before buyers are found.

“In other countries, and  particularly in the US, supply does have a sharper impact on prices, because the procurement model is based more on speculation,” said Phibbs. “A large American construction or development company will build quite sizeable amounts of stock basically on spec, and then see if they can sell it.

“If the market goes south and you’ve got 600 unsold houses sitting there in a large subdivision, you’re under a fair amount of pressure to reduce the price to get your revenue in.”

The banking situation in Australia is far less accommodating of on spec development, however, and makes far more stringent demands of  local developers.

“In Australia, with our banking system in particular, you’ve got to pre-sell a lot of the stock before you get finance,” said Phibbs. “For this reason you don’t get the supply overhang that occurs in other markets, and if you’ve pre sold the stock the only time it can really go belly up is if people bail out on their contracts.”