Continuing on from Part 1 where we had a quick look at the nature of the data, we’ll head into a potential policy solution for increasing affordability, but certainly by no means the only one. This is a rather long article (5000 odd words) that might not be everyone’s cup of tea, but if we’re going to do this type of thing, we may as well do it properly.
George Megalogenis hit the nail on the head in his article about housing affordability when he said:
“If the Labor Government is serious about getting more people into the property market, while also making those with existing mortgages feel less stressed, it has to find a way to get wages rising faster than house prices over the next few years.”
I’d add that it’s real wages that have to rise faster than real house prices for any increase in affordability to occur – you can see that easily by looking at the graphs from Part 1.
But from a policy perspective this is more problematic. The only real impact that the government can have on real wage growth is through enhancing productivity growth via broader economic reform – and while there is always scope for that, it’s generally a slow hard grind that takes years to deliver. A decade of reform starting in the 80′s took until the early to mid 90′s for the benefits to really show up in the metrics. While the economy today is much more reactive and adaptive to changes than it was 25 years ago, meaning that a new round of reform would probably start delivering observable benefits much earlier – it’s still a relatively laggy process.
Yet it’s the other side of the equation, the “real” house price side of the coin where the political problem becomes front and centre. Any policy that deliberately sets out to reduce nominal house prices would be political poison and realistically would not be countenanced by any government. Political parties are many things, but deliberately suicidal is rarely one of them.
This gets us onto something that really needs to be kept in mind here. When it comes to debating policy change, not enough attention gets paid by independent policy pundits (professional and amateur alike) to the political realities that surround any change in policy. It’s all good and well spruiking some grand policy proposal that could well be economic perfection on a stick over the longer term if, over the shorter term, it would kill the government that implemented it. Even the Hawke government, the most reformist of governments, didn’t introduce many policy programs that were pushed onto its radar (like indirect taxation reform – a GST) because it would have been a political step too far. That’s not to say that purity doesn’t have its place – it most certainly does, but realistically we all need to be mindful of the clichés of politics being the art of the politically doable.
Nowhere is this more acute than when dealing with the largest asset class in the country that forms the backbone of around 60% of the population’s net worth over their lifetime. Deflating housing values for some notion of the greater economic and social good is one thing, but widespread negative equity would be a dead chook hanging around the neck of any government majority.
However, house prices can be reduced in real terms while avoiding the electoral retribution of obvious negative equity and falling house price values if the NOMINAL price of housing is kept flat to small growth and inflation is allowed to erode its real value over time.
“The value of my house hasn’t changed for years” incites much less public indigestion than “OMFG! The value of my house is dropping!” – especially when the understanding of “value” that most people hold is one based on ‘nominal’ value (the cost of a house in simple dollar terms when it was purchased compared to its simple dollar value today), rather than real, inflation adjusted value. In many respects, the combination of inflation and time is (and certainly has been in the past on many occasions) a powerful and handy policy tool, even at relatively low levels of 2 and 3%.
The quantitative difference between the publics focus on nominal value and any policy goal’s focus on real value, provides a window for politically sustainable policy activity to deliver between 1 and 3% deflation in the housing market every year (assuming nominal growth in the median house price of between 0 to 1%). It might not sound a great deal, but throw in 10 years worth of time and the compounding effect of inflation slowly eroding the real value of the housing market would deliver a 20-40% reduction in the real value of housing from inflation alone.
Add in real wages growth of 1 to 1.5% per year and we’re talking about a reduction in real house prices in proportion to real wages getting close to halved over that decade period, while avoiding the electoral hysterics associated with falling nominal values of the housing stock.
Once you break it down this way – the problem looks far less insurmountable, and also suggests that drastic action isn’t required, but that slow, thoughtful policy responses can deliver the goods without pissing too many people off or creating any great deal of economic and political dislocation.
But the real beauty here is that it allows for public policy programs to deliver outcomes in the way that public policy works best – incremental behavioural change. Policy is like a good Irish stew; the slower it’s cooked, the better it delivers. A couple of percent change here, a couple of percent change there – add ten years to the mix and we’re quickly talking about serious adjustment.
So if we keep in our thought orbit the idea of maintaining the nominal value of the median house price somewhere around flat to small growth as an overarching policy target for the house price side of the equation, it gives us a foundation to work off in terms of the magnitude of behavioural change that needs to be delivered to ultimately achieve the objective of increasing housing affordability.
In the supply/demand nexus that justifiably dominates any discussion on housing affordability (and a great many other things like, say, taxation generally), the debate always seems to become demand centric. Arguments like “Policy X increased the demand for housing” , or “We need to implement Policy Y to reduce demand” seem to take up the bulk of brainspace in these debates – but it’s supply that needs to be focused upon here, and more particularly the how demand affects supply and the spatial distribution of supply. If we want to increase housing affordability, we simply need to increase the number of houses, but ideally we also want large parts of that increase to be, if not geographically where people wish to live, at least in large part where they would be reasonably willing to live. Yet as I argued in Part 1, the starting position for the Australian housing market is one where the supply of reasonably desirable land surrounding large metropolitan centres is simply swamped by demand because we have too few cities. Because each city has a small fixed amount of desirable residential geography – the fewer the number of cities we have, the smaller is the total amount of desirable residential land.
While we can’t just go out and build new cities (as exciting as it may sound for those with a capital works fetish – littering the national landscape with huge white elephants is probably a tad unnecessary), we do have plenty of scope to enhance the growth of larger regional centres organically, by both changing the destination of demand and more importantly the destination of supply, not only through tax and regulatory treatment of housing itself and its consequent price signals, but by assisting regional centres to emulate those economic qualities, but more importantly the origins of those qualities, that drive people to live in metropolitan areas to begin with.
But first up, how do we change the tax treatment of housing to better increase supply?
The current negative gearing regime that has run in conjunction with the two Capital Gains Tax regimes over the last 20 odd years has failed to increase the supply of the housing stock to match the increase in demand. But what is important to acknowledge here are the differing types of demand involved. We’ve had organic demand increasing simply as a function of not only population growth, but also the trend towards smaller household size – that sort of demand is simply a function of life.
But we’ve also had the situation whereby the tax structure applied to housing, in conjunction with the cheap capital costs associated with lowish interest rates in recent years, has increase the investor demand for mostly established housing. The increased competition in the housing market between the organic demand and the investor demand stimulated by tax treatment, has bid up prices across the board. But what it hasn’t done is spurred an increase in supply to match this demand. In a very real sense, we have half of our market not working effectively – and it’s not hard to see why. Investors chasing capital gains growth would maximise that growth by purchasing established housing stock closer to desirable locations (where capital gains are historically greater) rather than invest in new stock which, with our limited number of cities, is now mostly confined to areas far away from those desirable locations (where capital gains are historically much lower). The new supply of housing is essentially doing little more than meeting organic demand that has been pushed out of the established house market by the influx of policy stimulated investor demand.
So why don’t we utilise the tax treatment of housing to directly stimulate new housing rather than established housing?
This can be done without creating a great deal of grief or economic dislocation (i.e. making voters think they’re worse off) – and due to the time it takes to bring new housing stock to the market, we can slowly increase supply to be consistent with the overall objective of maintaining current nominal house price values.
Firstly, keep the CGT regime as it currently exists and grandfather out the existing negative gearing regime to current investors for their currently held properties. This way a government would minimise any backlash from existing investors by avoiding any change to the long term financial plans of existing investors. Those who already have it, keep it until they dispose of the property.
Secondly, keep the current regime for negative gearing whereby losses can be offset against all income sources, but only for properties where the investor is the original purchaser. This isolates loss offsetting against total income to new housing stock only.
Thirdly, for the established housing market, quarantine negative gearing losses to income derived from rent.
This way, the complexities of dramatically changing the CGT regime where someone always ends up worse off is avoided, current policy remains for existing investors until they dispose of currently held properties meaning political grief from that mob is mostly avoided, investment in established housing is still a reasonably viable option for those that are really keen, and negative gearing would finally be structured to actually increase supply by the tax system providing the greatest incentives for investment in new housing stock.
So saying, there will always be those on the fringe that will organise and reorganise their affairs in complex ways to cash in on such targeted incentives when they ordinarily wouldn’t qualify for them – that’s to be expected. But what’s more important is the way incentives change the behaviour of the bulk of the targeted group.
So how would this play out over time in terms of effects?
Increased demand for new housing should spur supply of new housing -but because it quarantines existing investors out of the new regime, there would be no mad rush to adapt (which is important), instead one would expect there to be just a slow, gradual increase in the demand for new housing stock at rates above organic demand levels, providing plenty of forewarning and opportunity for developers to bring new housing stock to the market.
Another consequence would be to reduce demand for established houses, easing pressure on any price growth in the second hand housing market. Even though there would be additional demand for new housing, possibly even to a level where it may start to slightly push up the price of new housing over the very short term, any price rises that occur from this increase in demand would have an effective price ceiling placed on it by the larger established housing market which would now be experiencing softer prices levels because of the way demand has shifted away from established housing into new housing.
A further interesting consequence would be budget savings. Since negative gearing losses claimed by investors would, over time, move from older established housing to brand new housing, there would be far less opportunities available for investors to claim losses via capital expenses and maintenance because the house in question is brand new. One of the biggest rorts of negative gearing are the things that can be claimed as expenses – which in reality are little more than loopholes for subsidising renovations for many. With new houses, gone (over the short to medium term at least) is the capability to redo the kitchen or the bathroom because they are falling apart, or renovate the aesthetics of the outside of the house under the guise of failing guttering and water damaged eaves.
New is new – meaning less scope to claim expenses, meaning less revenue forgone by the tax department (currently it’s about $2 billion a year on negative gearing).
Hopefully it would kill dead the growth in lost treasury revenue that negative gearing has delivered over the last few years. As the proportion of negatively geared new properties grows at the expense of negatively geared established properties, so too would the revenue savings be expected to grow.
One juicy potential of this budget saving is for it to be used to compensate State governments in return for reductions in their fees and charges applied to new land and housing developments.
If the costs of new housing could fall slightly by reducing government fees and charges, that would certainly assist the target of zero to small growth in the nominal value of the median house price – if it could be done in a way that is essentially budget neutral – well that’s the political cherry on top.
The other benefit from using the tax treatment of investor demand to slowly deflate housing prices by simultaneously reducing demand for established homes on the one hand while stimulating the supply of new housing on the other, is that it leaves open the opportunity to change the CGT regime in the future if, after a couple of years, it’s shown that nominal prices are falling or alternatively, rising too fast – giving the government a bit of fine tuning capability to manage the zero to small nominal house price growth target if needed in the future.
Finally, it’s probably worth mentioning the important role that expectations seem to play in the housing investment market. While discussion on the profit expectations of small property investors tends to be dominated by perceptions of capital gains growth (many people expect property will nearly always rise in price despite any empirical evidence to the contrary – you know the type: “You can’t lose with housing, mate”), there’s certainly more complicated dynamics at play. In terms of the risk assessment between property and other investment alternatives that small time property investors make, it’s not only the potential of the growth upside that plays out in the decisions on whether to invest in housing, but equally important are the perceptions of the possible downside of house price falls.
I had a squiz around the place for recent research on estimates of the absolute risk aversion coefficients of small time housing investors in Australia, but unfortunately came up with virtually nothing (if anyone knows of any research in this regard – please let me know!). But anecdotally the downside component of risk aversion for small time property investors seems to be a belief that any house price losses would be relatively small in proportion to the total value of the investment, and would recover over a relatively short time frame. This seems to be verified, anecdotally at least, by a relatively large number of otherwise conservative investors that go into property – including people that believe the share market is too risky a destination for their direct investment (where the downside risks are considered greater than that of property).
So while a policy target of flat to slow growth in the nominal median house price would expect to have consequences of reducing total investor demand as the realisation of small capital gains growth flows through the system, because of the nature of the risk aversion that drives at least some part of the housing investment market, the size of any reduction in total small time property investment one would ordinarily expect to occur through a decade of flattish nominal prices would seem to have a fair chance of being ameliorated to some extent by investors with conservative risk aversion coefficients that aren’t in property only for the capital gains upside, but also because of the minimal risk downside compared to alternative investments.
Add to this that property investment isn’t always singularly about capital gains, but also includes the future capability (after the asset is fully purchased) to provide an income stream in retirement, is perceived as a “safe” asset class that’s relatively liquid and also provides future leverage capabilities – I don’t think the housing investment volumes from small time property investors would necessarily shrink as much as we would ordinarily expect them too in an environment of flat to small nominal median house price growth. I’d be particularly interested in your thoughts on this?
Another thing I’d be really interested to hear your thoughts on regarding the change of housing market expectations is whether it would be likely to have an effect on the overall size of owner/occupier mortgages?
If the reality of flat to small house price growth starts to become institutionalised into the markets expectations, or at least into the market for mortgage owners – would that expectation of small to zero price growth reduce the incentives for borrowers to take out loans larger than they ordinarily would, simply to buy more expensive homes which could then be turned into larger capital gains upon later sale? If perceptions of the capital gains benefit involved with having larger owner/occupied mortgage debt started to erode, what sized impact would that have on the established housing market in terms of reducing the capital gains driven, debt funded price bidding war for established housing stock?
While changes to the negative gearing regime alone would be expected to increase housing affordability over time, it’s really tinkering around the edges because it doesn’t address the biggest underlying problem that the country experiences – too few cities providing too small an amount of desirable land, leading to a large supply constraint on desirable urban geography as the starting point for the national housing market.
To maintain longer term housing affordability, this really needs to be addressed otherwise we’ll start running into other problems like our capital cities becoming vast urban basins with enormous redevelopment costs; meaning bloated infrastructure budgets needed just to run large transport networks through existing developments simply to allow the cities to continue growing beyond their current fringes while, still, at least pretending to function adequately.
The big question here becomes one of “If we can’t build new cities, can we do anything that can attempt to emulate in regional centres those qualities that drive people to want to live in our capital cities in the first place?“
The most important quality here, and one which has an extraordinary bearing on many of the other qualities that drive people to live in our capital cities, qualities like the provision of services and economic opportunities, is simply the income ceiling of regional centres.
People, particularly young talented people that grew up outside of the capital cities gravitate towards the big metro centres because they can earn more money and have better career prospects.
High income households have enormous consequences on the economic geography surrounding where they live. High income households not only spend more, increasing localised demand and increasing employment to service that demand as a result, but they also purchase goods, but more particularly services that are themselves provided by other higher income earners, which in turn increases the volume of opportunities for localised high paying jobs, or at the very least increases local career paths towards those types of jobs.
Essentially it’s a twist on the old upstairs/downstairs economy playing out, with high income earners (the upstairs economy) not only increasing the demand for goods and services provided by lower income earners (the downstairs economy), but also providing demand for more sophisticated goods and services from the upstairs economy itself. It’s a perfect example of the cliché of “the ladder of opportunity” playing out in the real world.
If you want examples of this, you only have to go to areas at the centre of the resources boom in North Qld to see it happening, where the increase in high income earners has boosted the demand for more sophisticated local services from top quality accountants, lawyers, health professionals and financial advisers, through to more sophisticated and expensive recreation, through to the retail provision of more expensive goods like cars, boats and home entertainment products, which has, in turn, provided a larger number of better paying jobs for the entire local economy.
When I looked at the data for income ceilings and collated it up, I was actually a little surprised by the enormity of the income ceiling that exists outside of our metropolitan areas. To show its full graphic horror – if we accept as our baseline households earning $1999 per week as our income ceiling, we can then use the 2006 census data to show the proportion of families in each of the 150 electorates across the country that earn $2000 per week or more. That proportion of each electorate can be read from the left and right hand sides of the graph, each individual bar is an electorate, and the electorates themselves have been separated into three categories; all metropolitan electorates (the electorates classified by the Australian Electoral Commission as either inner or outer metro), provincial (an AEC classification for electorates surrounding large non-capital city centres that include places like the Gold Coast, Newcastle, Ballarat, Bendigo etc) and rural electorates.
The electorates have also been sorted within their geographic classification from highest to lowest on the proportion of families earning $2000 or more per week.
There are two big results here. Firstly, 57 out of the top 60 electorates in terms of the proportion of families earning $2000 or more per week are metropolitan electorates. Secondly, the median proportion for all metro electorates is higher than all but 3 non-metro electorates. Three!… and they are mining boom electorates.
So if we want to solve the great underlying supply problem Australia has, we need to figure out some way of increasing the income ceiling in areas outside of the capital cities, which essentially means eventually delivering an increase of around 50% in the proportion of families living outside of capital cities that earn $2000 or more per week – just in order to get people to perceive that the regional economy in question has an income ceiling high enough to make it a viable alternative to capital city living.
No small ask!
One of the possibilities here is to target high income earners in specific sectors to start the ball rolling – and it’s something that folds into the governments push for a high speed national broadband network (in whatever form that eventually takes).
Are their incentives that could be offered to firms to both encourage telecommuting from their employees that wished to live in regional centres but where their employer was based in a capital city, as well as any possible incentives that could encourage the relocation of some types of high paying firms, or at least units of those high paying firms to regional centres?
That would probably require the new broadband network to have some serious grunt, maybe not quite Fibre-To-The-Home, but certainly, at the very least, the top end of the ADSL+2 spectrum.
Once a decent sized cluster of high income earners develop in a given non-capital city location, the economics starts to become self-perpetuating and the income ceiling starts getting pushed higher as a result as the demand profile of those high income earners starts to affect the broader economy of the area.
I’d also be interested in hearing your thoughts on what you think the other qualities are that drive people to want to live in capital cities, and if there are any policy options available that could be used to emulate those qualities in non-capital city areas? Particularly in terms of incentive based policy options.
I thought I better add this since I didnt quite explain myself very well here. The usual types of regional development policies associated with decentralisation programs of the past didn’t work particularly well, and probably wouldn’t in the future. The problem when governments come in and start demanding people to do things usually backfires, and the “build it and they will come” school of regional development just seems to create white elephants everywhere. But are their more out of the box type incentives that could be used, not to copy the qualities that drive people to live in capital cities, but to emulate those qualities?
There’s also the big issue of health and education, where families with kids are unlikely to move to regional centres if they think that the quality of their healthcare and the quality of their kids education will decline -considering the state of the health system in most capital cities that might not be too difficult a proposition, but school quality may be.
Yet, unless we can find ways of making more of the population want to live in the regions, we’ll continue to face the problem of the supply of desirable urban geography being limited by having so few capital cities.
On something partially related:
Quite frankly I’m fed up to the back teeth with the vacuous fucktardery over Teh Culture Wars which was rammed down everyone’s throats during the Howard years in some kind of grand exercise of diversional therapy. That includes the idiots that participated in the great pollution of the national agenda on the media’s Op-Ed pages over the last decade, and the editors that thought it was a really shit hot idea to waste everyone’s time by pushing it.
I don’t know about everyone else, but I couldn’t give a rats arse about Teh Evil of Teh Left or Right or whoever it was this week that was going to destroy the fabric of civilisation with their nefarious memes, and I don’t actually know many people that do or ever really did give much of a tinkers cuss – which is funny, because I’d like to think that my circle of acquaintances isn’t exactly a peanut gallery…… but maybe that’s the point.
Every time (which was approximately every day) these irrelevant, self declared and self-absorbed insiders shouted at each other through the megaphone of the national press about, at best essentially nothing, at worst little more than figments of their own political paranoia – I found myself just scratching my arse wondering if this incessant downpour of drivel would ever end.
So it’s really nice to see more serious opinion and analysis pieces about real issues that actually affect national living standards turning up far more regularly of late, like the articles Megalogenis has been writing at The Oz (although he’s been doing that for a quite substantial period of time), a few that have been turning up in the Fairfax broadsheets lately, as well as what seems to be a substantial increase in the quality of the blogosphere over the last few months. – and it’s sure as hell more interesting, important and constructive than the horseshit that gets peddled by the likes of Planet Janet and the menagerie of mental malignancy that have been corralled down at Culture Warrior corner for the last decade wasting everybody’s fucking time…. pardon the French.
It’s a relief to see that zoo finally being emancipated from the public’s attention, assuming that it ever had the public’s attention in the first place, rather than just a disproportional hold over the media real estate.
And not a damn moment too soon can I add.
So keeping with the hope of a re-dawning of rational debate in this country that might even be worth listening to, for any bloggers reading that might like to yak about their own suggestions for housing affordability on their own sites, (or for any aspiring bloggers that have always wanted to, but never had a reason to start up a free wordpress or blogger site of their own until now) tell me via the comments, hit me with a pingback or drop me a mail and I’ll stick a link in to your housing affordability spiel right here. We’ll generate some traffic, we’ll generate some exposure to new ideas and we’ll do our bit to help move the national debate beyond the vapid twaddle that’s infected the recent past. After all, you’d be surprised at who is actually reading.
Also worth having a squiz at are the following pieces and suggestions on improving housing affordability:
Gary Sauer-Thompson has an interesting discussion on the changing nature of demand for different urban housing types. Worth reading on this was a piece the Fin Review ran over Easter in their Review section by Christopher Leinberger, which can be seen over at The Atlantic. Demand in the US for legoland developments is in decline with a projected surplus of 22 million large-lot homes by 2025, while higher density mixed-use urban developments are booming. Australia has only partially followed the US history of residential living trends – but that article certainly provided some data worth chewing over.
Christopher Joye and Joshua Gans with a timely proposal for an AussieMac , a means to maintain competition (i.e. keep mortgage rates down organically) in the domestic mortgage market during periods of international volatility in credit markets that have little to do with the overall integrity of the Australian mortgage market. Also over at Larvatus Prodeo where Joshua Gans says in comments, ” I keep asking the question “why not?” and have not heard an acceptable answer” – which is a pretty good way to put it.
From Sean of http://www.housingaffordability.blogspot.com fame comes an ominously titled forum called: http://forum.globalhousepricecrash.com/index.php?showforum=9.