- The Federal government is expected to announce a broad housing package in its budget on 9 May.
- Record low interest rates mean that mortgage serviceability is still manageable. The more pressing issue is around housing affordability because of high starting point valuations for housing, record low wages growth and subdued inflation. The difficulty in getting initial access into the housing market has resulted in lower living standards for first home buyers and rise in inequality.
- First home buyer policies to assist funding a deposit are often dismissed for adding to demand and therefore putting more upward pressure on prices. However, amongst a raft of other measures (supply-side changes and taxation reform) which would put downward pressure on prices over the longer-term, policies to encourage first home buyers back into the market could work be helpful in assisting first home buyers.
The Australian housing story over the past three years has been characterised by phenomenal dwelling price growth), record housing debt and booming asset values. The significant build-up of housing debt has led to heightened concerns over the risks to financial stability (if there was some negative domestic or global trigger) which led to a further tightening of macro prudential policy towards investor lending and interest-only loans by the Australian Prudential Regulation Authority.
The focus on risk management around housing is critical, given the high position housing has in consumer balance sheets and the significance of Australian banks in the stock market, but a focus on affordability issues are also just as pressing.
Housing affordability can be difficult to measure, because there are numerous indicators that can be considered. For instance, the Australian house price to income ratio is at the high end of the OECD range which would indicate poor affordability. Consumer confidence around the housing outlook is also poor, with the consumer “time to buy a dwelling index” trending lower over the past two years (see chart below) which has actually been a good general guide to home price changes. But another measure of affordability - housing interest payments as a % of income (which have declined to around 7% - around ⅓ on 2008 highs) would indicate lower affordability pressures. But interest payments are purely a measure of serviceability and numbers look favourable now because interest rates are at a record low.
Source: CoreLogic, Melbourne Institute, AMP Capital
While debt serviceability looks manageable (at least for now while interest rates are low), the more pressing issue around affordability is around first home buyers gaining initial access into the market through a deposit. This is particularly critical given the very high starting point valuations for homes, record low wages growth and very low underlying inflation. First home buyers make up around 13% of new loans – a record low (although some argue that first home buyers are also being masked as investors). Some would also argue that affordability pressures are only present in Sydney and Melbourne, but these two capital cities account for 40% of Australia’s population (!).
Positive economic growth should normally lead to rising wealth across time and across generations. This is the concept of rising living standards. The Grattan Institute has tracked wealth across different age groups and has showed that over the 8 years to 2011/12, most households had an increase in their wealth, except for the 25-34 year old’s (generally the first home buyer group) who actually went backwards in wealth. This highlights a decline in living standards and a rise in inequality, despite an expansion in the economy. Unfortunately this issue has been missed in the public policy debate.
The Federal Budget & Housing Affordability
The Federal Government has indicated that one of its key focus points in its Federal Budget (released 9 May) will be on housing affordability, although some recent comments from the Government appear to be downplaying the potential scope of the housing package, which is disappointing.
The pre-Budget speculation has centred around introducing the potential policies:
- First home buyers: Allowing first home buyers to use their superannuation savings as a deposit, with households then matching the contributions as savings for superannuation. The economic community was quick to dismiss this policy option because it could potential be another driver of higher prices. But, the policy could be an appropriate solution to the deposit gap, if matched by other long-term solutions to address supply issues. And, the evidence around first home buyer policies driving prices higher is not conclusive. In the chart below we highlight the times when the Federal Government introduced a national First Home Owners Grant. The uplift in dwelling prices after the grants were introduced also coincided with a series of interest rate cuts from the Reserve Bank, so first-home buyer grants weren’t the only factor adding to higher demand. Changes in interest rates still tend to be the major driver of housing cycles.
Source: CoreLogic, RBA, AMP Capital
The most recent comments from the Government seem to indicate that this policy around using superannuation savings for a deposit will not proceed. Another potential policy that has been floated recently is around first home buyers using pre-tax income to save for a deposit, a measure similar to salary sacrificing
The problem is that measures to assist the deposit gap that first home buyers face could add further fuel to dwelling prices through increasing prices. But, if they are introduced amongst a raft of other supply-orientated policies, then they could be effective in assisting the affordability problem. Currently, first home buyers appear to be gaining a deposit from loans from family/friends. This is not a sustainable long-term trend given the inequality issues it creates.
- Retirees: Allow retirees to be exempt from some superannuation rules/limits the Federal government has recently implemented if they downsize their home, encouraging a lift in supply. Other ways to encourage downsizing could be stamp duty exemptions for retirees if purchase of smaller home or tax breaks on the profit sale of an existing home.
- Land: Releasing some Commonwealth land (e.g. defence land). This is mainly a state issue though.
- Overseas buyers: More stringent measures on overseas buyers (e.g. imposing stamp duty on foreign buyers) with current indicators showing that foreign buyers make up around 10-15% of demand, but it is concentrated in some areas.
- Social housing: Increase building of social housing, potentially introducing a bond aggregator – which sources large amounts of capital from the bond market and then uses this money to provide low interest and long-term loans.
- Other: Greater incentives for settling in regional areas (this looks to be focussed towards migrants) and issues to address homelessness (e.g. introducing new targets).
Other schemes and measures the government could consider include:
- Other first home buyer schemes: A rent-to-buy scheme like in the UK where the new housing stock is leased below the market rate and renters can use the savings to buy a property or where there is shared ownership in a home. Another solution could be gaining access to mortgage providers that specialise in giving access to low deposit loans.
- Tax changes: Reforming negative gearing, perhaps through putting a cap on benefits that can be claimed or limiting negative gearing concessions to new housing (which wouldn’t’ cause huge disruptions to the renal market). Lowering the capital gains tax discount (currently at 50%) is also an option. The government has pretty much ruled out making changes to taxation around housing in this budget.
- Superannuation: A ban on direct borrowing of housing by small managed superannuation funds – a policy currently being suggested by Labor.
- Supply side changes: Increase the supply of standalone houses which have lagged this construction cycle, cutting land use restrictions, release land faster, cutting red-tape by speeding up the approval processes and encouraging greater decentralisation (this may be seen to be a state issue).
The outlook for housing and affordability
The government’s focus on affordability is a step in the right direction, but we worry the policies may be too soft on addressing long-term housing affordability issues because they tighten measures at the margin but the actual impact would probably be quite long-term. Proposals to reform negative gearing and capital gains tax would have a much faster impact (though not without its own risks!). Nevertheless, the broad set of issues facing the housing market (tightening of macro prudential policy lifting interest rates, a surge in new supply, particularly for apartments, and the pending housing package) should work to put downward pressure on dwelling price growth and after many years of very strong price gains we expect to see some moderation in prices. Once the Reserve Bank of Australia starts to hike rates (probably not until later in 2018), we expect a 5-10% pullback in property prices. But there will be wide variations across the states, with apartments in Sydney, Melbourne and Brisbane at greater risk given very high levels of construction.
Implications for investors
There is an important long-term role for residential property in investor’s portfolios, but the current state of play in the market would warrant some caution. Residential property remains expensive on the metrics and rental yields are low (at 2% or less). So investors are very dependent on capital growth.
But, there are variations across the states. Sydney and Melbourne are looking very overvalued but the other capital cities have not had such a large run-up in prices, with prices even declining in some states (e.g. Perth). It is best for investors to focus on areas that have lagged the housing price boom. Investors also need to allow for the fact that they already likely have a high exposure to Australian housing – as a share of household wealth it’s around 60%.
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