More supply does not immediately equate to lower prices
Australia Day traditionally flags the end of the real estate ‘vacation’ period, with the long weekend being the last chance most agents have to take a breather before the auctions begin and weekly clearance rates once again come under intense scrutiny.
Most predictions for 2015 conclude that the recent upward trajectory will continue – with particular focus on some of our largest capital cities: Sydney, Melbourne and Perth (with Sydney and Perth already past their previous peaks in non-inflationary terms).
The pace of growth will differ for each capital with a correction expected in 2015 – despite the talk of a sooner than expected rise in rates. The momentum that has built up throughout 2013 has come primarily from investors, largely driven by local speculation.
In Sydney, where supply has been hampered by stringent planning requirements allowing larger developers with a greater financial capacity to hold the upperhand, the shortage of stock to cater to the needs of a market share of over 50% investors, has resulted in a spike in prices. This has diverged considerably from other states and continues to drive the herd mentality.
Louis Christopher, managing director of SQM Research, suggests Sydney will have its strongest start to the year in more than 15 years. Even assuming the prediction is too bullish, it’s unlikely to be far from the mark.
The extra boom of apartment supply will assist in cooling demand and boosting the number of rental dwellings, but it will take more than one interest rate hike before we see the evidence translate into lower median values, hence why the run will last the duration.
Whether you celebrate or commiserate news of a continued increase in house prices will obviously depend on circumstance – with investors benefitting most. However, the higher entry cost will continue to impede first time buyers and low-income earners. With no immediate solution by way of structural reform to housing policy, the debate won’t move far from headlines.
I made clear in my column last week, why we have an affordability problem and how that translates across the different demographics.
In our most populous capital cities, house prices have gone from three times median income to nine times median income. The impact on low-income families – in particular those renting, or teetering on the edge of ownership due to divorce or job loss - is particularly disturbing. In Melbourne alone, from 1991 to 2011, metropolitan housing CPI rose by 50%, compared to 188% for rents across the LGA.
The swell of concern coming from the ground up is the best chance we have to push significant reform forward. It’s encouraging to see results from a recent Ipos poll, conclude that most Australian’s disagree that rising prices are a ‘good thing.’
Notwithstanding, a huge portion of private debt for the appropriation of business and commerce is secured against residential real estate. Its Australia’s largest domestic asset class with an estimated aggregated value of over $4 trillion, pinned to a banking sector, which has the highest exposure to residential mortgages in the world.
The sensitivity to maintain high prices is evident not only in the NIMBY-style practices that protest at all attempts to either increase density or assist development, but also in the inability of politicians to move ahead with structural reform to housing policy.
Consequently, governments tend to treat affordability issues reactively rather than proactively. Words always mean more than the actions.
Demand side policies are favoured and when supply is released it’s done in such a way that it feeds a monopolist culture – designed to maximise profit over the delivery of land at ‘affordable’ prices.
To illustrate the point – ‘economics 101’ suggests the most effective way to reduce prices is to simply increase supply. In Melbourne last week, Planning Minister Matthew Guy anno0unced that the city has “decades worth of land”; more than “400,000 potential house lots in growth areas”, of which five new precinct structure plans have been approved for development (amounting to 19,000 ‘potential’ bocks) and a “potential” 180,000 apartment blocks (more than enough keep all our offshore investors happy).
Clearly – we’ve got supply in spades!
Furthermore, broadly speaking, population growth in the outer suburbs of Greater Melbourne, predominantly in the newer greenfield developments, continues to be faster, and larger, than anywhere else in the greater Melbourne districts. So demand, in theory, should not be lacking.
But what Mr Guy fails to mention, is that in a five-year period from 2006 to 2010 the median land price in outer growth area suburbs jumped from $136,000 to $212,750, a difference of $76,750, according to Oliver Hume Real Estate Group. The typical starting price for a house and land package on a compact 450 square metre block of land is now transacting for a little over $400,000. Where is this cheap supply?
Of course, it all comes down to the development process. As soon as the urban boundary was implemented speculation began, existing landowners were able demand a premium for land now potentially available for residential purposes. Of those who decided to cash in, hectares were duly auctioned off to the highest bidder – resulting in a massive inflationary boom in values.
Precinct structure plans must be finalised before construction can commence – a process of which takes two to three years.
Funds for the provision of infrastructure - arterial roads, kindergartens, child health centres and so forth, are passed onto the buyer (initially the developer, who simply factors it into the final cost).
However, there is no timetable for the construction of this infrastructure. Councils can wait years for the funds to arrive because they are usually only payable upon subdivision. Notably land within PSPs can be held by landowners who have little incentive to bring it to market unless it’s financially beneficial to do so. The result is home owners pay for infrastructure which they may never receive.
Any areas of land a developer unwittingly acquires which is subject to ‘biodiversity conservation’ must be set aside. 10% of their land must be donated for ‘community open space’. Add to this GST, along with sales and marketing costs and you begin to get the idea of why supply does not immediately equate to lower prices.
Developers, with a desire to maximise profits, time their releases carefully. In other words, the state has auctioned away any chance of a plentiful supply of cheap fringe dwellings – and in light of the evidence Mr Guy is unable to claim otherwise.
Whilst inner city development may assist renters, the extent to which it does so is debatable. Investors seem undeterred by the higher vacancy rates in Melbourne, which have hovered around 3% for the past 12 months. We can see from work undertaken by Philip Soos at ‘Prosper Australia’ last year, that a percentage of newer units are allowed to sit vacant for much of the year – unclear whether they are being used for speculation, or as temporary vacation homes.
Building approvals data for apartments do not indicate commencement - the process of approval, to release (Off plan pre-sales), and finally completion, takes a number of years.
Charter Keck Cramer track each project from start to finish – and estimated back in July 2013 that 39,155 apartments will be added to the stock in Melbourne during the three year period of 2013 to 2015 (not including those for which subsequent planning approval has been granted).
To maximise yield and meet financial requirements, most apartments are small one and two bedroom dwellings (no more than 70 square metres in size). Unsurprisingly, they offer little attraction to the vast majority of local home buyers – being far more apt to meet the needs of student renters.
All in all, it’s an appalling state of affairs.
Australia is now entering its 23rd year of continuous GDP growth – the history of which is outlined briefly in HSBC’s recently released global research paper “Still in second gear”. It should come as no surprise that land is always the eventual beneficiary from the wealth of a burgeoning economy.
As productivity increases, jobs are created, the population grows, infrastructure is built, areas gentrify, land values increase, and owners benefit. The uplift in values finances additional development and so the speculative process continues.
From the trough of 1996 to the peak in 2010 land values have roughly doubled as a percentage of GDP – and the policies we have in place simply fuel the cycle.
In countries that have promoted home ownership both a means of ‘saving’ for retirement and a valuable asset to leverage against to accumulate additional assets – the eventual consequence is always the same. Tax strategies and inelastic supply side policies have encouraged speculation in rising land values with both the monopoly and restriction of the resource stagnating effective and affordable supply.
Until any sharp ‘correction’ is experienced (and eventually it will be), the advantage lies with those who hold the appreciating assets above those who don’t – particularly if acquisition was early on in the cycle as suburbs initially gentrified.
Whilst gains over the period wax and wane, spurred on by low rates or intermittent grants, the party can only continue whilst there is consistent demand at the entry level. This is why so much attention is focused on mortgage ‘serviceability’ rates, rather than the overall level of ‘affordability’ by way of calculating the gross amount borrowed.
It is possible to create a stable housing market that doesn’t subsist on ever rising prices. However, it can only be achieved by significant tax reform moving toward a broad based land tax - as was advocated in the Henry Tax Review - coupled with structural changes to the way we manage supply.
Without such reform, the social cost to our country and welfare system as a whole, will only worsen.
Catherine Cashmore is a market analyst with extensive experience in all aspects relating to property acquisition.