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Jul 28, 2010

Housing shortage? No, it's a debt-fuelled bubble

The property bubble denialists continue to ignore reality.

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The denialists continue to ignore reality. The property bubble denialists that is. Yesterday, a leading property developer claimed that Australia had a shortage of 200,000 homes, while last week one of the most often quoted property figures alleged that Australia has no bubble, and is “undersupplied, not oversupplied”.

Dr Frank Gerber, chief economist at BIS Shrapnel, told a Real Estate Institute of Victoria conference that:

We’re not over-geared, we’re not overvalued and we’re not oversupplied … I can’t remember in the last 30 years a time when I have been more comfortable and optimistic about investment in the market.

That correction is pretty much over and we’re starting to see the beginnings of a pick-up again.

Gerber’s optimism is hardly out of character — BIS Shrapnel has been among the loudest cheer-leaders of the recent housing boom. That price boom has seen the ratio of median incomes to median prices rocket to approximately six times in capital cities — double the historical rate. (Demographia calculated Australia’s income-price ratio at being 6.8 times, more than double the US’ ratio of 2.9 times).

The shortage claims were echoed by Australand boss Bob Johnston, who stated yesterday that “there is currently a shortage of some 200,000 homes at a national level and probably about half of that demand is in Sydney”. Johnston’s claims should be taken with a hefty pinch of salt — Australand benefits from higher property prices due to increased margins.

However, instead of taking the word of property developers and real estate agents, property owners and buyers should consider whether there is any evidence that Australia is suffering a housing shortage — other than the somewhat circular argument that a shortage must exist has been an increase in property prices.

If Australian capital cities were actually suffering an acute housing shortage, it would be evident that rental costs would increase at an equal (but more likely a greater) rate than purchase costs. In times of shortage, the need for a rental property would be more urgent than that the desire to acquire a permanent dwelling. If a dire shortage existed, people who did not own or rent a property would be forced to find alternative rental accommodation and would quickly “bid up” the cost of rental accommodation. (By contrast, purchasing a property is a more considered decision and is usually a lifestyle change, rather than a necessity). Simply put, the alternative to buying a property is renting a property — however, the alternative to renting is living in uncomfortable and often unobtainable temporary accommodation or finding a new city to live.

That logic means that if a study conducted the Tenants Union of Victoria, is correct, the housing shortage is most likely a fabrication. The TUV study found that rental costs have increased at a higher rate than general prices — however, rental prices rises have been dwarfed by increased on the cost of buying a home. The TUV study found that since 1995, the cost of median weekly rents in capital cities has increased in real terms at 41% (that is, stripping out inflation gains which have been about 47% in that time).

That means in nominal terms, median rents have increased from $164 per week to $340 per week — a rise of 108%.

Given that renting is a reasonable substitute for owning a home, the cost of purchasing a property should reasonably resemble that of renting a dwelling. There are various reasons for disparities (for example, government interference in the housing market or lax bank lending standards) but overall, one would expect the cost of buying a property to roughly track rental costs over the long-term. For example, even if buying a property attaches a slight premium (due to tax and lifestyle advantages) in 1995, that premium should remain relatively constant over time.

However, that has not been the case. While nominal rental costs have increased by 108%, the cost of a median capital city property between 1995 and 2010 has leapt by 190% (this figure was calculated by splicing together two sets of ABS data). That means over 15 years, house prices have outstripped rental growth by more than 75% (this has continued in the past 12 months, with median rental prices rising by 2.9%, compared with an 11% increase in property prices). Coincidentally, since 1995, the ratio of mortgage to debt to GDP has increased from about 33% to just almost 90%.

Another interesting comparison — since 1995, the All Ordinaries Index has risen by approximately 123%, substantially less than the increase to the median house price.

(Interestingly, the price of “project homes”, which are generally located on the outskirts of capital cities has increased by a more reasonable 81% — less than the rate of rental increase. This implies that the physical cost of building a dwelling has increased by far lower rate than land value and that the “shortage” problem doesn’t extend to every dwelling, only a smaller cross-section of properties.)

Most of the actual data suggests that Australia does not suffer a shortage, but rather, a debt-fuelled bubble. The ratio of income to house price, relative rental yields, rental price growth and the proportion of mortgage debt to GDP. However, our experts still gallantly forecast a continued rise in property prices due to an alleged housing shortage, which has never been proved but that is clearly contradicted by rental price data.

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