## Sunday, July 11, 2010

### Generations of housing affordability

The degradation of housing affordability is widely acknowledged, but unfortunately mainstream explanations miss the fundamental stories of easy credit and tax rules encouraging property speculation.

One of the best collections of Australian residential property analysis on the web has emerged at The Unconventional Economist.  Leith's latest article explores changes to housing affordability since the 1970s and the key drivers behind the change.

He summarises the article as follows:
• It is the demand for, and supply of, credit that is the key determinant of house prices. Whilst demand-side factors such as tax concessions, benign economic conditions, and population growth might increase people's willingness to borrow for property, ultimately, if you cannot obtain the finance, you cannot pay a high price. Similarly, tight housing supply would have little impact on house prices when credit is not readily available.
• Lower interest rates and easy credit do not make houses more affordable. Rather, they quickly get capitalised into house prices, increasing the amount that home buyers must borrow.
• When examining interest rates and their effect on housing affordability, it is real interest rates (i.e. the mortgage interest rate less inflation) that matters. Whilst mortgage interest rates averaged a seemingly high 9% in the 1970s, due to high inflation (averaging 11%), real interest rates were negative, resulting in borrowers' mortgage debt being 'inflated away'.
• Importantly, be very weary of offers of more credit and the promise that it will "improve housing affordability". Any scheme that increases home buyer's borrowing capacity, such as shared equity loans and the Never Ending Mortgage, will instead fuel further house price growth, thus eroding affordability.
• Beware the property spruiker. Always be sceptical when reading property-related articles in the press, or when listening to politicians talk about housing affordability. Whilst they might, on the surface, sound reasonable, they are often talking their own book. Instead, think critically about their motives and who their constituents really are.

1. Leiths article was well writen. The issue though is that lenders won't go back to 1980, they will stay in the present.

Although it may be more difficult to obtain credit than in recent years, for good borrowers with a decent deposit it won't be difficult.

There has to be a balance, what is the benefit of cheap homes if no-one can access credit to purchase. That is really the point of the debate, and it is a level that will be set by industry, not by legislation, although governments may try with some vague legislation about protecting borrowers and then leave the courts to sort out the detail.

At what point do you inflict a "nanny state" on people, and at what point do you let them have a say in their own future whilst maintaining that balance.

Cam neither you or Leith actually address that question. I would be interested in your thoughts.

2. Peter wrote: "There has to be a balance, what is the benefit of cheap homes if no-one can access credit to purchase"

Most of the current price of housing is in the land, not the house itself. If there was no access to credit, land would be extremely cheap. It does not have to be produced, so it costs nothing to create. The cost of buying a house would be reflective on the price of construction.

Regards,
Tim

3. Thanks for the kind words Cameron.

Peter, my negative gearing post suggested some reforms that would remove speculative demand from the housing market and would, therefore, improve housing affordability. But there is more that could be done. I'll write another post bringing together all of the housing articles that I have written to date and offer possible solutions.

I think a move back to 1970s credit rationing would be impractical and, in many ways, undesirable. But there are macro prudential tools that could be employed in order to lean against asset bubbles. I'll examine some of these tools in my next post.

4. Tim said - "Most of the current price of housing is in the land, not the house itself. If there was no access to credit, land would be extremely cheap. It does not have to be produced, so it costs nothing to create."

The raw land yes Tim, but not the finished product. God in his infinite wisdom didn't kerb and channel or lay underground power, water, sewerage, cable, or pay developers contributions to greedy state governments.

Leith - I look forward to your suggestions. Keep in mind though that both sides of our government seem determined to maintain the NG plank, so suggestions to remove it are fanciful without political will. I suggest that you get rid of stamp duties, the FHOG, and replace all of that with a broad based land tax introduced over a period of some years.

The political problem for that is - what do you say to someone who has just paid $40,000 in stamp duty to a state government and thus feels entitled to many years of NOT paying land tax in the same way that other land owners have benefitted. I'll await your thoughts. 5. Peter: Yep, I am including the cost of sewerage, etc. in the cost of construction (it's really part of the house). We also have to note the stamp duty paid to the state government, although it's highly unlikely they would continue to collect this if there were no sales. I agree with you Peter's comment regarding the removal of stamp duty and replacement with land tax. Those owners that have already paid stamp duty could have their land-tax account 'credited' with the amount they paid when they purchased. I suspect the removal of NG would be more palatable after a land/house price crash. It could be remove under the guise of "reforming the housing market", or some such. Cheers, Tim 6. Peter, you raise a very important question "what is the benefit of cheap homes if no-one can access credit to purchase." While this is one angle, the other is that cheap homes can be more easily acquired through saving. If a home costs 3x income, it may be possible to save for 10 years and buy the home. At 10x income, it almost rules out the saving for a home option. The lower the price the easier it is to save for a larger deposit. Why should people be able to borrow such extravagant amount for property in the first place? I remember travelling through Slovenia some years ago and in the countryside there were many unfinished houses. I thought they must be in the middle of a construction boom. My friends there assured me that wasn't the case. People there actually saved for their houses. They saved up and bought a block of land. Then they saved some more and built the house structure and roof. Then they saved some more and built in a room here or there. These houses grew over many years and people were debt free. Some people jumped in a built the whole house in a summer or two. Many didn't. I don't believe governments should intervene for the sake of affordability, but for stability. The few key changes to shift incentives away from speculation would be: 1. Remove CGT exemptions for properties held greater than 12 months (Germany taxes all capital gains on property at the highest marginal rate is sold prior to ten years ownership). 2. Phase out negative gearing against personal incomes - losses can only be deducted from future income from the property within a certain time period. 3. Reduce stamp duties and increase land taxes (couples with replacing other inefficient taxes in the mean time) But you are right - there is no political will for this to happen. 4. Remove the FHOG I must say I am somewhat surprised to see you promote land taxes here Peter. While I try to vigorously promoted land taxes, I now make it more clear that extra taxes are not good, but replacing other taxes with a land tax is a very big step forward. 7. Removal of CGT, negative gearing and all the other taxes are all well and good. Until Australia’s collective behaviour of “property doubles in price every 8 to 10 years” Changes we will see little change. This social conscience is the most powerful market driver. No matter what the market. 8. Cameron - Slovenia I assume has a tradition of owner built homes of more modest proportions that ours. Please correct me if I am wrong. Could I also ask if couples generally expect to own their own home in Slovenia, or is that only for the comparatively lucky few? The Slovenian solution would not fit well into our strict building code requirements. We also have a society where couples are marrying much later, so taking 10 years to build the nest is perhaps not an ideal option for many couples who marry close to the end of the females biological cycle. I know that has a very loose connection to house prices, but everything should be thrown on the table for discussion. It is all connected. Our higher expectations also has some impact on prices, but there is a problem in bringing low cost housing to the masses without creating future slums. I have listened to some compelling arguments for land tax, but I would only support it if it replaced what I see as an unfair stamp duty ad valorem tax system where the few pay for the infrastructure enjoyed by the many. I want it applied uniformly across Australia, but that may not occur. Another option would be no land tax but a higher GST to replace stamp duty. Of course we both know that Australian baulk at more taxation, but they don't care if it affects someone else. We could introduce a tax that unfairly targeted Lithuanian stamp collectors any day of the week, but asking the general populace to pay an extra$1.00 per week is grounds for a revolution.

I don't see any easy solutions that fit into your three times equation. It is more complex than that, and the market will set the trend anyway, not us.

Still I look forward to Leiths thoughts.

Time your idea of land tax credits is worth considering. Well done...

9. Wow can I just say that this is by far the most sensible (and certainly most civilised!) discussion of these topics I have ever read! Well done to all involved! Normally by now there would have been a bunch of intergenerational flaming going on with little regard for the topic. Check the comments on Leith's article for some pretty good examples.

Peter I agree completely that there is little that can be done without political will and lets face it there is currently none showing.

I'm with you Tim in hoping that if/when there is a housing crash (did that make me sound too much like a bear ;) the government will use it as an excuse to change some fundamental drivers behind the house bubble.

Leith and Cameron as always I look forward to your next articles. Leith's next one sounds like a corker.

10. Leith - I'm still waiting. I guess I will need to be more patient.

On your own blog you responded to Camerons post with these words - "The rewards were huge if you qualified for a loan"

I worked in lending for a bank in those days, and it was heartbreaking to turn away people everyday who had good savings, a large deposit, and more than sufficient income to service the loan that they sought. It's hard to believe now just how bad it was - so under that enviroment the few who qualified did indeed do well, but those who did not did poorly, and in fact couldn't get a house at all.

So essentially we have two different systems. One makes it possible for anyone with a good credit record, good savings, and a good job to buy a home, and one just allowed the wealthier better off applicants to buy a home.

Clearly on a strictly banking structure perspective the latter system fostered a much stronger banking system, whilst the first stytem has some structural weakness, but some social and wealth advantages for the common man that is just not there in the latter.

So clearly we have a choice of degrees - if it is too easy to access housing finance it forces up prices, puts some people into homes with loans they cannot afford, and it exposes risks in our banking system.

Conversely if we have a much more selective lending criteria, it strengthens our banking system, keeps prices lower by reducing demand (by reducing available buyers who have the capacity to complete) but it creates a two tier wealth system where some can get anything but others can get nothing.

I would hate to revert to a system that kept average Australian out of housing, so IMHO it is a matter of degrees. We then need to look at what LVR is a safe lending level, how we establish servicability for loans, what level of savings should a borrower have, and what constitutes a good credit record. What are your (and Camerons) ideas there???

It is one thing to stand outside a system and say this isn't working (which somewhat flies in the face of national average arrears of just 0.6%)and it is another issue to make real suggestions based on experience and research.

If your desire is to simply reduce house prices, then rationing credit will do the trick, but in an environment where many claim that all interference such as housing grants should be removed from the system, isn't a government imposed rationing just another interference in a market that has been adequately regulated by APRA with no apparent undue risk.

Another question - if people are excluded from home ownership by credit rationing, won't the state have to pick up the cost of their housing at some point, which may cost much more than a one off grant payment. Is it not in the best interests of the country to have as many people as possible provide for their own housing and retirement costs, rather that rely on the state as they have in generations past?

Sooo many questions - so few answers from the illuminati....

Look we are at one with our objective to maintain a strong banking system, keep prices affordable, and yet bring the possibility of home ownership to as many people as possible, but I only see criticism rather than answers from most bloggers and commentators.

Take a punt - go for broke and make some concrete rules we can debate. The time for target practice is over - shoot now...

11. Peter, I think Leith only has time to write blog posts on the weekend (from what I can tell from his postings). So by Sunday we might get his perspective.
I stand by my suggestions from an earlier comment. My belief is that prices are set not by owner occupiers, but by the investor/speculator buyer. An OO either chooses to pay the market price or to rent. It is the investor market that sets prices. If it wasn't this way, prices would be much lower. But investors flood in and grab up properties once they think the cost to them is less than their expected capital gain. So my suggestions are based on removing incentives for speculation on the market.

12. Cam - it's ok I can be patient occasionally.

You raise a good point about who actually drives the market. In my view it should be the owner occupier who buys with some emotional purpose, whilst an investor should only buy if it makes sense financially. Now your point is that he will look for capital gains, but surely not all IP's are sold to another investor. Has the ratio of IP to OO changed over the last two decades?

Logically it makes much more sense for prices to be driven by OO except in a market downturn, when traditionally investors will prop up the market as good buys appear.

I will however concede two major points.

1. The easier access to money has introduced far too many unprofessional investors into the market, who think it should be easy money.

2. There has been a triumph of marketing over reason on negative gearing. I'm much less anti NG than you because I know it is not a golden goose. It is beyond reason to buy a losing investment solely to lose money and gain a tax deduction - the numbers just don't stack up IMHO.

But I see many inexperienced investors who believe NG will make then wealthy - if only...

Talk to you next week...

13. I kind of always knew that you and Leith would avoid the difficult issues.

It's just so much easier isn't it....

14. Thanks for this info, Cameron. I wonder if the situation also applies in some adult communities. Charlotte (NC) is where my parents wanted to stay for retirement. They still trying to decide whether to rent or buy a house there, though. With the economic status and mortgage issues here in the U.S., I think it would be better to just rent for a while. I don't want them to experience losing their retirement savings into some risky house buying. But I think they'll consider staying in one of those Charlotte retirement homes early next year.