Housing Boom or Blame Boom?

There’s talk again of the house price boom (or even bubble). I know people who are looking to buy at the moment, and I feel so lucky that I’m not having to find a first home in the current market.

However, stories I read in the media suggest to me that we’re also in the midst of a blame game, where various bogeymen are out there pushing up prices to the detriment of everyone else. If you believe everything you read, we can blame:

  • First-home buyers – whose free cash from the government in the form of the FHOG (First Home Owners Grant) is making it hard for others to compete.
  • Overseas investors – who are apparently making the most of relaxed rules from the FIRB (Foreign Investment Review Board) to invest in Australia when other international markets are looking shaky and depressed.
  • Local investors (in particular Baby Boomers and Gen X) – whose access to the tax deduction of negative gearing enables them to sustain larger holding costs of property than non-investors.
  • Developers – who have been slowly releasing lots from their land banks rather than supplying enough to the market to meet the demand
  • Immigrants – who have been coming here in increasing numbers because it has a promising way of life but are now competing with the locals for somewhere to stay.
  • Governments – for allowing all of the above to occur.

Is there anyone left?

What is good in this debate is the recognition that it is supply and demand that is driving the prices in the market. However, the purpose of this finger-pointing seems to be to blame everybody else for the problem. I’m not convinced that any of the above factors are at the heart of the matter:

  • First-home buyers – the demand from these guys doesn’t explain why an unrenovated house in Richmond sells for more than $2m (as I read in yesterday’s paper). The whole market is booming, not just the cheaper end.
  • Overseas investors – although they are active, they are still a minority. I don’t think they could underpin the entire boom.
  • Local investors – negative gearing also results in lower rents than would otherwise occur, which should in turn reduce the demand for home ownership.
  • Developers – their land is generally at the fringe, and there is heavy demand in the centre.
  • Immigrants – these are a net benefit to a society, since they generate taxes and jobs, but have always been an easy target.
  • Governments – there is some truth to the saying that in a democracy, we get the government that we deserve. If governments continue to follow policies that we don’t agree with, we can only blame ourselves for voting them in.

On the other hand, a factor that I don’t think has gotten enough attention is our culture. In particular, the “Australia dream” of owning a house on a block of land.

I worry that it is the pursuit of this goal, more than any single segment of society, that is driving the demand for houses in the suburbs of our capital cities. We need to give up on this dream if we are to achieve sufficient densities in the inner ring of suburbs where most people wish to live.

Rather than blaming other people, I can fess-up to being as guilty as everybody else on this one. A couple of years back, Kate and I bought a house together that would’ve housed a family of five when it was designed and built around 1900 in Kensington. This is a typical, gentrified, ex-working-class neighborhood of Melbourne that probably has lower densities now than when it was new. We moved out after we had our first child, because it was too small for us (!).

In the same way that governments around the world have influenced the cultural desires for a certain family size, it ought to be possible to embark on a campaign to change our cultural expectations and change this demand factor. Make living in high-density accommodation the trendy option. Guilt people out of their large houses with empty rooms and private back yards. (Other countries have a higher density of living than us, hence why many immigrants are willing to live in apartment blocks that locals would avoid; another reason why immigrants aren’t contributing as much to the problem.)

At the same time, there needs to be more direct incentive to motivate people to embark on such a change. Make subdivision easier. Make building apartments on new land easier. Ensure that apartment blocks are built well (good climate control and sound/smell proofing) and there is provision for common outdoor areas.

I’ve spent most of my years since I left home living in higher density accommodation such as apartments and townhouses. Although I’m currently living in a house, I think I’d be willing to share walls again.

Negative news for property

We know that prices move due to an imbalance in supply and demand. If supply is unchanged but demand increases, prices will rise.

Back in 2000, John Howard and the federal government introduced the GST. At the same time, he also introduced the $7,000 First Home Owners Grant (FHOG) with the aim of offsetting the effect of housing price rises due to GST being added to contruction costs. Understandably, the FHOG was rather popular.

State governments took note, and added in their own grants. For example, in 2004, The Victorian government began offering a $5,000 First Home Bonus. Then in October 2008, Kevin Rudd and his federal government sweeteed the pot further with a $7,000 First Home Owner Boost ($14,000 for new homes). Everyone’s been seen to offer first home owners a hand-out.

But it isn’t clear that it was actually helping first home owners. As these grants didn’t directly affect supply, but they did affect demand, the prices of housing for first home owners would naturally rise. It’s not immediately clear how much prices actually rose, but we might be able to take a guess.

There are two basic ratios that banks look at when deciding whether to grant a home loan: the LVR (loan to valuation ratio) and DSR (debt to service ratio). The LVR (amount of loan divided by value of property) is typically limited to between 90-95%. The DSR (periodic interest payments divided by periodic income) is typically limited to 30-40%. So, the more deposit you have, or the more income you have, the more you can borrow for a particular property.

According to this Fairfax article by Jessica Irvine, banks will require as much as 5% of your deposit to be real savings, but the rest can be government grant. So, for a Victorian first home owner, eligible for $26,000 in grants to build a new home, if the DSR is not limiting them, and they are taking out a 90% LVR loan, then the grants allow them to borrow an extra $260,000 than they would otherwise be able to receive.

In practice, the DSR would limit our hypothetical first home owner, even with the historically low interest rates on offer at the moment. But the above exercise does go to show how significantly the FHOG and its successors can move house prices.

This might all seem pretty good: the government subsidises new home owners, and existing home owners and developers get more money for their properties. However, here’s the rub – the rumour is out that Kevin Rudd is going to rein in these grants, and perhaps even end them after this financial year. I didn’t think it would ever happen – it’s very hard to unwind these things once you’ve put them in. Anyway, he’s going to tell us in the budget announcement this month.

However much the FHOG has stimulated demand, removing the FHOG will undo it. If supply is unchanged but demand decreases, prices will fall.