Why Home Ownership Makes Economic Sense in Australia’s Housing Market

Imagine you contemplated buying an investment property.  On certain assumptions, you could expect growth and after-tax annual return of 4.6%.  If instead, you chose to live in it yourself.  Your return would, on the same assumptions, be 6.3% pa.

The difference is due to the fact that, while owner occupiers cannot claim tax deductions for interest, rates taxes and insurance, nor do they have to pay tax on the imputed rent of home occupancy.  Quite simply, long term home ownership makes economic sense.  It would make more sense if rents and capital values were lower, but it nevertheless makes sense regardless of market levels.

While social security asset tests distinguish between homeowners and others and rent assistance is available, home owners are also better treated by Centrelink.

Around the time Donald Horne penned “The Lucky Country”, 71% of households were home owning.  That proportion is now roundly 2/3rds. 

The relative cost of homes is quite a lot higher than it was in the past.  From example, from 1980 to now, the ratio of the median house price to median household income has tripled from 3.2 to 9.7.  Housing costs have, according to the Australian Bureau of Statistics (ABS), risen from one fifth to one third of gross household income.

The increase in housing costs coincides with an increase in real household income associated partly with greater family income as the proportion of females in the work force grew from just over 40% to about 2/3rds.   It also reflects the larger area of homes albeit on smaller blocks.

Other social changes have buoyed housing demand including the reduction in household size.  In 1980, the average household sheltered 3 people, now it is 2.5.  To the extent that this reflects fewer children it is immaterial to housing demand (except although the demand could be for smaller houses).  Household size is also influenced by the number of single adult households which has risen from 24% in 1980 to 28% peaking earlier this century at over a third. 

Part of this change may be attributed to the major social change of no-fault divorce.  The pent-up demand for divorces released by the Family Law Act 1975 saw the divorces per 1,000 people 16 and over spike from under 1.5 to over 4.5 and then settle to under 3.5 then start a long downward trend to 2.2 now.   The true rate of breakup is more as the statistics only include annulment of formal marriages.

People will spend what they can on housing.   Few aspirational people’s aspirations extend to living in battler suburbs.  This fuels the spiral.

As with everything, price is a function of supply and demand.  The demand side of the housing equation is influenced by the above.

Supply is determined by availability of land, labour and materials. 

While it is true that, with the exception of the odd volcano or Chinese atoll in the South China Sea, “the good Lord has stopped making land”, and indeed, with rising sea levels and coastal erosion, He is now unmaking some of it, that is not the whole story.  The Lord deals in hectares, housing demand is in lots, so the councils have taken over the divine task of making room for housing.

With the stroke of a pen a council can turn 20 residential lots per hectare into 80 or more and a cow paddock into a multiple backyard.  Because doing the former destroys the amenity and property values of rate payers without any compensation, councils are reluctant to do the former and need to be coerced by State governments which are further removed from the local dissatisfaction.

An recent illustration of why there is so little social license for infill is a house of reasonably recent construction in the Melville municipality that is bordered on two sides by apartment blocks five or more stories high.  The value of that property has been slashed and the owner likely received not a cent of compensation.   Economists call this a “negative externality”.  Meanwhile grumpy rate payers watch sullenly and helplessly as Councils approve infill and hope it effects other people, not them.

A small per apartment contribution to adjacent landowners would improve infill’s social license.

Freeing up rural land raises arterial infrastructure costs which has its own problems for governments.

So in the face of the difficulties in securing more supply, Governments, State and Federal of all hues have opted to subsidise a class of purchasers (namely first home buyers) with grants, stamp duty relief and the first home superannuation saver scheme which directly stoke demand thereby causing price rises which need further Government mitigation. 

The latest iteration of this mind set is free mortgage insurance under which the Government guarantees lenders against default above 80% of the property value.  This used to be provided by specialist companies because banks know high loan to valuation ratio loans can cause losses.  So they ask the borrower to effect insurance and the insurance providers charge a premium because they know claims will occur.  Along comes the government and say, “forget that we will pick up the tab”.

This is of course good politics, particularly the guarantee as it costs nothing in the short term – leaving later governments with the problem.  It is terrible economics.  It makes little sense to use taxpayers’ money to exacerbate a shortage. 

Houses are basically built by laying one brick on another with an encompassing layer of mortar, a process not unfamiliar to the Pharaohs.  It is a labour intensive process and labour was cheaper for the Pharaohs than it is now. 

Cheaper construction methods have long been touted as a way of containing building costs, but they must run the gauntlet of the banks.   Banks are reluctant to lend for thirty years unless they are satisfied that the asset will survive that time.  This renders innovation difficult.

Commentators talk much about negative gearing.  Gearing and capital gains tax discounts are a feature of all asset classes including housing.  

Housing is somewhat different from other asset classes as one cannot shelter in a five-year indexed Commonwealth bond, a fully paid ordinary share or a 180-day floating rate note, much less a Bitcoin wallet.  

So it makes sense to consider changing the rules for housing. 

It has been suggested that new rules apply to people with multiple properties to quarantine deductions and remove the capital gains discount.  That suggestion is founded not in economics but in envy.  If changing rules for multiple property investors will reduce housing costs, logic suggests changing the rules for everyone will further reduce them.

Commentators criticise investors for driving up housing prices.  If an investor buys a house from an owner occupier, the stock of rental houses increases, easing the plight of renters at the expense of availability for owner occupiers.  Reversing the process reverses the effects.  In both cases, the total housing stock is unchanged.  

Experience with discouraging investors in the housing market was disappointing.  Public backlash and rising rents lead to the 1987 reversal of the 1985 quarantining of property losses from other taxable income by the Hawke government.  There have been some suggestions of restricting tax benefits to newly built residential stock, but so far little legislative appetite is evident.

It remains easier to curb demand than it is to create supply.  Hence the clamour for reduced migration.  

A respected investment fund manager has recently labelled the migration fueled housing market as a Ponzi scheme.  It is clear that housing costs cannot continue to rise faster than household disposable income.  There is a limit to capacity to pay rent or loan instalments.

This is a bubble sixty years in the making.  It is to be hoped that it deflates in an orderly manner and does not burst.  Either way, this is of little consolation to those currently struggling to achieve home ownership.