COVID provided a real-life experiment on house price theory and what makes owning a home unaffordable

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In March last year, Australia’s international border was slammed shut.

The decision wasn’t made without good reason, but it had massive economic ramifications.

Employers could no longer access the steady stream of skilled and unskilled workers they relied upon, universities couldn’t bring in international students, and the forecast for the housing sector was bleak.

For years, conventional wisdom among many economists (inside and outside the government) was that population growth was at least a significant force behind rising house prices.

But when the migration tap was turned off, while property prices initially slumped in some areas, they are now roaring.

Closing the international borders was the sort of experiment economists had only ever carried out with a spreadsheet, never expecting it to actually happen.

The results surprised a few, and have many questioning whether the right lessons are being learned.

What really drives house prices up?

There are undoubtedly a whole range of things that influence property prices, and rents too.

The question for economists and policy-makers has always been around which have the strongest influence, and which can be adjusted if prices need to be reined in.

Brendan Coates from the Grattan Institute suggests one key influence has won the day.

“I said at the start of COVID, we’re about to find out what matters more for house prices: interest rates, or underlying demand or supply,” he said.

“And I think we’ve been proven that interest rates matter more.”

Interest rates were already low before the pandemic came along. They are now even lower, with the RBA holding the cash rate at 0.1 per cent.

It does not plan to increase rates before 2024, although some in financial markets are not convinced it will wait that long.

Mr Coates argues while cheap finance is driving buyers into the market, raising rates will not solve housing affordability.

“The Reserve Bank’s been very clear, it’s not going to raise interest rates to reduce house prices,” he said.

“And that’s a very smart move, because there’s not much point having cheaper housing if you have hundreds of thousands of Australians out of work and no-one’s wages growing, which would be the consequence.”

Which leaves policy-makers with a difficult question: if the biggest lever in housing affordability cannot be pulled, what is left?

The supply side of the housing equation

Asked what the biggest problem in housing affordability is, Liberal MP Jason Falinski suggested it was actually pretty obvious.

“Lack of supply, it’s simple,” he said.

Mr Falinski is currently chairing a parliamentary inquiry into housing affordability, but said he has a clear picture of what needs fixing.

“It’s not that we don’t have enough land in Australia,” he said.

“It’s not that we don’t earn enough money, because we have some of the highest average weekly earnings in the world.

“It is because poor regulations have ensured that people are not allowed to build the homes that they want to live in, where they want to live in them.”

The planning regulations Mr Falinski is referring to are almost entirely handled by state and local governments.

Outside of work facilitating supply, like running the National Housing Finance and Investment Corporation, the federal government has little role to play.

But what if it’s not supply?

Urban planner Nicole Gurran from the University of Sydney said if the inquiry is steering down the supply path, it is heading in the wrong direction.

“I often think, ‘I wish it was that simple’,” she said.

“Because if it was that simple, having a liberal planning regime and simply wanting the private sector to build more property, even as prices moderate, or fall — if it was that simple, we would have fixed the problem by now.”

Dr Gurran points to the closure of the international borders, and the forecasts of a resulting oversupply of housing, as evidence that supply is not the issue.

She said a key problem with simply loosening planning laws is the vast bulk of housing construction in Australia is undertaken by the private sector, which is best motivated to build more houses when prices are strong.

“The issue is not so much that we’ve got a regulatory constraint on new supply, it’s that new housing supply in Australia is primarily delivered by the private markets … and they will only increase new supply in response to increased profits,” she said.

She argues if housing is to be made more affordable, the relationship between new housing supply and forever increasing house prices needs to be broken.

“We need to wean the housing industry and housing construction away from house price inflation as a driver for new housing development,” she said.

“We need to wean ourselves away from that private sector housing market drivers towards looking at a sector of the housing system that responds to housing need, and that is social and affordable housing.”

Why is tax off the table?

Two federal elections have been fought with housing affordability as a central issue.

Twice Labor has argued to scrap negative gearing for existing homes, and tweak capital gains tax rules, in an effort to assist first-home buyers.

And twice it’s fallen short – leading to it now abandoning the policy.

Economist Saul Eslake thinks that’s a problem, as both are part of any solution.

“I wish that we could have an honest conversation about the demand side,” he said.

“It’s very disappointing that the Labor Party has gone to water on a policy which they took to two elections, one of which they almost won.”

Mr Eslake highlights sweeping changes made in New Zealand on both negative gearing and capital gains tax.

“What’s remarkable about that is that the sky has not fallen in in New Zealand, as is routinely predicted by property-related interests, and by the Coalition, whenever this subject comes up in a conversation on this side of the Tasman,” he said.

What if politics is the problem?

The terms of reference for the new housing affordability inquiry include “the impact of current taxes, charges and regulatory settings” across all levels of government.

Mr Falinksi said while he is happy to have the conversation, it is time for the argument to move on.

“What people who make the demand-side arguments are basically saying is that there are a group of Australians who should not be allowed to own their own home,” he said.

“How they’re going to do that is by reducing tax incentives, by reducing government programs that help first-time buyers get into the market, by increasing taxes, by increasing interest rates – that’s certainly one answer.

“There is another answer — how about we just provide enough houses so that all the people who want to live in a house have somewhere to live?”

Mr Eslake, though, questions whether politics is really steering the conversation on housing affordability.

“There are 11 million Australians who own at least one property, and within that there are at least two million who own more than one property,” he said.

“And the last thing those 11 million Australians want any government to do is anything that slows down the rate of growth of property prices.”

By some tallies, there have been at least five federally led inquiries into housing affordability in Australia in the past two decades.

Mr Eslake — and many others — are not holding their breath for a quick, easy fix to come from this one.

By political reporter Tom Lowrey (Original ABC Article)