Solution to housing affordability 'crisis' is to help the market work better

By Stephen Sedgwick

The Australian,
13 March 2008, p. 30

THE Rudd Government is correct to direct its response to the housing affordability "crisis" at renters rather than home buyers because renters, and particularly poorer renters, suffer most from housing stress.

It's questionable, though, whether the supply of rental housing will increase that much if landlords are required to charge up to 20 per cent less than the market rate.

It helps to be clear on the problem. People are usually defined as being under housing stress when their housing costs consume more than 30 per cent of their household earnings. On this measure, 13 per cent of people owning or buying their home were stressed in 2006, up more than 3 per cent from 2001. More renters - almost 25 per cent - were stressed, but their position had not worsened much over the five years.

However, these are average figures supposed to show the position of a typical homeowner. Digging deeper provides a picture surprisingly more complex than conveyed by many headlines or soundbites.

Among the lowest income quartile of house owner-buyers, there was little change between 2001 and 2006 in the proportion experiencing housing stress, according to HILDA survey data analysed by researchers at the Melbourne Institute.

The numbers show an increase in stress among those in each of the higher next three quartiles. In other words, over this period, housing stress was an issue not for the poorest home-owning households but for the better off. Moreover, the data show that most households move out of stress: less than half of those initially in housing stress remained stressed a year later and less than a third were in that state two years later.

These HILDA figures suggest that the deterioration in the position of middle and upper-income groups is not because they bought second or rental properties. Instead, it probably reflects their decision to secure better properties, possibly including lifestyle choices of older households (even borrowing to support holidays). This appears to be the result of rising incomes, secure employment and access to cheaper and more flexible credit.

Reserve Bank figures put variable housing mortgate rates at 8.05 per cent at the end of 2006, the same as at the end of 2000. However, rates fell sharply in 2001 and then rose progressively from April 2002 by about 2 per cent. The HILDA data suggest owners kept repayments reasonably constant as rates increased - that is, they reverted to paying off their mortgage on time rather than ahead of time. Even so, 2006 ended with half of households ahead in their repayments and less than 5 per cent behind in their repayments.

Mortgage rates have risen by a further percentage point or so since 2006. Nonetheless, nominal mortgage rates are still a percentage point less than the average of the 1990s. This suggests that any worsening in housing affordability over the past decade has been caused by rising housing prices rather than by interest rates.

With supply relatively fixed in the short run, higher real incomes, greater job security, freer access to more affordable credit and increased preferences for better housing quickly translate into higher prices.

Government policy can try to smooth out price hikes by speeding the response of housing supply to higher demand. For example, the commonwealth is right to try to make regulation and approval processes more efficient and less costly, but more efficient supply at the fringes will not of itself stop the rise in prices of well-located housing close to the city centre, particularly when people want to live close in because of lack of amenities on the city outskirts.

Rather, local planning restrictions need to be relaxed to permit higher densities in the centre, or housing on the city fringes needs to be made more attractive through expensive, subsidised investments in community infrastructure, including transport.

First-home owners may benefit from subsidies aimed at them, but when demand exceeds supply such measures are also likely to benefit existing home owners and sellers by pushing up prices. Higher prices are usually needed to encourage greater supply, including of well-located housing in high demand, and ensure that resources are directed to where the return is greatest.

In any case, the housing affordability "crisis" is more to do with renters than buyers. The HILDA data shows that, among the two lowest income quartiles, the proportion of renters in financial housing stress in 2006 actually fell between 2001 and 2006. For higher income groups, rental stress was generally stable, as incomes grew as fast as, or faster than, rents.

So, what is the problem? First, rental vacancy rates have declined for at least three years and rents have now begun to rise sharply. The TD Securities-Melbourne Institute's Inflation Gauge shows that rents rose 8.5 per cent in the year to February, suggesting that affordability for renters could be deteriorating quite a lot.

Perhaps more importantly, housing stress is far more prevalent for renters than for homeowners. In 2006, 40 per cent of renting households in the lowest income quartile were experiencing stress - 3 1/2 times that of poorer homeowners.

This suggests that the Government is right to emphasise the needs of renters - not because this is a new issue but because it is longstanding. Australia has a relatively high proportion of homeowners and a relatively low level of social provision of housing.

Negative gearing provides incentives for cashed-up individuals to invest in rental property but tax concessions available to corporates and not-for-profits have been focused elsewhere.

The Government's new concessions for social housing will extend support into this market segment, but it will only be effective if the all-up return is attractive compared with alternative uses of funds. It remains to be seen whether the requirement that landlords charge 20 per cent below market rent to qualify is consistent with achieving this outcome. Arguably, apart from enacting fair landlord-tenant legislation and removing any tax-induced distortions, increased rental supply is best achieved not through subsidies but by making sure the overall housing market works properly.

Professor Stephen Sedgwick is director of the Melbourne Institute, which is hosting this month's New Agenda for Prosperity conference with The Australian.