THERES no doubt that housing affordability has deteriorated substantially over the past decade or so. Indeed as conventionally measured in terms of the income required to service the mortgage needed to purchase a median-priced house in any of Australias major cities purchasing a home is currently less affordable than at any time since the late 1980s, when the standard variable mortgage rate peaked at 17.5 per cent. It was those high interest rates which were the main cause of the housing affordability problem back then; and the solution was, at least in principle, obvious and simple lower interest rates. It took a severe recession to deliver the lower inflation required to make lower interest rates a feasible proposition, along with other reforms such as removing the potential for political interference in the setting of monetary policy; but once interest rates began to trend sustainably lower during the 1990s, the housing affordability problem was effectively solved, at least for a while.
By contrast, todays housing affordability problem is largely due to high housing prices. And they, in turn, are largely the result of the sharp decline in interest rates during the 1990s and early 2000s effectively being capitalised into the price of housing. Lower interest rates, combined with sustained steady growth in incomes, enhanced competition and innovations on the supply side of the mortgage market, substantially increased the borrowing power of buyers; at the same time, rising levels of immigration and the on-going decline in the average number of people living in each dwelling boosted the underlying demand for housing. Over the past fifteen years the increase in effective housing demand more than outstripped the increase in the supply of housing by a wide margin, so that a substantial increase in housing prices was more or less inevitable. And it was exacerbated by the halving of the capital gains tax rate in 1999, which effectively converted negative gearing from something which historically allowed those availing themselves of it to defer tax into a strategy for permanently reducing as well as deferring tax, thus bringing another cohort of would-be landlords into competition for the limited supply of housing with would-be owner-occupiers.
Absent a sharp decline in interest rates which looks unlikely any time soon given the Reserve Banks publicly stated judgements regarding the risks to the outlook for inflation the only solution to the contemporary housing problem is lower housing prices. But given that almost 70 per cent of Australian households own (or are in the process of buying) their own dwelling, and that for most of them their own dwelling accounts for the bulk of their net worth, lower housing prices are hardly likely to attract much support.
Most of the proposed solutions to the housing affordability problem entail putting more cash into the hands of home buyers, for example through increases in the First Home Owners Grant, or further reductions in (or exemptions from) State stamp duties. By allowing would-be home-buyers to pay more for the dwellings which they wish to acquire, such proposals would effectively make the housing affordability problem even worse. The governments who would be expected to fund these solutions might as well give the cash to vendors, because thats where the cash given in the first instance to home buyers will eventually end up. The same is true of shared equity schemes, unless they are subject to tight eligibility criteria (as Western Australias scheme is). A would-be home buyer who is willing to spend $300,000 to buy a $300,000 house, confronted with the possibility of buying a $300,000 house for (say) $200,000 under a shared equity scheme, would probably see that as offering the potential to buy a $400,000 house for the $300,000 he or she was orginally willing to spend. The inevitable result, if such schemes were sufficiently widely available, would be that $300,000 houses would increase in price to $400,000.
Supply-side solutions based on increasing the supply of land which can be used for housing, or reducing the cost of bringing new housing on to the market potentially offer greater chances of improving housing affordability. But they do suffer from the problems that the majority of would-be home buyers dont want to live in the areas where new land supply could be most readily brought on to the market, on the far fringes of our major cities; and changes to town planning laws which might permit greater urban density tend to be highly unpopular with existing residents of established suburbs.
One possible approach which in my view merits serious investigation is to extend to home-buyers the same tax treatment as is available to investors that is, to allow home-buyers a tax deduction for interest payments on their mortgage provided they agree to pay capital gains tax on the increase in the value of their principal residence if and when it is sold. It can be thought of as a shared-equity scheme funded by the Australian Tax Office. It would certainly cost the federal government money up-front through lower income tax collections as home-buyers claimed tax deductions for interest on their mortgages. But a proportion of these revenue losses would be recouped as capital gains tax became payable when these buyers subsequently traded up. The net cost could be reduced by restricting eligibility to homes of less than a stipulated purchase price (which might have to be set at different levels for different regions) or to home-buyers with less than a stipulated income. And those who wanted to preserve the tax-free status of their principal residences would be under no obligation to participate. But even this proposal is arguably open to the suggestion that, by enabling home-buyers to take out bigger mortgages (since the interest would be effectively subsidised through the tax system), it could put additional upward pressure on house prices.
Its also important to remember that for all the public attention devoted to those encountering difficulties with their mortgage repayments, they will at least own something of considerable value when the struggle is over. Those who are devoting high proportions of their income to paying rent dont end up with anything to show for their commitment. And most renters have lower incomes than home-buyers. There are probably more things that governments can do to make rental housing more affordable directly or indirectly increasing the supply of rental accommodation than there are things which would genuinely improve affordability for home buyers.