Housing affordability: Some thoughts and an idea

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.

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Andrew Reynolds
14 years ago

I agree with you on the source of the problem – supply has not increased to meet demand, ergo price has risen. I would also agree that increasing the borrowers’ ability to borrow is not the solution. As you note, This does little or nothing for what is proving an inelastic supply curve.
I can’t agree with your tentative partial solution – all that will do is make ownership more attractive vs. renting, not reduce the demand / supply issue that is driving the price. Granted, for the buyers, this may well result in long-term benefits, but it comes at the cost of reduced flexibility in housing arrangements by increasing the costs of moving.
Additionally, longer term the urban sprawl is likely to encounter increasing resistance on several grounds, not least of which is environmental.
To me at least, we are simply going to have to live in higher densities and planners will have to move to accommodate this.

14 years ago

Why not start looking at areas not directly related to housing? I have two suggestions:

1) If we fixed up the training schemes in Australia, we wouldn’t be so reliant on immigration to plug holes in the workforce, and thus it should be possible to reduce immigration. This would reduce population growth which should indirectly reduce demand on housing.
2) Why not think about infrastructure style solutions? If a proper fast train (i.e., one that goes 300ks/ph) was put between, say, Wollongong-Sydney-Newcastle (and also Melbourne-Geelong-Ballarat etc.), people could happily live in these smaller cities where there is much more available space (and the space could be used more wisely given that it isn’t built up yet) and still work in the big cities (Wollongong to Sydney would take 20 minutes — much better than coming from the outer burbs). This would allow people to live on, say, the beach in Newcastle than the aweful suburbs of Sydney. This is surely preferable for many people (a similar phenomenon has occured in Paris thanks to the TGV).

David Rubie
David Rubie
14 years ago

Andrew Reynolds wrote:

To me at least, we are simply going to have to live in higher densities and planners will have to move to accommodate this.

It’s a tough ask. The enormous boom in renovation (and the amounts of wealth that have gone into it), along with a pretty healthy NIMBY culture have put paid to any suggestions that our inner cities could feasibly be redeveloped into higher density arrangements. Even the middle suburbs that looked ripe for apartment blocks along the train lines have succumbed.

It might be more useful to look at why (for example) some bits of Sydney have boomed and continue to do so: access to the CBD seems like a major driver of this given that there is a distinct area effect whether you are inside or outside the major “beltway” that starts at Pennant Hills Road and curves around the more desirable middle and inner suburbs. The real problems started when the houses outside that belt started taking on prices that were being dragged up by the houses inside it – although there’s already a thread on the side effects of inappropriate lending practices which helped this.

What else is driving it? Transport issues. Lack of infrastructure makes your commute from anywhere to anywhere in Sydney a distinct hassle. (Having never lived in Melbourne I’m not sure if the same problem has arisen though, perhaps a mexican can tell us).

Why? My guess is a real reluctance on the part of state governments to make long term infrastructure investments and their complete failure to plan city expansion properly. If the infrastructure had been there, the desirable suburbs may not have risen so quickly and over-inflated the outer suburbs. I think it’s a bit too late to do anything other than try to address the underlying issue and wait 10 years, but that isn’t much comfort to the poor bastards who have to find somewhere to live.

Alan Moran
14 years ago

There is no problem with discussing treating housing as in the US and allowing mortgage deductibility but placing a capital gains tax on sale.

I doubt that it would have the effects forecasted. After all the roller coaster interest rate activity of a decade and more ago also occurred in North America but most of the population (cities like Houston, Atlanta, Toronto, Pittsburgh) saw little growth in median house prices while others like LA, New York etc saw Australia type price inflation. The difference between the two outcomes was not fiscal differences but the incidence of smart growth land restraints.

It may be that there has arisen a break in the previous fungibility of house/land packages and that the inner suburbs are now relatively more desirable. This does not seem to apply to those with children. Even if it were true, the supply constraint on the city peripheries is in place and artificially inflates prices by $50,000 to $200,000 per house depending on the city. Even devout inner suburban types might be attracted to move to the sticks for a house that was one third or more less than it is at present.

It is true that the inflated wealth of incumbent home owners creates a massive interest group against opening up more land. It is also true that NIMBYism prevents more intensive inner city developments. Both these distortions which so adversely affect Gen Y should be combated. We have seen government regulation create self interest in its preservation before with the tariff debate but overturning it was a lengthy process.

Brendan Halfweeg
Brendan Halfweeg
14 years ago

Couldn’t have put it better myself Alan. Supply is the problem, not finance and not taxation.

Nicholas Gruen
14 years ago

I think I disagree with Saul’s suggestion for a bunch of reasons. The income test would leak into middle class welfare. And improving supply is the most promising route I suspect.

But there probably is a case for trying to get some people off rent support and into becoming home owners.

If we did that I think we should do it directly ie. with subsidies (perhaps just subsidies diverted and relabelled from rent subsidies) – not through tax deductibility. If we did, we should by all means make those houses CGTable – which might make the whole scheme revenue positive. I’d also be happy to add HECS style repayments to the scheme in the event that the home owner starts earning a decent living.

14 years ago

Increasing supply is all well & good, but who wants to live in 21st century replicas of circa 1900 English tenement housing? High density housing is NOT the answer. Let’s be serious for a moment and recall that this is a vast country with a tiny population in global terms. If resolving the housing supply truly is the answer, then governments need to ensure that development costs are minimised and profiteering by developers is contained. Then of course there’s the issue of infrastructure. As our cities expand, create or take on satellite localities, those who choose not to live cheek by jowl with the other rats in the race will require transportation and similar amenities.

You’ll never catch me moving into high-density housing. Not when there is literally hectare after hectare of open countryside just begging for buyers at basement prices. Too far from work? Change your lifestyle. Change your career. There are more avenues in this country than simply whingeing about a lack of cheap housing.

14 years ago


Change your lifestyle. Change your career.

And if many, many more people don’t do that, voluntarily, NOW, they’re will be doing it perforce before Gen Y’s kids leave school. What price your inner city shoebox when food – growing & transporting – it to the millions of urbanoids cheek-by-grimy-jowl becomes a real issue?
In OZ we have that option, Europe does not and amerika blew the chance with their reliance on vast suburban sprawl and cheap petrol to commute to their superfluous, and soon to be non existent, jobs.

14 years ago

Great post on the issue of housing affordability.

I have to disagree with the solution of getting the Government involved in easing the solution. As a FHOG-eligible person, I am grateful for it, and will use it sometime soon, provided it still exists when I am ready for it but, I think getting the Government involved will only complicate things in the long term, and in the medium term the problem will still not easy.

The basis of the housing price issue is primarily one of supply versus demand. I believe that it is best that the Government refrain from meddling in the markets, and let the markets chart their own course. Every time the Government gets involved with some sort of affordability scheme, the markets will experience a correctional shift, and the problems they were trying to fix will reveal themselves again.

Just my $0.02.

Nicholas Gruen
14 years ago


Europe will have its chance again! Some countries there have fertility rates of around 1.3! They’ll be losing tens of millions in population each decade quite soon!

14 years ago

Greetings from the UK – I use Google alerts on my keywords so it is interesting for me to read that you have the same problems down under.

In the UK we have introduced a system on Shared Equity Mortgages name Open Market Homebuy – my link is in my website address. So far the scheme has been very slow getting off the ground. But if you search the terms used then hopefully it might generate some interest.

Cheers David

Robert Merkel
14 years ago

Fascinating reading.

I think Conrad hits on one of the more important issues. While the concerns about absolute housing affordability are very important, the middle-class angst seems largely to be about not being able to buy the lifestyle they want at a price they can afford.

Improving transport links, and amenities in more affordable suburbs, would seem to me to be one of the primary ways in which we can improve lifestyles – along with greater attention to urban planning more generally.

Graham Bell
Graham Bell
14 years ago

Saul Eslake

“…. todays housing affordability problem is largely due to high housing prices”.

Not even “largely”. It is a significant part of the tangle of problems but there are other factors that are just as important.

As you yourself said

” … bringing another cohort of would-be landlords into competition for the limited supply of housing with would-be owner-occupiers”.

a problem exacerbated by, for example, the lending practices of financial institutions which shove money into the hands of young short-term “investors” to buy an older house yet deny a family the chance to buy the self same house for the purpose of actually living in it. Nobody expects private financial institutions to be charities – but nobody takes kindly to such egregious acts either; word spreads – and eventually that won’t do much good for business..

Conrad [on 2]:
Spot on.

And you can add to that, lending practices that do impede the reasonably free movement of labour. Look at what happened to workers who were keen to move to where the jobs were after the industry shut-downs in Newcastle and Woollongong …. never mind, they could just go on the dole, couldn’t they? …. and they had the cheek to call Australia “The Clever Country”

Nicholas Gruen [6];
There is no supply problem. There are more than enough houses and flats on the “market”.

The problems are those of (a). access to long-term affordable and appropriate finance., (b). price., (c) a housing “market” that is a twisted perverted parody of a market.

” …. there probably is a case for trying to get some people off rent support and into becoming home owners …. “

You bet there is! And in late 2007, it even has a law & order aspect to it.

Be careful what you wish for; your wish might come true. Whichever party/faction forms the next government, Capital Gains Tax will be whacked onto the family dwelling. They just can’t help themselves. Never mind that the consequences of imposing that tax will outweigh any apparent transient benefits. There is need for reforming tax but that is best done by careful thinking and wise planning, not by swinging sledgehammers around.

Niall [8];
You can have urban consolidation without creating 19th Century high-density slums.

One of the nice things about Europe is the prevalence of communal vegetable gardens in the midst of medium density housing; they are great places for bumping into your neighbours, swapping gossip, etc.

14 years ago

“Capital Gains Tax will be whacked onto the family dwelling”

Not a chance. It would be political suicide. Any solution to the problem of high house prices that involves CGT on the family home is a non-starter, at least while Australia remains a democracy.

Malcolm Fraser got himself re-elected in 1980 by scaring the voters in thinking that Labor would tax the capital gains on their homes. It is al esons that has not been forgotten by either party.

It’s an intractable problem, because the people who are already in the market quite like the capital gains they have made on their homes, and these people greatly outnumber the people who are trying to get in. Now you may argue that these gains are illusionary because when they sell their homes the house they want to buy will also have gone up in price, but they don’t care. And son’t forget that many people have used the capital gain on their house as collateral which they have used for loans for cash generating investments like investment housing and shares?

High house prices are a problem? Only for the losers who couldn’t/didn’t get in early.

Graham Bell
Graham Bell
14 years ago

Spiros [14]:
The ideologues currently pretending to be politicians and policy specialists don’t see the slamming of a Capital Gains Tax on the family dwelling as “political suicide” any more than did the booze-sodden generals of the First World War see the of ordering men to charge machine-guns and barbed-wire see that as military suicide.

Never mind what is logical or what what happens out there in the real world [you already mentioned Malcolm Fraser’s successful political stunt]; once the next election is safely out of the way, they’ll do it. No doubt there is someone already draughting a scholarly paper to explain away all the unexpected harm done by imposing CGT on the family dwelling as being caused by melting glaciers, the abolition of the Greek Drachma and inauspicious zodiacal conjunctions.

Graham Bell
Graham Bell
14 years ago

Saul Eslake:
In view of today’s news item on predatory lenders and on the horrendous cost of such near-criminal activity …. can we assume that the executive of the Mortgage and Finance Association are avid readers of Club Troppo? :-)