Alice in Australia: The Housing Crisis

The Australian housing crisis is real. Over the years, we’ve seen a dramatic increase in housing prices making it increasingly difficult for young people and families to enter the market and achieve the homeownership dream. But what is causing all this?

If you’ve been in tune with media coverage surrounding the issue, you may have come across terms such as investment properties, supply issues, and negative gearing.

Every now and then, the price to real wage increase is brought up. And recently, with the hike in interest rates, mortgage stress and inability to pay off loans, as well as the ‘passing on’ of the aforementioned hikes to renters has flooded news outlets.

Let’s break this down.

Australia has experienced an increase in housing developments since the early 2000’s but research shows that, although real house prices have increased by over 150%, real wages have only increased by about a third. Basically, house price increase is outstripping the increase in wages.

This discrepancy has made it difficult for first time homebuyers to save up for a mortgage deposit as they struggle to keep up with the price hikes. The economic impact has been felt in the widening inequality in asset ownership among different age groups, as well as ever increasing household debt.

To make matter worse, there are not enough houses being built (supply) to meet the demands of the market. The latter fact alone causes upward pressure on prices.

It’s not uncommon for more than 100 potential buyers to show up to an auction while anywhere up to a third of properties end up being sold prior to the auction. Even with all the pressures of rising interest rates, properties are still being sold well above their reserve rate. There just aren’t enough homes to go around!

The issue is exacerbated by the immense pressure unavailability of homes has caused on the rental market. The rental market has been hot for decades, but recently renters have been hit with rent bumps of up to 35%.

This comes as a response to the interest rate hikes imposed as inflationary control measures by the RBA as landlords pass on the costs to renters. Compounding the issue is the vacancy rate of around 1% in major cities which allows property owners to exercise bargaining power in rental agreements.

Why don’t we just build more homes?

Building more homes would help combat the supply issue, and it is an avenue that should be pursued whether it be through government policies incentivising private construction or public housing schemes.

But is the solution as straightforward as it sounds? Last year, Western Australia hit headlines when public housing schemes were faced with the issue of construction material and worker shortage making it difficult to kick off much needed projects.

Whether new housing will only end up being stockpiled into short term rentals such as Air BnB which has taken away from the already limited supply especially in holiday destinations such as the Sunshine Coast begs the question if this is a regulatory issue just as much as it is an issue of physical supply.

Are we a ‘rentierized’ society?

In their report, Ryan-Collins and Murray (2020) explore the idea of the financialization of the housing market and the issues that arise when housing becomes more about earning profit than serving its intended purpose of being a home.

They put forward the argument that it is actually demand side factors resulting in the treatment of housing as an income extraction mechanism rather than shelter that are the main cause of Australia’s spiralling housing shortage. This theory seems to line up with the current state of the housing market and housing investment.

The housing market is a speculative one. Australian property investors have come to treat it as a lucrative means of earning money at the expense of inducing supply issues for first time homeowners.

Government policies surrounding negative gearing have only contributed to the pattern of normalising accumulation of investment properties that are then served up in the rental market at exorbitant prices with the idea that they will cover their own costs.

Does the issue lie in negative gearing facilitating property investment?

Negative gearing is a type of financial leveraging where the income generated from an asset is less than the expense incurred in owning that asset. In other words, the investor is running at a loss and relying on the capital appreciation of the asset to generate a profit in the future.

The Australian taxation system makes these losses eligible for a tax deduction. In a sense, it’s a failsafe for investing in real estate because it allows the owner of the property to offset any losses through the tax system until they are ready to sell or have repaid their loan.

On one end, negative gearing allows buyers to invest in real estate to secure their financial future. On the other hand, it does exactly what Ryan-Collins and Murray suggest by incentivising the treatment of property as a generator of passive income.  

So, what could be done?

The abolition of negative gearing would undoubtedly have a negative effect on homeowners that have stretched themselves thin to enter the property market.

The government could consider having special measures in place to protect this line of investors while still coming down hard on negative gearing for property moguls and future investors.

Enforcing stricter requirements on the conversion of residential property into short term rentals would help alleviate some of the pressures in and around holiday destination areas (a policy Queensland would be well placed to welcome with open arms).

An increase in public housing would enable easier access to affordable housing. And rent control could help stifle the exploitation of the renters that are in need of a roof.

However, government protectionist measures also have a dark side. By attempting to manipulate the free market, governments run the risk of promoting conditions conducive to the formation of secondary markets or disincentivising participation in the market altogether.

For example, tighter rent control could see property investors pulling their rentals out of the market, or leaving the market completely, thus disrupting supply and demand for properties by affecting the profitability signalling of the housing market.

Another example would be the possible formation of an informal rental market which could place renters at risk due to imbalance in their bargaining power relative to landlords, along with a lack of legal protections.

There are many ways economists and policy makers can go about solving a crisis. Economics studies the available trade-offs and their short and long term effects. Ultimately, our choice of policy will be contingent on the trade-offs we are willing to make, and it is our desired balance of short and long term trade-offs that should characterise the problem solving and decision making processes deployed in mitigating the negative effects of housing inaccessibility.