Australian Housing Market Analysis

This assignment provides an in-depth analysis of the Australian housing market. It explores factors influencing prices, such as interest rates, affordability, supply and demand, and investor behavior. The report examines historical trends, current conditions, and potential future developments, considering both economic and social implications. It also proposes policy measures to address potential risks and ensure a stable and sustainable housing market.

The Dangers of a Steady Low Cash Rate Approach
The Reserve Bank of Australia (RBA) has gradually lowered cash rate since 1990. The last
significant upward cycle took off in the early 2000’s but was drastically cut short in the wake
of the 2008 Global Financial Crisis (GFC). However, as the global economy bottomed down in
2009, and Australia witnessed its largest mining boom in recent history, in November 2011
the RBA started to gradually cut the official cash rate to its current record low of 1.5%. While
this has a series of diverse effects in the overall economy, more significant implications are
seen in the unemployment, consumption, corporate investment and housing markets.
The current low cash rate strategy has created a short term ‘safety-stability-net’ for the
Australian economy which helped the economy to remain relatively stable while other global
economies suffered significant consequences of the Global Financial Crisis (GFC). However it
is uncertain if this strategy is sustainable and raises concerns of its long term effects, which
may not be positive for the economy.
While maintaining low rates has helped the Australian economic stability, it could, in the long
term, have negative implications. Some of these include increasing risky debt, speculative
bubbles, leakages from foreign investments, the risk of not being able to increase interests
without significant economic consequences; and inequity, reducing the quality of life for the
less wealthy and favouring the richest. In the long run, these implications may have other
economic consequences such as the need for additional government subsidies, further
leakages, high crime rate and recession.
Cash rate
The Reserve Bank of Australia (RBA) sets the target ‘cash rate’, which is the market interest
rate on overnight funds. Target ‘cash rate’ areone-day loans that help banks keep each other
liquid. This cash rate is a key instrument for monetary policy used to stimulate the economy
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on the desired direction. The RBA dropped the cash rate to 1.5% in August 2016 and has
remained at that level. The drop in cash rate has been done in response to the losses in the
mining industry and to diversify the economy.
The cash rates have different effects, if they go up lenders would want to increase demand
on overnight loans as they would get more revenue from them; the effect would be a
decrease in supply of long-term loans, which potentially would result on interest increase for
other types of loans, including mortgages. When interest rates go down, borrowing becomes
cheaper so there is an increase in supply of long-term loans at lower rates, including home
loans. Therefore, a lower cash rate incentivises low interests in long-term loans and with this
investment, consumption, production and employment increases.
The RBA took on a more aggressive ‘cash rate strategy’ since 2012 when the mining industry
took a decline. RBA aimed to maintain inflation within a 2% to 3% range. Through the low
cash rate strategy, RBA aims to stimulate and achieve a diversification of the economy. The
rationale behind the strategy, is that savings for banks ‘pass on’ to consumers.
While interest rates are low, investment grows and consumers have more liquidity to spend
in the economy; also, as interests on savings are also low there is less incentive to save.
Based on the circular flow model, savings are considered a leakage whereas investment is an
injection so low cash rates seems to be the perfect formula to keep a healthy economy while
supporting diversification.
Price elasticity of demand and the Australian housing prices
Due to the price elasticity of demand, as long term loans like mortgages became more
affordable, demand on housing increased, however as the supply was less than the demand,
this led to a significant increase of housing prices in most Australian cities.
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The mix of high demand, low debt cost and low supply stimulated growth of residential
construction with a rise in real estate investment. As a result, RBA was able to meet its short
term desired target of increasing employment and consumption in the country.
However, this approach has a side effect attached as well. While the rise in housing prices
has been a greatly profitable business for constructors, prices have risen so much that
housing has become unaffordable for the consumers.Hence, individuals who are not in the
investment game find it difficult to compete against investors when trying to buy a home to
live in.
Debt levels on the rise
Marion Kohler and Michelle van der Merwe (2015) explained how the housing prices have
increased consistently with a 5 % average inflation rate in the past decade. The main concern
here is that housing debt-to-income ratio has increased as well (see chart 1 in appendix) and
if interest rates go up or tax benefits are reduced the debtors in the population may not be
able to afford their mortgages and this could result in a recession.
Another consideration is that housing prices continue to rise at a significant rate, faster than
consumers’ incomes. While benefits and tax exemptions seem to help investors, there are
little benefits to alleviate home owner’s consumption pattern.
Analysts have expressed concerns that the Australian house prices to income ratios are
showing similar trends to those observed in economies prior to speculative bubbles to burst.
Current housing prices to income ratio in Australia is close and in some cities even higher
than the levels this ratio presented in the U.S. before its two biggest recessions in 1929 and
2007 (see charts 2 and 3 in appendix).
The risks of oversupply
In early November 2016 the RBA announced that despite the housing supply hasn’t reached
equilibrium with demand in major Australian cities yet, if construction continues to grow at
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current rates there will be an oversupply in the CBDs of some capital cities in the next 5
years.
It is important to note also that Australian population growth rate of 1.3 - 1.4% per year
(Australian Bureau of Statistics, 2016) is significantly slower than current dwelling
construction rates of 2.5% (IBIS industry report, 2016) which can possibly reach a point of
saturation in the next 5 years (see chart 4 in appendix).
Another consideration is the type of dwellings that are currently being built. Majority of the
investment is going towards apartment blocks in the inner city of major CBDs, however, this
is not necessarily the type of housing the Australian consumers are looking for. Young
families prefer houses with backyards in the suburbs rather than crowded apartments.
This trend has already been seen in Melbourne where a great percentage (around 20%) of
new rental apartments are vacant even after a year of completion. Some analysts believe
that the government is somehow subsidising these losses with ‘capital gains’ and ‘negative
gearing’ and this has become a dangerous game as these benefits can possibly be more
powerful than the rental income.
Cash rate effects on savings
While low cash rates stimulate debt they also discourage savings. As expenditure goes up,
savings go down. Interest return on savings is so small that money remains injected in the
economy instead of leaking into consumers savings.
This, apparently is a significant result of the low cash rate strategy; however it also has a
direct effect on housing affordability for consumers and an immediate effect for the oldest
population.
Low interest rates have made it difficult for consumers to save for a house deposit which
continue to increase as the house prices go up. It can be said that low interest rates and its
potential consequences have reduced the possibilities for consumers to own a home. There
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is only a small proportion that can safely afford housing at today’s rates, borrowing 80% or
less of the property value as recommended by the RBA. In the long run, low interest rates is
building an economy in which the rich investors are vastly benefited and the consumers are
destined to pay rent all their lives or have to take huge debt to afford a house.
Despite numerous regulations which intend to prevent risky debt, it is important to notice
that banks are lending huge amounts of money through mortgages. If this trend continues, it
is most likely that construction will reach a point of saturation in the next 5 years. The
saturation in the construction and housing market may come with side-effects such as the
possibility of high unemployment. Moreover, lending at today’s rates cannot guarantee
buyers will always be able to afford their debt if interest rise again which can be a strong
threat to the economy on the whole.
It seems that a population without savings wouldn’t be prepared to respond to a recession or
to afford their mortgage payments in the case of unemployment.
Inflation
The RBA creates monetary policy to control inflation within a target range they consider ideal
for the economy, currently defined between 2-3%. This rate of inflation is sufficiently low
that it so it does not materially distort economic decisions in the community, but as it is
always above zero it indicates that prices always go up incentivising consumers to “buy now
before things become more expensive”.
As inflation goes up Aggregate Demand (AD) also goes up. The RBA argues that if inflation
was too low, consumers would tend to save more and spend less and this would create a
contraction effect in the economy that could eventually drive to a recession. It is important
to notice that while current inflation is lower to the desired rate (1.3%), trust in the economy
remains strong, and as stimulus in consumer savings are so low this contraction effect is
unlikely to take place at this point.
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As discussed previously, as per the demand pull inflation while demand for housing
increases, prices climb; and property becomes an excellent opportunity for investors.
However, this type of inflation can have a negative effect on consumers. Investors have also
multiplied, from a local and foreign background. In an economy where there are many
wealthy investors who have benefited of the reduced rates and tax benefits spend in the
economy, there is an increase in demand in local and imported products, which increasing as
a result demand, and with it the prices of the entire economy, moving into a wage-price
spiral.
On the other hand, with constant inflation there is a constant currency devaluation, this
favours Australian exports as they are cheaper for overseas buyers and also stimulates
foreign investment; including real estate investors and constructors, who spend significant
amounts of money in the local market favouring the price rise for dwellings.
Unemployment
The Phillips curve states that unemployment and inflation are inversely related: as levels of
unemployment decrease, inflation increases. The relationship, however, is not linear.
Graphically, the short-run Phillips curve traces L-shape, when the unemployment rate is on
the x-axis and the inflation rate is on the y-axis.
In Australia, currently inflation is lower than the desired range (1.3%) and we can see the
unemployment rates are low but have increased in the past years, remaining between 5 to
7%, averaging 6.93% from 1978 until 2016, being the highest rate in October 2015 and
lowest in February 2008. If inflation remains in the desired range (2-3%) it is expected that
unemployment remains between 5-7%
Maintaining unemployment rates under control so that the government can ensure the
economy is active, consumption keeps moving and the government payments for
unemployment is maintained under control.
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Based on the Australian Bureau of Statistics report from August 2016, we can see that,
consistently with the Phillips curve the Australian economy has followed a trend while
inflation has gone down, unemployment has gone up (see charts 5 and 6 in appendix).
Despite both inflation and unemployment have remained under 10%, some analysts have
raised concerns that in the case of a speculative bubble burst and a recession,
unemployment will rise and inflation would go down, this could have disastrous
consequences affecting consumption, the local economy and the exports.
Speculative Bubbles
As property price to income ratio has increased its current high levels, some analysts believe
this is a symptom that the Australian property market is in a speculative bubble which could
burst in the next couple of years.
One of the arguments behind this prediction is that it seems the current property prices are
more driven for who can pay more for them than their real value, and how much could be
the future financial benefit to them. Property auctions in the main cities, on the other hand,
has allowed that some properties are sold to investors at prices which were not expected. It
is reported that foreign investors find it reasonable to invest in Australia despite the high rise
in housing prices.
It is important, that the RBA keeps monitoring these anomalies and ensure it puts measures
in place to avoid these skyrocketing prices to continue. This is in order to prevent the bubble
to continue to inflate and eventually burst, which would generate a recession and damage
the current economic stability. It is also important to keep into consideration prudential
regulations for lenders so they ensure that buyers can afford their debts if interest rates
increase in the future.
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Economic Inequality:
Dr Anne Holmes (2015) defines economic inequality as the unequal access to wealth and
income and how as this mostly refers to income, in most developed countries like Australia,
market income is mainly from wages and salaries, but also from returns on capital such as
shares and rents. It is concerning how the cash rate strategy, along with the negative gearing
have favoured real estate investors to a point that most recent statistics have starting to
show entire suburbs in the main capital cities where more than 50% of the units are
investment properties, and this number continues to increase.
The Reserve Bank Board sets interest rates so as to achieve the objectives set out in the
Reserve Bank Act 1959, these include the stability of the currency of Australia; the
maintenance of full employment in Australia; and the economic prosperity and welfare of
the people of Australia.
The current monetary policy is achieving all these objectives however, the growing inequality
is putting consumers in disadvantage and the economy at risk, it is incentivising heavily
investment but making it hard for consumers to acquire homes, and those that do are
acquiring enormous amounts of long term debt which are risky if interests go up. On the
other hand, the increase in investment properties will favour a high supply of rental
properties which will destabilise the rental market, however the current generation of
consumers who can’t afford owning a home will be destined to rent, and eventually will
become a generation the government will need to subsidise.
The Cons
We have seen how the low cash rate strategy has helped maintain economic stability and
growth but also how it has a series of compromises in the overall economy and the
opportunity cost seem to be a problem for the long term future of nation.
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While low cash rate benefits investors and stimulates the expenditure in the economy, this is
also stimulating debt and discourages savings. Low interests in savings affect directly a
vulnerable group of the society; retirees who depend on their savings to live; as well as
younger generations who can’t save for a deposit, therefore can’t afford to buy a house, plus
the fact both groups are taking enormous risks and debt to acquire properties or
investments. The long term effects of this could be negative for the economy, both
demographic groups would require further support from the government in the coming
years, will probably need additional subsidies to live and maintain a decent quality of life
when they become less productive.
There is also the growing disparity in the society where, investors receive the benefits and
become richer and those who can’t afford entering the investment game have no benefits,
find it hard to own a place and eventually become poorer. This also means that rich people
are who are more likely to save and if the economy fails, they can more easily move their
wealth to other markets that are more profitable.
The trap
There are many things that at this point could hurt the economy and it seems it has been set
in a position where there is no much possibility to make changes without having huge
effects.
If new housing construction reaches a saturation point and declines, both investors and
employment will suffer, and with them, the economy. If on the other hand, interests rise, the
investors will “cost push the inflation” to the tenants and rents will become expensive,
which could affect housing, consumption and in an economy where consumers can’t afford
owning their home, the economy will shrink. For those that have bought, higher interest
mean less disposable income to spend in consumption which has the same effect.
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If on the other hand, the government removed the current tax benefits for investors, this
would have a similar effect, the costs will pass on the consumers or tenants, plus their
investments would go into other markets that are more profitable.
In the long term it seems the measures to keep the economy stable have put it ratheron a
fragile place where any move will have it’s compromises and the space for moving is
minimal, pricings are so high that lower them would mean losses for current owners and
investors, interest are so low that increasing them would hurt them as well; and the
economy is mainly supported by mortgages to a point that in the case of a recession or
bubble-burst the consequences would be catastrophic.
Unfortunately after this analysis it seems that we can conclude that the measures that
started with the search for diversification of the economy and moving it away from its
dependency on the mining industry, have moved the economy into a dependency on the
housing industry, however the risks associated with this, seem to be the same or worse than
they were when dependency was on the mining industry in the first place.
Getting out of the trap
As discussed before the strategy of the RBA has some long term risks for the economy and
the welfare of Australian citizens; however there are some measures that could be taken in
order to prevent the economy from failing.
If monetary policy can only be used to achieve one only objective at the time and considering
that keeping inflation between 2-3% since 1990 has helped keeping the economy stable; but
the main risks of this strategy are its long term effects. An improved monetary policy should
now focus on the domestic economy, currently at risk.
It should work along with fiscal policy to reduce the dependence of the economy on the
mortgage industry, currently exposing the economy to a potential recession or a bubble
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burst, in other words should aim to deflate the bubble while maintaining healthy investment
levels and consumption and the quality of life of the consumers.
The new monetary bubble should keep the goal of reduced inflation, but ensure it provides
restrictions to the banking system on the lending risks they take, and discouraging the
growth of investment at the costs of the consumer's quality of life.
Some recommendations would include;
● The banks: Maintaining a low cash rate (between 1.5% and 3%) but limiting the
amount that local banks can borrow from foreign banks, to limit the effect on the
case of a foreign crisis. Implement a minimum reserve for banks and reinforce
regulations to ensure they only lend to qualified consumers that could afford an
increase in interests in the future. Offer stimulus for banks to offer savings benefits to
consumers that are in disadvantage like pensioners that live from their savings or
aspiring homeowners that need to save for a deposit. Incentivise early debt payment
● The investors: Increment barriers for foreign investors and facilitate local investment
so leakage is reduced. Continue to incentivise the housing construction, but ensuring
it is the quality the market is demanding and not the current one that is saturating.
● Housing prices: Re-look at the auction system and regulate housing prices; looking at
an approach of set prices per square meter depending on location instead
● The affordability: Implement regulations to ensure salaries growth is aligned with
inflation. Create benefits not only for investors but also for consumers /homeowners
● Diversification: Provide stimulus to other industries to really diversify the economy,
support internal production or services. Put higher barriers and taxes to imports to
incentivise local production.
● The population: Incentivise natural growth of the population so consumption can
naturally increase as inflation increases (currently 1.4%). Educate the population on
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basic economics and investment, teach the local citizens to take advantage of their
money and help them to keep moving the economy
● Long term benefit housing: Offer benefits to organisations that want to support
making housing affordable for consumers, not only investors. And building the type of
housing that improves the quality of life of new families, incentivising natural
population growth.
Despite monetary policy can only affect one thing it can work in conjunction with fiscal policy
and small adjustments in different areas can provide a safer environment for investors and
local consumers; as the economy is at a very sensitive point the measures should be taken
from an overall perspective, to ensure all possible implications have been considered and
with them preventive measures implemented.
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References
Reserve Bank of Australia cash rates announcement, August and November 2016.
IBISWorld Report. House and Construction in Australia, November 2016.
Samuelson, W. & Marks, S., 2014, Managerial Economics, 8th edition, Wiley.
Marion Kohler and Michelle van der Merwe, 2015, Long-run Trends in Housing Price Growth.
Dr Anne Holmes p.44, 2015, some economic effects of the inequality, Parliament of Australia.
Tim Lawless, 2014, National Market, Research Blog Industry Analysis
Rocio Sanchez-Moyano, 2013, How Helpful is the Price-to-Income Ratio in Flagging Bubbles?
Harvard Joint Center for Housing Studies
Reserve Bank of Australia, Reserve Bank Act 1959. No 4.
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Appendix
Chart 1. Debt and price to income ratios. Source ABS with RBA data
Chart 2. Ratio dwelling prices to household income across Australia. March 2016. Source.
Australian National University
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Chart 3. US price to income ratio 1991 to 2012. Source Joint Centre for Housing Studies
Harvard University
Chart 4. Underlying Supply and stock deficiency. Source Australian Bureau of Statistics
Chart 5. Australia unemployment rate 2016 to August 2016. Source ABS
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Chart 6. Australian inflation rate 2006 to August 2016. Source ABS
Chart 7. Investor owned dwellings are heavily concentrated within the inner city
apartment markets. Source Tim Tawless (2010)
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Chart 8. Australian Cash rate 1990 to November 2016. RBA report
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Chart 9. RBA interest rates
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Chart 10. Consumer price index forecast RBA
Chart 11. Australian GDP Growth and inflation
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Chart 12. Household sector. RBA Charts pack
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Chart 13. Interest rates. RBA
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Chart 14, Australian population growth. Australian Bureau of Stadistics. March 2016
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