House prices, interest rates and land supply

It is astonishing the disconnect between those looking at housing from the financial market perspective and those of us looking at the regulatory barriers.

 Christopher Joye in the AFR today discusses a debate he has been having with fellow self-proclaimed housing guru Gerard Minack.  Apparently these two are sparring partners on the financial advisory circuit and now, as usual, give contrasting views about the direction of housing prices.  Their views seem to be dictated solely by interest rate movements. 

Interest rates are clearly highly significant to house prices.  Lower rates mean cheaper mortgages and with supply only able to shift gradually, housing become more affordable and prices rise in response to the consequent demand surge. 

 Well that’s Economics 101.  But like all theories it needs to be tested empirically.

And here we find some discordant outcomes.  In the US interest rates like elsewhere are set nationally.  But some markets (California, Miami, Seattle) see price booms and price busts.

 Here the Shiller index for San Francisco

San Francisco

 Prices almost doubled between 2002 and 2006 then almost halved to 2010 and have since increased by 40 per cent.

 Here is the Shiller index for Dallas

 Dallas graph

Prices rose 10 per cent 2002 to 2006 then fell 5 per cent to 2010 and have since increased by 10 per cent. 

It is almost as if they were different countries. 

Joye is certainly right to warn of the RBA seeking to accommodate the boom in housing prices – the San Francisco trend is testimony to what happens when central banks do that. 

But missing from his analysis is the factor that has driven the different outcomes seen in Dallas (and most of the south, and mid west) and San Francisco (and most of the west coast and east coast).  And this is the land supply to allow flexibility of new building.  In places like Dallas, land supply is not regulatory suppressed by the government.  In California, the land supply is strictly controlled and prices are high so that new home prices are also high and these levels are reflected throughout the urban areas.  The price oscillations when demand softens are considerable.

Australian urban areas are like San Francisco.  Governments have bent to a Baptists and bootleggers alliance.  The Baptists are environmental activists against urban sprawl and productive uses for land; the bootleggers are speculators and developers (boosted by recent buyers of new over-priced properties) wanting to maintain prices.  the would-be new  home owner is crushed between them being forced to pay $100,000 -$200,000 more for a new house than its underlying value.  State governments in Victoria and NSW are seeking to tilt the balance back to the consumer but the interest groups and the residue of regulations and bureaucracies assembles over several decades may make this difficult. 

Joye barely recognises the supply side issues stem from land supply.  But he does finish with 

“A final concern is Australia’s housing supply challenge. We do need to build many more homes to accommodate the circa 15 million additional residents that will live here within 35 years.

 “Developers do require positive price signals to commit scarce capital to constructing new supply. If our mounting supply-side deficiencies are allowed to accumulate we could see an even more exaggerated housing market cycle.”

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23 Responses to House prices, interest rates and land supply

  1. Snoopy

    Great post. Suggest you add “Here is the Shiller index for Dallas” above the second graph.

  2. Rafe

    In addition to the inflation of land values by restrictions on supply both state and local governments impose major costs by regulations and levies. Some councils in NSW have minimum sizes for units which far exceed the size of places that many people would happily purchase.

  3. .

    Supply is the killer.

    Also Rafe there are regulations on minimum sizes for complexes and also economic imperatives like scale economies (made worse by rising costs elsewhere in the industry). There are mid level developments which are made uneconomic around where they are demanded, such as train stations.

    The tell tale sign is that the PCI has been in a decline phase for 39 straight months. There is little profit in development and prices are high.

    The only logical conclusion is that taxes and regulation are responsible.

    This must be quoted once more:

    House prices up to 44pc tax: HIA report

  4. .

    A bit of simple maths, if I may.

    What would the tax RATE on dwelling construction be then?

    If the tax comprises 44% of price, then there is 56% of other costs.

    (44/56)*100 = 78.57%

    The tax RATE is almost 80%

  5. H B Bear

    There is not scarce capital for land development. There is hundreds of millions of dollars worth of land banked around the major cities. This exercise is only profitable because of the extraordinary price rises achieved as its zoning transforms from cow paddock to residential. Cut out the zoning and regulations that allow this huge price differential, eliminate the ability for capital appreciation to offset lengthy holding period costs and you would produce a much more flexible land supply and eliminate the predominantly oligopolistic supply of urban land.

    Then start on the hidden taxes and charges, excessive POS requirements and mandatory environmental building standards.

  6. Craig Mc

    Thanks for this piece. We were wondering how the US property market was doing just last night.

    Simple fact, if everyone wants to live in one of just seven capital cities (practically – just five), then you’ll have price pressures, and it won’t matter much what land-use policies you have.

    It’s quite striking how differently regional cities seem to have developed overseas. In the USA for instance, state capitals are in regional centres – not the majors. That’s like the equivalent of a mini-Canberra. A concept like Canberra has its manifold problems, but could you imagine the price pressures if its population was incorporated in Sydney or Melbourne instead?

    France is remarkably decentralised compared to us. That has to take pressure off Paris and its smaller siblings. There seems to be a small town every 5-10kms. Living in a village has its downside, but it must work for a lot of them. France has about twice the rural population we do (as is the USA).

    Different countries with different geography, history, social expectations and demographics develop differently, so I won’t pretend I have a practical means to bring about decentralisation. All I know is price pressures are inevitable, no matter what land-use policies are, as long as we don’t.

    And that’s probably a good thing. I’d rather be Singapore than Detroit.

  7. Luke

    There is no point even discussing the housing bubble unless you are willing to discuss the biggest influence on over-pricing – negative gearing. Negative gearing does not creates new housing. Demand creates new housing! Negative gearing merely ecourages investors to over pay and advantages investors over home owners.
    Oh and the State setting land values for the purpose of rates and land tax (and you thought we were a free market society) . Whilst you don’t have to pay that price for land, it sets the mental anchor for value and pushes up ongoing costs. Council’s have had the biggest financial booms ever in the last decade (pure undeserved extra income).

    The effects of the housing bubble are getting worse as the flush baby boomers and early gen Xers exit the working world and so too does their disposable income. They are being replaced by people who have far less disposable income and savings because more and more of their income is being swallowed up by housing costs (and HECS debts – how many baby boomers started their working careers with an entire year or two’s wages worth of debt?). It is this increasing capture of new workers’ income being swallowed up by high housing costs (and a degree by HECS debt) that is locking in a slowing of our economy.

    It is simply ridiculous that in a country almost the size of America with only the population of Holland should have housing prices that are getting up to 7 times the average wage (which is itself high).

  8. Rabz

    That there are shortages of land for housing in a country the size of a continent is infuriating, inexplicable and unacceptable.

    Yet again, this issue can be sheeted back to the utterly criminal incompetence of our so called leaders and the infestation of local and state governments and bureaucracies with arrogant, lobotomised leftist numpties (BIRM).

    Ultimately, if they had their way, this is what we’d all be living in, peoples.

  9. H B Bear

    The other factor is the US has a more mobile population. People are moving to Texas, Alabama and from California because that is where the jobs are being created. In Australia stamp duty and other transaction costs are a very significant barrier to labour mobility. The US also has a much more competitive state taxation jurisdiction that is almost completely absent in Australia.

  10. Bruce

    Supply is a huge issue, no doubt, and state governments should take a serious look at this.

    There is another issue, and that is the fundamental shift in employment patterns over the last generation. With the mass entry of women into the work place, the average household income has increased significantly. This enables buyers to pay more, which drives up prices: people choose to spend more, making more expensive houses the norm; and governments can gouge more.

    I am in no way concerned by the move of women into the work force, but it is a fact that this dynamic has left people without two incomes in a hole: single people have trouble buying, and so do couples with children and no second income, or a small one. This in turn puts pressure on families to have the wife back at work ASAP, which is in itself a discouragement to having children. I believe that this dynamic was a large part of Abbott’s motivation for his full replacement PPL scheme.

    The reality of this inflation of expectations was brought home to me when my wife and I bought a four bedroom house in Canberra. Built in 1970,at 102 square metres it had a kitchen / tiny dining / small lounge area, four modest bedrooms, one toilet, one shower room, one bathroom. It suited us well, but it would never be built these days – and in its day, it was for a family with three or four kids. These days, an en suite is essential, and four bedrooms means at least two living areas. In comparison, our flat when we first married was three bedrooms, an en suite and 120 square metres. I’m not complaining about increased living standards, but we must be realistic about what that means regarding prices.

  11. Rafe

    Another consequence of inflated house prices is the need to have two-income familes and hence the demand for other people to help with child care and parental leave.

  12. How much are house prices inflated by our unlimited family home tax shelter ?

  13. Alan Moran

    Your 12 square house of 1970 was a bargain and doubtless we can make economies on current houses but the fact is that in spite of massive increases in building regs the cost of building a house has remained modest. This is due to the industry being highly competitive based on non-unionised small business contractors. If you look at the house ads you will see that there are many offers for 3-4 beroom houses 2 baths two garages for $120,000

  14. Token

    Negative gearing does not creates new housing. Demand creates new housing! Negative gearing merely ecourages investors to over pay and advantages investors over home owners.

    From what angle are you starting this discussion?

    Address the stupid layers of tax which make alternate investments to housing less attractive, or just the old game to remove this discount on tax which most people can understand and people from all income levels may access?

    How much are house prices inflated by our unlimited family home tax shelter ?

    Same question as above. Is the question posed in a way to address the layers of tax and regulation which make people hide much of their capital in housing?

  15. Token

    Another consequence of inflated house prices is the need to have two-income familes and hence the demand for other people to help with child care and parental leave.

    Am I missing something in this discussion?

    Dual income families is also driven by the desire of women to have a productive career where they are finacially rewarded.

    Once the money comes in, they look to investments they understand and so many see housing as the best way to go. Are there successful alternate models from overseas where people address the need for certainty in terms of their housing while not over-investing in their home?

  16. Myrrdin Seren

    In addition to the inflation of land values by restrictions on supply both state and local governments impose major costs by regulations and levies.

    and while I can’t prove it empirically, I suspect this is a big flow-through to the ridiculous cost-of-living relative to income levels in the Australian cities.

    People are squeezed and I am genuinely surprised that C-o-L wasn’t a bigger issue in the election.

    Granted – Australia is a long way from the rest of the world, but transportation has become cheaper. We have a huge agricultural base.

    Okay – our small population wants to cluster in a few coastal cities, so supply/demand is an inflator – but really, ask anyone who has lived overseas or moved here in the last few years. Australia is insanely expensive.

  17. one old bruce

    Where is the restriction on supply? My impression is you are perfectly free to buy cheap real estate in the underpopulated towns of most of inland Australia – a vast area. But few want to.

    The recently unfettered mobile population of most of the world is migrating away from rural agriculture to megacities – this appears to be the current human obsession. If you want to facilitate this, then I suggest bulldozing Mosman, or any part of Sydney with low rates of population per square km, and allowing shanty towns to grow there, just as Australia’s rural towns began in the gold rushes. Is Mosman full of environmentalists?

  18. Myrrdin Seren

    Is Mosman full of environmentalists ?

    Well bruce, some of the Mosmanites would presumably welcome a discretely placed, lowly paid underclass for domestic duties – as occurs in India for example.

    But you will find they will get very ‘green bans’ if you threaten the visual amenity of the suburb 🙂

  19. one old bruce

    Also, many folk actually wish to live near or on our Sydney Harbour. But what purpose does that body of water serve? Why not increase the supply of land – exactly where people want it – by allowing infilling of Sydney Harbour? A tram service can more cheaply replace the ferries. Indeed people will be able to walk across the former waterway.

    Certainly there is currently a restriction against filling in and building on the Harbour. All those environmentalists no doubt. Open it up for development!

  20. Docket62

    Negative gearing…

    I work in finance. I work with first home buyers, investors,developers et al. Have done for nearly 20 years, and own and gear property myself, so I have some understanding about how it works, who it works for, and what it does.

    The rules changed in the early 80’s when lenders made a quantum leap in allowing spousal income to be used to service debt. Almost all growth in debt, personal, mortgage, credit cards etc. stem from this fundamental change.

    The supply side of the equation (again economics 101) is simple. We lack supply. The past 6 years of government have shutdown the lungs of the country (construction) and life needs to breathed back in to it to start generating construction. Much of that initially is being done through investment…..

    so the venting here regarding NG is focused on only one asset class – property, and yet any appreciating asset can be geared (shares for example) but I never hear the naysayers bleating about their superannuation returns which often ride on the back of geared equities. Instead they point the finger at the mum and dad who want to try and minimize their tax through perfectly legal means, and build something for the future. Along the way, they will pay land tax, rates etc and finally CGT on the profit, all the while maintaining a property that someone who either can’t or does not want to afford, occupies.

    Property growth, like shares is a cyclic event. Driven as much by increased wages, as supply. (The more you can afford the more you can borrow). There are clear markers for upticks in the cycle, and they are in place now. The banks are swimming with cash (savings) and bookended by trillions of $ in Super. We have a limited supply and a growing demand fueled by greater confidence. The kicker will be subtle changes in lending criteria to release the cash in lending. When that happens. Buy

    NG is as essential to provide housing as it is to leverage shares. People buy where they can afford, and rent where they can’t. You can buy homes for 3 to 3.5 years multiples of ‘average’ income… I know that for a fact, I finance them. Just because you WANT to live where the prices are 7x isn’t the markets issue- it’s yours.

    Buy where you can afford. Make sacrifices to do so… Or STFU

  21. .


    Go back to the supply fucntion.

    GDP = f(L,K, A, t…)

    Earning a 2nd income and investing in housing ought to bring dwelling prices down with industry adjustment. But it doesn’t – somethign is wrong with supply.

    Investment in property ends up earning economic rent in the true sense, or being a crap investment. Those who are already holding assets will earn rents, but the yields may be pathetic.

    People may overinvest in their home as they have already paid taxes on it. It is why you are better off extending than buying a new home. The current system provides incentives to maximise capital gains on taxes already paid or exempted rather than to create more cash yielding assets that would expand supply.

    Stamp duty is an impediment to rational housing decisions such as building a new bigger home or moving for work.

  22. brc

    Where is the restriction on supply? My impression is you are perfectly free to buy cheap real estate in the underpopulated towns of most of inland Australia – a vast area. But few want to.

    The problem is one of relative costs. Because so much of the cost is tied up in regulations and taxes, it is unrelated to the location of the property. Stamp duties punish families for moving, and restrictions on development are just as acute in regional centers as in cities.

    A house in regional Australia should be a smudge over the construction costs. But they are not. They are still pricey. So people opt to live in cities and enjoy the higher wages and better services that this brings. This is ultimately not about who can’t bear to live away from a latte dispensary.

    Negative gearing is a distraction, as is two-income families and two-toilet homes. All these factors are present in other jurisdictions like the US (you can deduct interest on the family home there). A friend of mine just moved to Lexington, Kentucky, a regional area of the US. A quick browse on the Internet finds large, 5 year old homes on big blocks for $150k. A smaller, older place in Bathurst will cost double that.

    This is a supply side story, caused by excessive taxes and regulations coupled with crimps on demand from punitive taxation. We moan about the carbon tax while the average family has to pay a 15k moving house tax. It’s outrageous.

    So dump the muddled thinking around dual incomes or housing size and look at the supply side or negative gearing or ‘cashed up baby boomers’, because they do not mean anything in comparison to the regulations-enabled supply side strangle we have.

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