When reading the mainstream press in Australia, one would get the impression that the housing/rental crisis in Australia can be ‘solved’ simply by building more housing. The logic of this mainstream belief is simple: there is a housing/rental crisis because there is a shortage of housing in the face of rising demand; therefore, the only way to ‘solve’ this problem is to increase the supply of housing. As a result of such beliefs, ‘solutions’ such as (1) increasing the government release of land for home building and (2) encouraging investments in home building are proposed.
This is where we differ from mainstream opinion. While it may be true that there is a rental/housing crisis in high demand areas, we doubt it is true for Australia as a whole. Hence, in this article, we will question some of the beliefs in mainstream thinking (we need to thank the people discussing at Steve Keen’s Debt Deflation blog site for shedding light on these issues):
- Is there really a shortage of housing? Let us turn our attention to the census data at the Australian Bureau of Statistics (ABS):
2001 2006 Growth Number of Total Private Dwellings 7,790,079 8,426,559 8.17% Number of Unoccupied Dwellings 717,877 830,376 15.67% Number of Households 6,744,795 7,144,097 5.92% Population 18,769,249 19,855,288 5.78% Number of Dwelling/Household 1.15 1.18 2.60% As we can see, from 2001 to 2006, the growth in the number of dwellings far exceeded the growth in the number of households. In addition, the growth in the number of dwellings also far exceeded th population growth. As the average number of persons per household in both the 2001 and 2006 census is 2.78 (i.e. remained the same) this could not be explained by the decrease in the size of households. This hardly looks to be a shortage situation!
- Is there hoarding of housing? According to the census data, the proportion of dwelling that was unoccupied during the census night in 2001 and 2006 was 9.22% and 9.85% respectively. Looking at it another way, the number of dwellings exceeded the number of households by 15% in 2001 and 18% in 2006! Furthermore, the rate of increase of unoccupied dwellings increased almost 3 times the increase in population. Some of these unoccupied dwelling could be due to temporary factors, but it would be fair to say that a significant proportion of unoccupied dwellings are surplus vacant dwellings (i.e. hoarding).
- Are rental price sensitive to interest rates? Whenever the RBA decides to raise interest rates, those with vested self-interests will scream that this will result in another surge of rents, thereby ‘exacerbating’ the rental ‘crisis.’ We believe this is a myth. The real cost of rents is impervious to real interest rates, as shown by these graphs:
Source: Discussion forum at Global House Price Crash (RBA, APM June newsletter, Abelson 2004, ABS)
So, given these findings, here are our theories on what may happen when interest rates rise:
Given that there are expectations of further interest rates rise in the near future, there will be declining hopes for favourable and economical capital appreciation of residential properties for investment purposes (see Australian property good investment? Part 3—prospects of capital appreciation). This is especially true in Sydney where property prices are expected to remain flat. For western Sydney, property prices can even fall.
Since a significant number of dwellings are vacant, interest rates rise will increase the real costs of holding those dwellings as investment properties (i.e. non-productive assets). Since investors cannot count on capital appreciation to make such investments worthwhile, they have two choices:
- Liquidate those properties.
- Put up those properties for rent.
Such outcome will put further downward pressure on property prices and rental yields.
For properties that are currently being rented, are landlords able to increase rents easily to cover higher interest costs? Perhaps so in high demand areas, but we doubt they can easily do so everywhere else. As the above-mentioned graph has shown, the majority of landlords will probably find it difficult to raise their rents. Even if they could do so, would that be enough to cover higher interest costs? Since they have to face competition from investors who are hoarding vacant properties, it is even harder for them to jack up the price of rents.
Thus, with flat property prices, increasing interest costs and flat real rental returns, investors will find themselves squeezed. This will further encourage the liquidation of investment properties, resulting in further downward pressure on property prices. When property prices deflate, what will happen to the rental market? As we said before in Australian property good investment? Part 2—Rental & affordability crisis,
Because housing is largely unaffordable to a large segment of society, it serves as an impediment for them to leave the rental market through the acquirement of their own property. If they cannot leave the rental pool, it can only lead the pool getting larger as more and more people enters the pool.
That means that when property prices deflate sufficiently, renters who previously could not afford to buy their own homes can now do so. This in turn will shrink the rental pool and thus, reduce overall rental demand. This will put further downward pressure on rent prices, which will further put pressure on property prices, resulting in a vicious feedback cycle.
In short, these are our findings:
- There is no overall housing shortage. The increase in the number of dwellings far exceeded the population growth and household formation. Furthermore, the increase in unoccupied dwellings is almost triple the increase in population growth.
- Hoarding could be the reason for housing ‘shortage’
- Overall, real rental costs are resistant to changes in real interest cost.
As a result, many of the conventional solutions to the housing/rental crisis will not work. Therefore, the only sustainable solution is to introduce/change policies that will encourage a sustained decline in property prices (e.g. remove Capital Gains Tax exemption, close negative gearing loophole)- we recognize that such solutions are politically costly (nobody wants to see the value of their property fall). If the government will not make such a move, then sustained interest/mortgage rates rise will have to step in to do the job. Given that this is a highly probable outcome (see Interest rate rise in Australia- be prepared for more to come), we believe that Australian residential properties are bad investments at this stage of the economic cycle. For first-time home buyers, this will be good news.
