Why Housing Is Unaffordable

Richard Giles

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We are here to talk about housing affordability. Housing affordability is falling and we want to know the reasons for it.

What is Housing Affordability?

Reduced to its simplest terms declining housing affordability means two things. First, those who are renting or buying homes are spending more and more of their disposable income on rents and mortgages. Second, it means that more and more folk who want to buy a home cannot do so because the mortgage is beyond them. Those are obvious conclusions from the information on your Facts and Principles Sheet. That information in the end says nothing more than this: the cost of accommodation is rising faster than incomes. The result is that shelter is absorbing an ever-greater proportion of wages, even though, as now, that is most often a double income. That the cost of shelter can rise faster than the rise in incomes is partly due to an important principle. This is that the cost of housing tends to absorb all surplus disposable income. Food, clothing, shelter are the basics of life. So it is not surprising that people will try to meet the rising cost of shelter.

To illustrate: in the 1970s double incomes became common and provided overseas holidays and other 'extras'. But now what we see are two things. On the one hand rising property prices are absorbing those gains so that many on double incomes are no better off than single income families were thirty years ago. On the other hand we find young people more prepared to stay at home or batch in large numbers while holding on to the 'extras'.

Land Appreciates; Houses Depreciate

Some weeks ago I tuned into one of those TV advertising programs that tell you how quite ordinary people can become immensely wealthy. My attention was immediately captured, not by the prospect of becoming immensely wealthy, but by a principle the speaker began with. It was this."Land appreciates in value; houses depreciate in value". His comfortable life today, he said, was based on that principle. So I immediately learned where the wealth was coming from. It was coming from the mounting value of land helped along by generous helpings of tax depreciation allowances and negative gearing. The speaker even showed us how to do it. Knowing that it is really the land and not the house that matters buy a mediocre house in a smart new suburb. The house will make no money at all but, courtesy of the renter and the 'tax breaks', it will at least pay for itself. But, as the new suburb fills with smart new houses with well-kept streets, lawns and gardens, and, consequently, as amenities increase, the land value will leap ahead.

It was as if we have opened a secret bank account, a land account, one that will never be robbed. Having a house on the land pays the account-keeping fees! Our salesman even spoke with some pride about the fact that his house was the worst in the neighbourhood. And, of course, he did not live there. So much for his contribution to the community. One other thing - and it is remarkable. He claimed (I do not know how honestly) that he had used none of his own money. The money had come from the bank, from the renter, and from the Australian taxpayer. Of course there is nothing wrong in any of this and quite extraordinarily ordinary people, one after the other, came forward to thank him for making them millionaires and to tell him how he had improved their self-esteem. He had helped make the world a better place! Or had he? And here we come more directly to our subject of housing affordability.

The Effects of 'Rent-Seeking'

Our salesman was encouraging us to undertake certain economic activities, activities doubtless called rent-seeking that add to the wealth of some individuals. But do they add to the wealth of the community as a whole? I surmise that, in a properly run society, anyone who makes a million dollars over, say, a six or seven year period (and some had), will have made a very significant contribution to society. So let us ask the persons in our story what they had done. They had borrowed funds, and bought and sold houses. So their contribution to society seems to have been to exchange titles to property. That does not seem to be much of a contribution.

You might say that I have missed the point. The fact that their activities are rewarded by government by 'tax breaks' shows that this is an activity that ought to be encouraged. We do tend to look at the matter that way and, indeed, that is one way to look at it. But there is another way. Remember the house was already there. So they had not increased the stock of housing. What they did was to buy the house and leave it empty until someone who wanted to live there paid the rent they demanded to get access to it. The trick here seems to be create an obstacle, then demand money to remove it! These people entered the housing market when they did not need accommodation. They increased the demand for houses and the demand for housing finance. So their efforts helped raise the cost of housing; that is, the cost of housing land and the cost of housing finance. Forcing up property prices and interest rates does not sound much like a contribution either.

My intention is not, maliciously, to heap criticism on a group of investors who have legally and courageously taken risks to better their own condition. My intention has been to highlight what is an obvious structural weakness in the housing market. This weakness is that presently the housing market encourages rent-seekers to compete with both genuine home buyers and genuine investors.

Confirmation that this is the wrong way to do things is given by the economics of this activity. It makes nonsense out of the laws of supply and demand. We might remember that for a long time the Reserve Bank deferred raising interest rates. Its Governor was well aware of a growing "bubble" in the housing market but he delayed applying the brakes to this rent-seeking activity. This was because he saw that raising interest rates would also stifle useful investment. In other words what was going to stop this harmful activity would harm useful activity as well. This is the kind of dilemma that policy-makers face when they confront rent-seeking. The dilemma is based upon the fact that investment in land seems to work quite contrarily to other investment. Normally, when prices for a commodity go up, increasing demand causes the supply of that commodity to expand. But, when the price of land begins to move upward, supply tends to freeze. The reason, of course, is that everyone is tempted to hold onto property, expecting the price to go even higher. In short, with land, increasing demand reduces the supply!

One other thing: this increasing price which, might for ordinary goods and services cause demand to slacken, actually causes demand for land to increase. This causes a more rapid escalation in land values. The reason is again obvious. The rise in land price is now so obvious that the general public are lured into investing. So we have increasing demand as well as falling supply. The "bubble" is a speculative value; that is, its value is far beyond the value of its location. We might indeed say that something is very wrong with the land market. But what is it that is wrong?

Not 'Housing' but Land

You may have noticed that I have talked of land when, ordinarily we talk of housing. But, remember, houses depreciate. If we talked less about housing and more about land we might begin to better analyse housing affordability. Let us take this analysis further. It is land that appreciates in value and not houses. So, many who can afford to, prefer to hold valuable land vacant. That reduces the supply of serviced land and increases its price. It also increases the cost of supplying those services. So new home buyers invest in relatively unserviced land around the edge of the city or in satellite towns and councils extort development levies from them under the so-called user-pays principle. That again adds to already high prices for land.

We may call these places commuter suburbs. Denied land closer to the centre these new home buyers live far away from relatives and old friends. More to the point they are often far from their jobs. There, time and money is wasted commuting. This fragmented life is not good for families. That and the financial pressure of excessive mortgages can often destroy marriages. With two or even three jobs needed to keep abreast of the mortgage and so much of their disposable income spoken for, child-bearing is postponed or abortions increase. These families have a home but too little disposable income left to furnish it. Thus, they tend to live on credit. The relation between credit-card debt and mortgage debt is too little appreciated.

Do We Want Affordable Housing?

But let us stop complaining and protesting. What we seem to want by being here is to make housing more affordable. So let us turn first to the experts. A prestigious inquiry was held in Canberra in June, 2006. It was called the National Summit on Housing Affordability. Symbolically, it was held at old Parliament House. Unfortunately, like all previous inquiries, this one gave us no answers. It called for a new Federal Department of Housing to keep statistics and to set "benchmarks" and a Five Year Plan (would that solve anything?). It called for national leadership (but was not this Summit supposed to give that?). It called for 'tax breaks' for private investors (as if that was not part of the problem); it called for more infrastructure and for what it called a "more supportive economic environment" (but that would only raise land prices); and it called for another inquiry.

Curiously it called its report A Call for Action. That was a perfect disguise for the fact that it had failed itself to take action. In other words, the experts called on the government to do something while the government called on the experts to do something! So let us start from scratch. What is the problem? What we have already discussed shows us what it is. It is that there is a chronic under-supply of land that, periodically, becomes acute, leading to excessively high prices for land. At this time we have inquiries.

But when we state the problem this way we come to an ominous conclusion. We see that why the problem will not be solved is that we like rising prices for land. We just do not want action that will once and for all reduce the price of land. For that reason the recent Summit virtually turned the inquiry into a welfare issue. It gave the term affordable housing a new meaning. It became housing for the poor. That was a safer issue to address and something could be done about that problem. Government could create more public housing and more 'tax breaks' could be given to encourage private investment.

Take note, as a society we greet rising land prices as good news, while we see falls in the price of residential land as disastrous. As a society we hold solidly to the interests of the "winners", property-owners, and not to those of the underdogs. In one sense we need go no further. We just do not want to make housing more affordable!

Increasing Land Supply

But, treating the matter as a hypothetical, what would we do if we were really serious about increasing the supply of land?

Funnily enough we are very serious about increasing the supply of labour and the supply of capital. But, without increasing the supply of land, the effect of policies to increase the supply of labour and the supply of capital can only be to further increase the price of land. What else? So far we have treated land unaffordability as a single issue. It is really two issues. There is the long-term problem of a tendency of land values to rise, and there is the short-term problem. The short-term problem is due to speculative "bubbles". The long-term problem is due to the fact that the on-going rise in population and increases in economic efficiencies create rises in land values. It is that long-term problem which causes the short-term problem of speculation.

You might have noticed that I have said that the growth of the economy is the long-term problem. That might seem silly. It is bizarre, but it is nonetheless true, that progress itself is the most serious cause of what we call housing unaffordability.

Mortgages have now been extended from 25 years to 30 years and, soon it is envisaged there will be 50 year mortgages. To repeat: something must be rotten in the land market when progress itself causes it to break down.

It seems like we are expecting the problem to get worse. But let us continue our analysis.

Land Values as Public Revenue

We got to the point of saying the obvious: that rising population and economic improvement are the driving forces behind the upward movement in land values. A speculator in land values knows that proposition is indisputable.

But the problem of land unaffordability is not unresolvable. We only like to make it look like that. All we really need to do is to look at the problem from a community viewpoint rather than from a personal viewpoint. To do that all we need to do is to do something quite horrid by the norms of modern economics, we need to replace a selfish view of the issue by a moral view.

Justice requires that we see that land values be returned to those who produce them. And that is the community. It alone has a moral right to land values and it alone needs the moral courage to take them.

Let me put this another way. We produce land values and we suffer the effects of not collecting it. If we adopted a more principled way of dealing with land we would make the land market work more like other markets. For instance, the only ones buying land would be those who wanted to use it. Speculation would vanish. Owners of productive land would release it for use. There would not be, at least in the foreseeable future, any shortage of land, any failure of supply. Revenue generated by community growth would be spent upon public services. Infrastructure would then stop being extorted by development levies from unwilling developers and home buyers. You might say that we as a community would be like a vast company that 'ploughed back' part of it earnings in services that would enable further growth while, at the same time, it paid its individual share-holders a citizen's dividend. It really is so easy to have abundance and happiness but it is only just that we must deserve it!