Housing shortage furphy

July 8, 2011

RBA and Interest Rates

This is a piece I have wanted to write for some time but never could quite get around to it. But I’m sitting at Melbourne Airport waiting for a plane back to Newcastle and I have stumbled across a really good article that Dr Ed Shann has written on News.Com (H/T Prince over at MacroBusiness) It is an important article because it looks at the furphy that is the idea that house prices can’t fall because of the shortage in Housing. It is a topic near and dear to my heart and one that I have been talking to clients about while I have been down here in Melbourne.

Now you may wonder why I’ve called it a Housing shortage Furphy and the reason I say that is that the question is not of the housing shortage but of housing at prices that people can afford. Or as Shann puts it very succinctly

Some claim house prices must rise as there is a housing shortage of 200,000 houses that grows by 30,000 annually. This is bunk.

The figure is calculated by comparing how many houses are being built, with the houses needed given population growth and the current average household size.

It makes no allowance for house prices, affordability and changing tastes, so it does not tell us how many extra houses are actually wanted at current prices.

There is no housing shortage at current prices. There is a shortage of affordable housing. If house prices fell, more people could then afford to buy a house. To claim that means there is a housing shortage is like claiming there is a shortage of Ferraris or Grange Hermitage.

Exactly. Perfectly put.

When I was a kid growing up in Sydney’s Western suburbs my street was a “mixed” street. That is our side was private homes and the other side were Housing Commission Homes were the families paid rent in the Government provided housing. My Grandparents house in Auburn was a Housing Commission House that they eventually bought as did most of the people across the road from my place.

Back then the shortage in housing was alleviated by the Government provision of housing for families that couldn’t afford to buy or didn’t have the income to to support a housing loan.

So isn’t what we have today in Australia, and probably particularly in Sydney, a situation where as Shann says of houses,

Lots of people would like to own them, but they cannot afford to buy them given current prices and their income.

It’s a classic point and one we have made a couple of times in this and other spaces. Housing is still just a market like any other and pricing is usually set by the marginal player or the last buyer or seller.
So I’d argue that the people who can’t afford to purchase a house at the moment aren’t actually in the market for housing. It is because there is what economist call “price elasticity”. That is the supply and demand for products differs in relation to the price.

In the chart above we have the demand curve of an inelastic market on the left and an elastic market on the right. For an inelastic market think electricity for example – the price rises don’t materially impact on the demand for base load electricity or think of rail services from the Suburbs into the city during peak hour – these are largely unaffected by movements in price as people still have to get to work.

Now there are a myriad of things that impact on elasticity and the way you work out what the elasticity of demand in a market is is by determining the percentage change in quantity demanded divided by the percentage change in price of the good.

If the market is highly inelastic then a small change in price only sees a very small change in demand or perhaps no change in demand. If a market is highly elastic then price matters and a small change in price can lead to a massive change in demand as in the right hand chart.

Now even though the demand for housing is constant in the sense we all have to live somewhere and in a growing economy with a population expanding then there is an actual shortage of accommodation. With housing I’d argue that there is a fairly distinct tipping point where the market becomes VERY elastic.

Think about it – you can either afford to service a mortgage OR NOT. The bank will tell you they will either lend you the money OR NOT. So above a certain price where housing becomes “unaffordable” demand drops away significantly – people just can’t service or just can’t get the loan.

Now we know we aren’t building enough homes in places like Sydney and we know also that in other parts of the country there is a surfeit of demand over supply. But it is not at the market clearing price but rather at some price point below the average cost.

So as Shann says, there may be a shortage of affordable housing. This can be remedied in many ways – house prices can fall, incomes can rise, we could build more smaller non-luxury apartments, the Government could provide more housing and so on.

I agree with Shann’s conclusion in his article.

The number of unsold houses in Melbourne has jumped 50 per cent over the last year according to SQM Research to more than 40,000. That suggests an excess of supply relative to demand for buying houses at current prices and interest rates, as do recent gentle house price falls.

If the Reserve Bank keeps raising rates this year then house prices will stay weak.

However, rising incomes and weak house prices limit the downside in house prices, because houses become more affordable and demand rises.

It would need another major financial market disruption and jump in unemployment hitting demand for house prices to fall sharply.

Yes Indeed – we don’t expect a crash in prices but neither do we expect any big gains in the next few years ahead while Australians focus on paying down debt and the upgrader market is largely absent. But at the end of the day if your home is where your heart is and your family is happy it doesn’t matter really anyway. One of the best ways to make money on your home is to actually accelerate the time till you make your last payment. You can save years off the loans and 10’s of thousands of dollars. Now that’s a way to make money in the property market and one that is in the long run very beneficial for the economy.


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