What Is the Deal with Housing in Australia?

The housing market is the perennial conversation topic of choice across Australia. Eye-watering capital gains have driven consumer’s attraction to housing investment over the past two decades. Even the disruptive force of the COVID-19 pandemic has been insufficient to drive down housing prices for long. In 2019-20, housing prices rose by 3.0%, and this is expected to be followed by 6.2% growth in 2020-21. Amid unprecedented debt levels and no clear ceiling in sight for housing prices, the long-term sustainability of the housing boom is coming into question.

Australia maintains some of the most expensive housing in the world, when comparing average housing prices to average consumer incomes. Globally, Sydney is the third most unaffordable city to buy property and Melbourne is sixth. The residential housing prices index, which measures price changes in residential dwellings across Australia’s capital cities, has risen at an annualised 2.9% over the past five years. Solid growth in prices throughout 2020-21 is expected to lead the property price index to surpass the previous highs achieved in 2016-17.

Negative gearing

A major factor driving price growth is the nation’s unique taxation system, which has encouraged investment in property. The Australian taxation system enables interest payments on investment properties to be offset against an individual’s taxable income. This process, known as negative gearing, cost the Australian budget $13.1 billion in 2017-18, which is roughly equivalent to 40% of the Federal Government’s spending on education in the same year.

According to the latest taxation statistics, Australia had 2.2 million property investors in 2017-18, and close to 60% were negatively geared. The influence of property investors in driving up housing demand has been significant, with property investors accounting for 31.3% of total lending for housing over the past five years.

Negative gearing has provided a major boost to the Real Estate Services industry by driving up demand for property management services. Industry revenue is expected to rise at an annualised 0.4% over the five years though 2020-21, to $27.3 billion. Property management services are expected to account for 15.2% of industry revenue in 2020-21.

Negative gearing was originally designed to encourage new development in the House Construction industry. However, this effect has been muted as the same tax concessions apply to existing houses. The Australian Labor Party proposed policies that would scale back negative gearing to only newly constructed housing in both the 2016 and 2019 elections, but lost both. Labor has not indicated whether it will take this policy to the upcoming Federal election.

Interest rates

Growth in housing prices has consistently outpaced growth in real wages over the past two decades. Despite this trend, housing has mainly remained accessible due to the assistance of falling residential housing loan rates, which have enabled average families to borrow greater sums while maintaining the same monthly mortgage repayments. As a result, declines in the mortgage affordability index have been subdued over the past two decades, while the household debt to assets ratio has risen. The cash rate now sits at 0.1%, the effective lower bound, removing the prospect of rate cuts as a way to deliver greater mortgage affordability.

But how will indebted households react to rising interest rates over the next five years? An increase in mortgage repayments will likely constrain real household discretionary income, and consequently exert downward pressure on household consumption expenditure. Despite the Reserve Bank of Australia signalling that the cash rate will likely remain unchanged until 2023-24, pressure to raise interest rates is growing. Positive developments in overseas economies, a stronger than expected economic recovery in Australia, and potentially tighter lending standards or macroprudential tools to stem housing price growth are forecast to place upward pressure on interest rates.

Challenges with addressing housing affordability

For governments, the issue of unsustainable housing price growth is a difficult challenge. Outright attempts to lower prices through shifts in policy, such as removing negative gearing, are simple in theory but politically difficult to enact. For this reason, policy has focused on boosting the purchasing power of first-home buyers rather than reducing prices outright.

The First Home Super Saver scheme was introduced in 2017-18 to enable younger Australians to use the favourable tax concessions of the superannuation system to create a housing deposit. While this policy has provided first home buyers with more capital at the micro level, it has simply fuelled further growth in housing prices at a macro scale. While the Federal Government has not yet enabled Australians to directly use their superannuation savings to purchase a home, this policy will likely change over the next five years. Such a change would represent a threat to the Superannuation Funds industry, due to a loss of funds and the long-term retirement capabilities of younger generations.

Potential solutions

Growth in housing supply, the shift of economic activity to regional areas, and tighter lending standards are available options to exert downward pressure on housing prices. While price growth is expected to continue in the suburbs around Sydney and Melbourne, an increasing share of demand will likely shift away from the major cities over the next decade, as prices remain prohibitively high for some buyers. Demand for housing in regional areas spiked during the COVID-19 pandemic, as work-from-home arrangements lessened the need to live near work. This trend will likely persist after the pandemic subsides.

The government may seek to increase the supply of housing stock by reducing the requirements for development permits. This would support both the House Construction industry and the Multi-Unit Apartment and Townhouse Construction industry, which are expected to grow at an annualised 1.9% and 9.6%, respectively, over the five years through 2025-26.

IBISWorld reports used to develop this release:

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