The shortage of shelter

The shortage of shelter

The objective of improving Australia’s housing affordability via the management of interest rates was one of the key points of policy discussion during November’s election campaign. However, as is discussed in this article, low interest rates may not necessarily be the solution, the new Federal Government needs to solve the emerging fundamental problem of a shortage of housing.

The housing demand-supply imbalance

Two pieces of economic data were released over the past week highlighting the extent to which the demand for housing is out stripping supply. The first was the June quarter population statistics, which showed Australia’s population exceeding the 21 million mark. At 1.5%, Australia’s annual rate of population increase is at its highest level since 1989.

The second piece of relevant data was the building approval statistics for October. These showed a 2.8% decline in the number of approvals provided for the construction of new residential dwellings. Although slightly above recent lows, the current volume of new housing construction is widely viewed as being insufficient to meet current population growth rates.

Source: Australian Bureau of Statistics & Hillross Financial

In the year to June 2007, Australia’s resident population rose by 316,000. Over the same period there were 149,000 new residential dwellings constructed. This created a ratio of population growth to dwelling completions of 2.12. As indicated on the chart above, this is the highest ratio recorded since 1988. Hence this crude measure of the housing demand/supply balance, suggests that supply conditions in the housing industry are at their tightest level for two decades.

Will housing supply respond to demand?

In 1988, when Australia last had a shortage of residential housing of a similar severity to today, Australia was already in the midst of a housing boom. Following the stock market crash of 1987, falling interest rates and rising house prices saw a flood of investor dollars enter the housing industry.
Property developers responded with new construction and supply levels quickly adjusted upwards.

However, conditions in the housing industry are currently somewhat different to those that prevailed in 1988. Unlike the period leading up to 1988, interest rates have been near historical lows for some time and are on an upward, rather than downward, trend. Interest rates are therefore unlikely to be a factor that will stimulate a new level of investor and property developer interest in the sector.

In addition, with rental yields still low and expectations of housing price growth muted by the recency of the previous price boom, investor support for the sector is questionable. The four consecutive years extraordinary returns on equity markets have increased the attractiveness of equities relative to residential property; with the cause of residential property not being helped by ongoing high transaction costs and government duties.

Another factor restricting the ability of the housing industry to generate additional supply is the restricted stock of land available for new housing. Governments around the country have pulled back on the volume of land being made available for new residential development in favour of increased density in existing urban areas. In addition, property developers, and therefore the buyers of dwellings in new land release areas, are being asked to pay a greater proportion of the upfront infrastructure costs than they were previously.

In summary therefore, conditions are not necessarily ripe for housing supply levels to immediately increase via the substantial increase in new building activity required. The relative shortage of stock may therefore remain in place longer than it has in previous cycles.

Implications of the housing imbalance for investors

If the shortage of housing stock is maintained, low vacancy rates will continue to push up rental levels. With rent being one of the more important components of the Consumer Price Index, increasing rents will add to inflationary pressures and hence potentially contribute to higher interest rates.

A lack of new housing supply may also help keep a floor under housing prices. However, with housing affordability already stretched to a record low level, the scope for prices to increase at a faster rate than wages growth is somewhat limited - unless there is an influx of new investors into the property market with increased purchasing power.

Ultimately rising rental yields should stimulate this additional investor interest in housing, thereby pushing prices higher and improving the economics for new supply to come on board. However, with rental levels somewhat “sticky” and often tied up in longer term contracts, this process may take some time.

The alternative for a new Government that may not wish to preside over a period of rising rents and more expensive housing would be to find structural solutions that bring on new land supply and property development at a faster rate.