The Reserve Bank of Australia (RBA) was invited to make a submission to the Inquiry into Home Ownership.
It’s well worth a read.
I’ve summarised a few of the key points below.
Home ownership rates
While the media headlines chose to focus almost exclusively on a brief reference to tax legislation reform towards the end of the report, generally the Reserve was fairly moderately positioned in its viewpoints.
Home ownership rates at the time of the last Census in 2011 sat at 68 per cent, which represents a moderate decline, yet also a fairly stable result over the past five decades.
Before the 1970s, home ownership rates were considerably lower.
In particular, notes the RBA, home ownership rates in metropolitan regions were typically very low until the 1950s.
Home ownership rates in Australia today are fairly high compared to most of the world, and a little higher than those in several of the other most comparable countries.
Age of home ownership
The data compiled by the RBA does show that the share of home-owning households in the 25-34 age bracket has declined over the past quarter of a century since 1980.
In part, this has been due to higher house prices, although the RBA also notes that people are doing most things later than they used to.
For example, the median age of first marriage for women in 1974 was just 20.9 years.
There have also been a number of other significant demographic shifts according to the RBA, including higher divorce rates and an increase in the number of single-parent households.
The submission spent some time musing over the complex relationship between housing affordability and home ownership, where all is not quite as clear as it initially might seem.
For example, as the above chart shows, much of the decline in home ownership rates between the ages of 25 and 34 took place in the early 1980s, before the run-up in house prices, rather than after it.
Furthermore, in a curiously reflexive manner home ownership rates can oftentimes be lower in more affordable locations, with Queensland and South Australia having the lowest home ownership rates of the Australian states.
Another point raised by the RBA which is rarely discussed is that for some people renting makes more sense at certain points in their lives, particularly given the increased mobility of the modern labour force and the heavy transaction costs involved in buying and selling property
The submission also spent some time looking at the composition of net immigration, including the projected surge in student arrivals.
New South Wales and Victoria receive a disproportionate share of foreign students, with more than two-thirds of student migrants heading to those states (and to Sydney and Melbourne in particular).
Mortgage serviceability and the deposit hurdle
Demand for housing was boosted for property in the 15 years or so to 2005 by financial deregulation and the structural shift to low interest rates, notes the RBA.
Thanks primarily low mortgage rates, initial repayments on new housing loans as a share of household disposable income are presently significantly lower than they have been, and are hovering well below the decade average.
The flip side to this is that rising house prices may require a higher deposit. It’s also worth noting that households with two incomes today clearly have a significant advantage over those with a solitary income earner.
However, the RBA does point out that 20 per cent deposits are no longer a requirement for first time buyers, where a 5 or 10 per cent deposit can often suffice:
“The maximum loan-to-valuation ratio (LVR) available in the Australian mortgage market has increased noticeably over recent decades, from the 80 per cent typical in the pre-deregulation period to around 95 per cent at present.
Equivalently, the deposit required of a first home buyer is no longer necessarily around 20 per cent of the purchase price, but rather, more often in the 5–10 per cent range.
This shift would have eased the accessibility constraint imposed by the deposit requirement more than would be apparent from a simple comparison of a fixed percentage of the median purchase price over time.”
In a discussion which is overwhelmingly dominated by generalisations it’s inevitably tough to avoid generalising, but there’s no doubt that housing markets close to the centre of Sydney have unsurprisingly become very expensive, with the population of the harbour city imminently set to surge past 5 million.
Though I don’t follow the Melbourne market closely, I assume that inner city Melbourne presents similar dynamics.
The RBA submission implies that with a 5 per cent deposit requirement, areas further from the city are likely to present a more realistic entry point for first time buyers.
Unfortunately many first-time buyers in Sydney are not so keen on living in the more affordable areas such as Blacktown or the Canterbury-Bankstown region.
Based on the limited sample of first-time buyers I come into contact with, many prefer to buy an investment property in a so-termed “secondary location” and rent somewhere closer to the city themselves.
“Be careful what you pray for…”
Probably the most significant part of the RBA submission for my money was the section noting that there are “no examples of large falls in nominal house prices” either in Australia or overseas without there being significant reduction in the capacity to pay (which generally means very high interest rates, a deep recession or high rates of unemployment):
“There are no examples internationally of large falls in nominal housing prices that have occurred other than through significant reduction in capacity to pay (e.g. recession and high unemployment).
There is no mechanism to get a large and sustained level shift down in prices while a substantial fraction of the population can – safely and sustainably – service the obligations involved in paying the higher price.“
This echoes closely what housing economist Michael Oxley argued in London back in 2004.
While an increase in the supply of dwellings is both necessary and desirable, this alone will not cause a material correction in house prices while the capacity for households to repay existing mortgage debt remains comfortable.
In larger cities, where only a small percentage of the housing stock is new in any given year, this is even more so the case.
This suggests that the risks of a material housing market correction are considerably higher in smaller cities and towns where unemployment rates are elevated – or at risk of becoming so – and where the new supply of dwellings as a percentage of existing stock can be higher.
While the Pavlovian response in the media headlines called for a review of “negative gearing” legislation, what the submission really appears to be hinting at is a review of the way in which tax deductions on interest repayment interact with the capital gains tax discount in order to encourage property investment.
The RBA notes that tax legislation also to some extent favours owner-occupiers since capital gains are tax free and there is no taxation on imputed rent – although there are no deduction on owner-occupier mortgage repayments in Australia.
Recent data suggests quite clearly that a greater number of Australians are leaning towards buying property as an investment rather than as a home.
While unsurprisingly and perhaps reassuringly the greater share of household debt is held by those who can afford it – higher than average income earners – equally the evidence that wealthy Australians are “rorting” negative gearing through residential property as a tax shelter seems rather sketchy.
More than 90 per cent of those using negative gearing deductions are claiming deductions on only one or two investment properties – and nearly three quarters of them are claiming on just one.
As such, if the wealthy citizens of Australia are trying to rort this so-called “tax shelter” that is the prevailing tax legislation, they don’t seem to be doing so very effectively.
Realistically, most genuinely wealthy Australians have better things to do with their money than rack up net rental losses through negatively gearing investments in the cottage industry that is property investment.
Noted the RBA:
“The ability to deduct legitimate expenses incurred in the course of earning income is an important principle in Australia’s taxation system, and interest payments are no exception to this.
To the extent that negative gearing induces landlords to accept a lower rental yield than otherwise (at least while continued capital gains are expected), it may be helpful for housing affordability for tenants”.
Finally, the RBA submission somewhat unsuccessfully attempted to divert some attention away from the booming Sydney property market through suggesting that the ratio of house prices in Sydney to those in other capital cities is merely reverting to trend.