I had a coffee or two today in Woollahra’s sublime Queen Street with share investment guru Peter Thornhill of Motivated Money fame – he’s sold more than 35,000 copies of that self-published book and it’s an absolute ripper too.
What a great part of the world Woollahra is, and one which thankfully appears forever destined to be unspoiled by large and unsightly apartment developments.
This is one of the reasons why folk tend to invest in property in these leafy green suburbs, since there is frequently an effective height restriction on new developments, and NIMBYism dictates that the new supply of dwellings remains forever limited.
The residents of Woollahra will surely be spinning in their cemetery plots long before any equivalent of Parramatta’s new Aspire Tower could ever receive approval in that beautiful and historic part of town.
However, contrary to popular opinion, I don’t believe that NIMBYism is the primary cause of constrained dwelling supply in Sydney, and nor is it a lack of available land for development.
The primary cause of constrained dwelling supply, in my opinion, has been price. The cost of development in so many cases has simply been too high in recent years to allow an effective supply response.
Of course, if I were to club together with my mates next door to object to each new multi-unit or apartment development around the Pyrmont area and this then resulted in a project being blocked, we will have thereby hindered supply to a very small extent.
But the principle reason supply in cities such as Sydney has been so weak is explained by this chart from the Reserve Bank.
Housing depressionists, crashniks and conspiracy theorists deplore this chart since it attacks the very core of their beliefs.
Why? Because the clear implication thereof is that the reason dwelling supply in Sydney was so weak from 2004 onwards has been that constructing infill apartment developments has not been commercially viable due to the associated prohibitive cost.
RP Data’s chart below shows that after Sydney dwelling prices peaked in Q1 2004, the price of dwellings soon fell below replacement cost and the supply response almost immediately evaporated.
What this means?
Unless our independent central bank has taken lately to falsifying data, which seems unlikely, its research shows that two bedroom multistorey flats in 2010 in Sydney cost developers close to half a million dollars per dwelling to bring to the market.
Since the median apartment price has until relatively recently been somewhere closer to ~$450,000, depending on your preferred source, the implication of this is that an elevated proportion of developments have simply not been viable for residential developers to pursue, motivated by maximising shareholder returns as they are compelled to be.
Dwelling approvals in Sydney collapsed by more than 50% for their peak during the price boom.
As many of our larger developers are publicly listed companies, were this to be an incorrect position, then it could immediately by disproved through highlighting conspicuously strong gross margins, EBIT(DA) or ROAs in the respective residential divisions of developers.
However, as regular readers will know, I’ve ploughed through Annual Reports, investor presentations and Australian Securities Exchange releases many times before, and unless I’ve somehow missed it, there is scant evidence of developers achieving lofty operating margins on residential developments, which adds credence to my theory.
By the way, I’d be more than happy to stand corrected if anyone can show me conclusive evidence of price gouging by our residential developers.
I covered some of the reasons why construction costs have spiralled over the past decade-and-a-half and what some of our developers are now planing to do to address here.
Since 2010, the date to which the above chart was prepared by the RBA, we have seen a material uplift in Sydney unit prices of around 10-20% in various sectors of the market in concert with a slashing of the cash rate from 4.75% to just 2.50%, thereby facilitating a far greater number of profitable projects.
And, lo and behold, if you live in Sydney and have a working pair of eyes you’ll no doubt have noticed that for some time now there has been a crane on every second corner: at long, long last we are getting some supply!
This is because the price uplift combined with the lower cost of financing developments has made widespread construction viable for the first time in nearly a decade.[sam id=40 codes=’true’]
There is something of a lag effect and projects take time to come to fruition, but over the next 2-3 years we appear destined to see new projects coming online aplenty which will eventually remove some of the speculative heat out of the market once again.
It will take some time, but dwelling prices will eventually ease and approvals drop back again, as the sequence continues.
This is why we call it a property cycle.
How will this play out?
Fortunately this is not one of those tedious circular arguments which will drag ever onwards.
If I’m correct and the predominant constraint on dwelling supply has been price versus replacement cost, then cities such as Sydney will quickly go on to lead the greatest apartment construction boom in Australia’s history.
And if I’m wrong, it won’t happen.
Simple as that.
As this point in time, I’m confident, and I note that apartment approvals have increased by a whopping 33% over the past year, but we’ll have to see how it plays out (click chart).
Also implicit in the above argument is that simply arguing for the freeing up of more land will not in itself solve the housing affordability issue.
While it would no doubt be helpful to a point, there is arguably a poor level of substitutability between greenfield sites on the distant city fringes and brownfield apartment sites in the inner areas.
With dwelling approvals set to hit the highest level in three decades, it appears to me that available land is not the primary problem, since there is presently stacks of it being rezoned from industrial to residential use in formerly commercial regions such as great swathes of Sydney’s inner south.
Fixing the affordability issue
One of the challenges in a country such as Australia where population growth in the capital cities is so rampant, is that tinkering only with the demand side could quickly see supply killed off and the affordability issue returning with a vengeance.
For example, were the negative gearing tax rules to be quarantined or grand-fathered, apart from once again potentially sending rents soaring higher in the cities with tight vacancy rates (e.g. Darwin, Sydney) and public housing waiting lists again roaring northwards, the best information I have available tells me that such an amendment would dampen demand from property investors and thus impact capital city dwelling prices.
But if supply is then also killed off, how quickly will we return to a crushing under-supply situation (click chart)?
I’ve blogged before my opinion on how housing supply and thus affordability might be addressed for the longer term.
That is, through subsidies such as have been employed in the past by German governments and making discounted loans available to commercial housing companies to meet social and lower income housing objectives.
With a colossal $1.5 trillion in Australia’s superannuation coffers according to the Treasury – “equivalent to our national GDP” – there are vast reserves of pension fund capital potentially available for this purpose.
Assuming that Treasury would desire any such reforms to be fiscally neutral, how should any shortfall be funded?
Given that homeowners have effectively received a material wealth dividend, a substantial element of which has been derived from state investment in infrastructure and urban development, it strikes me that the sensible answer would be through a progressive and recurrent property tax (i.e. one which is charged annually, with owners of the largest dwellings attractive the most tax).
As Australia has an elevated rate of home ownership when compared to many equivalent developed countries, such a tax could be spread widely enough not to be damaging, and if accrued annually the impact could also be spread over time too.
It’s likely that such a tax would be best introduced with an exemption in the early years of ownership for first time buyers, and perhaps with a lower level of tax to be levied on certain types of required dwellings (i.e. medium/higher density units and apartments).
One wonders, though, whether governing bodies have any genuine interest at all in addressing housing affordability, except to the extent that higher dwelling prices might pose a threat to future financial stability.
A final observation for today.
It being the Easter break I headed down to the New South Wales south coast this weekend, a beautiful part of the world in which I have been holidaying at for some 15 years now.
Interestingly, despite what has happened in some of the capital cities, housing prices have never really gotten much more expensive down in those parts in real terms.
There is plenty of land available for release, and importantly, a great deal of it is greenfield land.
Unlike Sydney’s infill sites which are awkwardly expensive and cumbersome to develop, the south coast offers seemingly endless 500+ square metre DA approved blocks from $75,000-$100,000 which are extremely easy to plonk a project home on (“your new home here in 9 weeks!”).
There’s another clue here, I think, as to how housing affordability might be addressed over time: by improving transport links and creating more employment hubs located away from the four major capitals.
Unfortunately while the focus remains on how we might cram 8 million or more people into our two major cities yet somehow keep dwellings in the inner few kilometres affordable – the very definition of madness – and while the supply response is almost entirely dependent upon profit-motivated private sector developers, housing affordability appears likely to get worse before it gets better as interest rates eventually revert higher.