The most basic economic law of supply and demand may not apply to real estate, according to Professor Laurence Murphy from the University of Auckland.
At Sydney University’s Festival of Urbanism, Murphy demonstrated that rapid price increases can occur in spite of high levels of dwelling supply.
In reaction to the research, proud economists everywhere are having an existential crisis
One of the first things you are taught in economics is that the more of a good you supply, the less competition exists for a particular unit of that good, and so its price should come down.
It is the reason rare items (like gold) are so expensive, or plentiful items (like university graduates) are so cheap.
So why is it then, in spite of record dwelling approval and commencement figures in New South Wales, do values continue to rise so rapidly?
Murphy points out that the real world is more complex than economics 101 would have you believe.
Housing is different to products that more closely resemble a basic supply and demand model, partly because of the institutional forces that influence finance and development.
Housing has the ability to perform counter cyclically (to increase even as other economic indicators start moving down) because individuals are able to borrow more against housing relative to other asset forms.
This counter cyclical performance is particularly apparent in the Sydney housing market (see Graph 1).
Counter Cyclical Performance of Sydney Property
Source: ABS and Onthehouse.com.au
Despite nation-wide conditions of low wage growth (2.3%), high official unemployment (6.3%) and low GDP growth, Sydney house values increased 21% in the year to July.
Murphy illustrated the unique operation of property using the case of Ireland, where house prices have, in the past, continued to increase with supply.
If only we had the data to examine the Australian situation.
Oh wait – we’re Onthehouse.com.au – of course we do.
Graph 2 shows median house values in NSW over time, over ABS residential dwelling construction data.
Construction of Dwellings vs. Median House Value (NSW)
Source: ABS Dwelling Construction Data (Catalogue No. 8752.0) and Onthehouse.com.au
From 2013 onwards, it is especially clear that record levels of construction seems to have no effect on the slope of the median value line, which indicates a very high rate of growth.
Murphy’s reasoning for the fact that house values increase with supply were put simply, but are powerful.
He analysed the economic behaviour of developers, which partly explained the phenomenon.
It would not make sense for profit-seeking developers to produce houses in order to make them cheaper.
Developers use the rate of house price increases to guide their supply decision
Therefore supply is being driven by prices going up.
The ability to borrow, coupled with tax concessions that make housing an attractive way to build wealth, encourage people to purchase houses as their income goes up.
In other words, the elasticity of demand for housing is very high.
This means that increasing housing supply is not an effective way to achieve lower house prices.
In fact, Murphy collated research from economists who found from forecasting models that supplying a large amount of property every year would, in the long term, only very marginally improve affordability.
Further to this, he emphasised that attempting to achieve high levels of supply would drain resources from other parts of the economy into a sector that has relatively low productivity.
This suggests that demand side policy could be more effective than increasing supply.
Supply is relatively inelastic to demand because it takes a lot of time and money to build houses.
However, addressing demand is not as simple as vilifying investors
To do so ignores the importance of a multidisciplinary approach to restoring housing affordability.
For example, one might consider the implications of superannuation and pension reform on motivations of investors to purchase property.
A holistic approach to addressing demand side factors could present a much more effective solution to deteriorating affordability in Sydney.
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