Unaffordable housing is making Australians buy homes later in life, reducing current demand for homes and bringing the new supply coming on stream into balance with demand.
That's the conclusion of a recent ANZ Bank Insight report by senior economist Daniel Gradwell who suggests that there is a significant level of latent demand for housing in Australia, which will underpin prices and require construction to remain elevated.
Census 2016 data shows people in the 20-to-34 age group were pairing off and forming households later in life, cutting the overall demand for housing to 21,000 dwellings this year compared with the 117,000-home shortage that would be the case if the so-called headship ratio had stayed at its 2011 level.
While it still showed that the estimated 780,000 new dwellings built in the five years to 2016 were less than the total overall demand, it showed a market broadly in balance, the report said.
Underlying demand for housing remains solid and will keep supporting house prices.
The report suggests Austarlia's strong population growth will ensure construction of new dwellings remains strong, even if it comes off recent high levels.
At face value, Australia’s housing market appears to be broadly in balance.
However, we find that this headline result masks the fact that some people are increasingly unable to form new households, primarily due to affordability constraints.
As a consequence, we believe a significant level of latent demand for housing still exists in Australia, which will underpin prices and require construction to remain elevated.
Following the release of 2016 Census data, we reviewed our analysis of Australia’s housing balance.
We found the net 780,000 dwellings built over the five years to 2016 has technically been enough to absorb the increase in demand.
This has decreased the shortage of dwellings nationwide.
Since 2011, the headship ratio (propensity of people to form new households) has steadily fallen, with the younger age cohorts the worst affected.
The relative unaffordability of housing, especially in the Sydney and Melbourne markets, means that people are waiting until later in life to form new households, and this artificially lowers demand for housing.
If the headship ratio had not dropped, Australia’s housing shortage would be 117,000 dwellings – much more significant than the 21,000 currently reported.
There are three implications from this finding:
- The solid level of underlying demand is likely to provide support to house prices.
- Australia’s strong population growth means that construction activity should remain around elevated levels.
- There is little to suggest that the affordability picture for potential first-home buyers is going to improve in a meaningful way.
The five years to 2016 saw Australia’s stock of housing expand strongly, with the net addition (after allowing for demolitions) of 780,000 dwellings since 2011.
The majority of this came from the construction of units and apartments, which now account for a record 27% of Australia’s total housing stock.
This strong increase in supply was necessary, given the rapid population growth in recent years.
Until the end of 2012, this was centred in Queensland and Western Australia as the mining boom was in full swing.
New South Wales and Victoria have since taken the population-growth baton, with Victoria’s population increase of 2.4% in 2016 the fastest since at least the early 1980s.
Rapid population growth is not new – it has been persistent over much of the past decade.
Over the 20 years to 2005, Australia’s population growth was relatively stable around 218,000 people each year.
Since then, it has accelerated rapidly, reaching a peak increase of 460,000 people in the year to December 2008.
While that rate of growth has not been sustained, an increase of 360,000 people in 2016 is still well above historical levels.
We can see in Figure 2 that housing construction initially failed to keep up with this sustained increase in population growth.
Indeed, the delayed supply response was quite remarkable.
It resulted in a significant shortage of dwellings across most of the country.
Although dwelling construction has certainly picked up in recent years, it is largely just playing catch up after a decade of not building enough housing.
The increase in construction since 2013 has helped prevent an even worse shortage of housing.
But changing household formation rates has also been a key factor in shaping our apparent transition toward an apparent housing surplus.
We find that Australians are forming new households later in life mostly because younger people are being ‘priced out’ of the housing market.
The 2016 Census shows that the ‘headship ratio’1 continued to fall for the younger age cohorts.
This implies that people are forming new households later in life, which lowers the indicated demand for housing.
This trend is a significant factor behind our estimate that the housing market is broadly balanced.
Historical data show that falling headship ratios are not a new phenomenon; the national average has been declining since 2001.
But the pace of change has picked up in the past five years, driven by the key ‘household formation’ age group of 20-34 year olds.
Figure 3 shows that the headship ratio for the 20–34 age group has been steadily falling since 2001, and the decline accelerated over the most recent Census period.
In particular, New South Wales has seen a significant decline and now has the lowest household formation rate of the country.
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This means that younger people across the country, but especially in New South Wales, are waiting until later in life to create their own households.
The implication of falling headship ratios is that on average, there are more people living in each dwelling.
In turn, this means that the implied demand for dwellings is less.
We can quantify the impact of falling headship ratios by running the same analysis, but keeping the headship ratios constant at their 2011 levels.
See Figure 4.
We found that if headship ratios were sustained at their 2011 levels, the added demand for dwellings would imply a much larger shortage at the national level.
In 2017, the shortage would be 117,000 dwellings, compared to the actual result of just 21,000.
The same is true at the state level, where New South Wales and Victoria would have a shortage of 40,000 (instead of 7,000) and 48,000 (instead of 10,000) dwellings respectively.
Given the above analysis, it is important to assess why headship ratios have been falling amongst younger people.
We believe worsening housing affordability is the principal cause.
Recent research by the Reserve Bank of Australia supports this view.
It suggests that the ‘generation rent’ phenomenon - where fewer potential first-home buyers (FHBs) enter the housing market - “is a reflection of higher housing prices rather than a shift in preferences.”
The RBA found that higher house prices have pushed potential FHBs out of the market.
On the other hand, demographic characteristics, such as education or employment status were not found to have changed the probability of someone becoming a FHB between 2008 and 2014.
So, much of the delay in forming households (and falling implied demand for housing) is, in a sense, involuntary.
The affordability issue has several root causes.
Clearly the strong house price growth in recent years does not help.
But that has been compounded by a fall in wages growth to the slowest rate on record, and lower returns on savings due to falling interest rates.
As a result, the time taken to save a deposit for an average dwelling in Australia has been increasing for the past five years.
The story is different across the country.
Sydney and Melbourne have experienced the worst of the affordability difficulties, in line with their exceptionally strong house price growth in recent years.
For an average income earner in Sydney, the time taken to save a 20% deposit for an average dwelling price is now sitting at over 10 years.
Melbourne is not much better, at 9 years (Figure 5).
And this assumes that prices do not grow faster than incomes over that saving period.
In isolation, the housing market balance has little direct impact on price movements.
The housing balance is a long-term, structural measure, whereas prices can move quickly in response to many factors, including sentiment, policy, interest rates and incomes.
The added complication of worsening affordability and falling headship ratios make interpreting the housing balance more difficult.
Our analysis does however provide useful guidance on the outlook for prices, construction, and affordability.
This strong latent demand (FHBs currently priced out of the market) is likely to provide support to prices.
Any dip in prices may well activate the pool of potential entrants, resulting in additional demand and thereby sustaining prices.
We noted in a recent housing market update that it is hard to see house prices falling (in the absence of sharp interest rates increases), and this research supports that view.
Australia’s strong population growth needs ongoing supply.
We expect dwelling investment will slowly decline over the next two years as the current backlog of construction (primarily of high-rise apartments) clears, but the fundamentals are in place for construction activity to remain historically high over the longer term.
Finally, the outlook for FHBs is not encouraging.
The probability of strong population growth and the presence of many potential FHBs mean the market is likely to remain extremely competitive.
We have previously noted that stamp duty incentives are great for a lucky few, but such measures do little to address the underlying issues.
It is difficult to envisage Australia’s supply-side response suddenly boosting the availability of affordable housing, so it looks like home ownership will remain a challenge for 20–34 year olds.
Source ANZ Insights. Author Senior Economist Daniel Gradwell