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Runaway House Prices Leaves Looming Affordability Issue

For as long as I can recall, housing affordability has been an issue in Australia, but since the 1990s it’s gone from being a periodic cyclical concern to a chronic problem.

The 20 per cent rise in prices during the past year has put the spotlight on the issue again.

With the surge in house prices since the 1990s has come a surge in debt which brings with it the risk of financial instability should something go wrong in the ability of borrowers to service that debt.

In this article, we look at the main issues including :where is the property market now, what’s driving poor affordability, how big is the risk of financial instability, what can be done about both issues, and what’s the outlook for home prices.

Home prices up 20pc in a year

After a dip around mid-last year in response to the initial national coronavirus lockdown, average residential property prices have since risen around 20 per cent, according to Corelogic.

Average Australian property prices at a record high

House Prices

^Source: CoreLogic, AMP Capital 

The gains have been led by houses and regional Australia, with units and Melbourne lagging.

And while the monthly pace of growth has slowed from 2.8 per cent in March, despite east coast lockdowns daily Corelogic data indicates that its remained strong at around 1.3 per cent in September.

The gains have been driven by record low mortgage rates, buyer incentives, a tight jobs market, a desire for more home space as a result of the pandemic and working from home, numerous government home buyer incentives, the “fear of missing out”, and lower than normal listings.

This has pushed average prices to record highs and real house prices to around 23 per cent above their long-term trend.

Poor affordability

As can be seen in the last chart, house prices have been well above trend for nearly the past two decades, which brings us to the issue of chronically poor housing affordability.

Home prices and household debt have gone up together 

House Prices

^Source: ABS, RBA, AMP Capital 

During the past 20 years, average capital city dwelling prices rose 200 per cent compared to an 82 per cent rise in wages. Over the last 10 years dwelling prices went up 58 per cent and wages by only 26 per cent.

The ratio of average house prices to average household disposable income has more than doubled over the past 30 years from around three times to around 6.5 times

Affordability has deteriorated more in Australia than in other comparable countries. According to the 2021 Demographia Housing Affordability Survey, the median multiple of house prices to income for major cities is 7.7 times in Australia compared to 4.8 times in the UK and 4.2 times in the US. In Sydney, it’s 11.8 times and in Melbourne its 9.7 times.

The ratios of house prices to incomes and rents versus long- term averages are at the high end of OECD countries.

While interest rates may be at record lows, the surge in prices relative to incomes has seen the ratio of household debt to income rise nearly three-fold over the past 30 years, going from the low end of OECD countries to the high end.

This is making it far harder for first home buyers to get into the market—it now takes eight years to save for a deposit in Sydney and nearly seven years in Melbourne. While government grants and deposit schemes can help speed this up, the higher debt burden will take today’s borrowers far longer to pay down than was the case a generation ago.

What’s the problem with high home prices?

While a gradually rising level of home prices in line with growth in the economy is healthy and positive for the wealth of existing property owners, very high house prices and debt levels relative to wages pose two key problems.

First, high debt levels pose the risk of financial instability should something make it harder to service loans.

Secondly, the deterioration in affordability is resulting in rising wealth inequality, a deterioration in intergenerational equity (as boomers and Gen Xers benefit, and millennials and Gen Z miss out). Confining more to renting will exacerbate wealth inequality and it is likely contributing to rising homelessness. All of which risks increasing US-style social tensions and polarisation.

What’s the risk of a financial crisis?

Predictions that high debt levels would lead to a crash in property prices threatening the financial system and the economy have been a dime a dozen over the past two decades.

None have come to pass. Most borrowers are able to service their mortgages. Non-performing loans are low and the collapse in mortgage rates has seen household interest payments as a share of income fall to levels last seen in the mid-1980s.

Household interest payments have collapsed 

House Prices

^Source: ABS, RBA, AMP Capital 

However, there is a danger in getting too complacent here. Household debt to income ratios are very high and allowing them to get ever higher runs the risk that there could be a major problem at some point so it makes sense to act pre-emptively to cool things down.

But whether there is the risk of a financial crisis or not, the really big problem is poor affordability.

So why is housing so expensive?

There are two main drivers of the surge in Australian home prices relative to incomes over the last two decades.

First, the shift from high to low interest rates has boosted borrowing ability and hence buying power.

Second, there has been an inadequate supply response to demand. Starting in the mid-2000’s, annual population growth surged by around 150,000 people per annum and this was not matched by a commensurate increase in the supply of dwellings resulting in a chronic shortage (see the green line in the next chart).

The supply shortfall relative to population-driven underlying demand is likely the major factor in explaining why Australian housing is expensive compared to many other countries that have low or even lower interest rates.

And the concentration of Australians in just a handful of coastal cities has not helped either.

Home construction and underlying demand 

House Prices

^Source: ABS, RBA, AMP Capital 

A range of other factors have played a role including negative gearing and the capital gains tax discount for investors, foreign buying and SMSF buying, but they have been relatively minor compared to the chronic undersupply.

And investor and foreign demand have not been drivers of the latest surge.

So what can be done?

The good news is that we may be getting closer to the end of the 25-year bull market in property prices: interest rates are likely at or close to the bottom so the tailwind from falling interest rates is fading; strong home building in recent years and the collapse in immigration may lead to an oversupply of property; and the work-from-home phenomenon may take pressure of capital city prices.

However, there are no guarantees. And things could just bounce back on the demand side once the pandemic recedes and immigrants return. A long-term multifaceted solution is called for.

The first thing to do is to tighten macro prudential controls to slow record levels of housing finance. Raising interest rates is not possible given the weakness and uncertainty hanging over the rest of the economy and crashing the economy to get more affordable housing will help no one.

So, a tightening in macroprudential controls to slow lending is warranted.

With housing credit now growing faster than incomes and at a faster monthly pace than when APRA last started macroprudential controls in 2014, and more than 20 per cent of new loans going to borrowers with debt-to-income ratios above six times, up from 14 per cent two years ago, they are arguably overdue.

This time around investors are playing less of a role in the property boom so macroprudential controls should be broader than in 2014-17.

The main options are restrictions on how much banks can lend to borrowers with high debt-to-income ratios and high loan to valuation ratios, and increased interest rate servicing buffers.

Ideally, first home buyers will need some sort of exemption. With the Treasurer supporting action and the Council of Financial Regulators (RBA, APRA and ASIC) expressing concern about household leverage they look to be on the way, although their implementation still looks several months away.

And last decade’s experience showed that they work.

Of course, this is just a cyclical response and more fundamental policies are needed to address poor housing affordability. Ideally these should involve a multi-year plan involving state and federal governments. My shopping list on this front include:

  • Measures to boost new supply—relaxing land use rules, releasing land faster and speeding up approval processes.
  • Matching the level of immigration in a post pandemic world to the ability of the property market to supply housing.
  • Encouraging greater decentralisation to regional Australia—the work from home phenomenon shows this is possible but it should be helped along with appropriate infrastructure and of course measures to boost regional housing supply.
  • Tax reform including replacing stamp duty with land tax (to make it easier for empty nesters to downsize) and reducing the capital gains tax discount (to remove a distortion in favour of speculation).

Policies that are less likely to be successful include grants and concessions for first home buyers (as they just add to higher prices) and abolishing negative gearing would just inject another distortion in the tax system and could adversely affect supply (although I can see a case to cap excessive benefits).

What is the outlook for home prices?

National home price growth this year is likely to be around 20 per cent with prices already up by around 17 per cent.

Next year is likely to see property price growth slow to around 7 per cent as a result of worsening affordability, reduced incentives, possibly higher fixed mortgage rates, continuing lower than normal immigration and macroprudential tightening.

If the latter does not happen then we are likely to have to revise up our house price forecasts.


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Lending restrictions could hit property investors

property investors

Property investors are likely to find it harder to obtain the big mortgages often required to buy free-standing homes after regulators signalled they would likely act to tighten lending rules.

The Council of Financial Regulators says that with credit growth materially outpacing growth in household income, there is increasing medium-term risks facing the economy, even though lending standards remain sound.

The Australian Prudential Regulation Authority (APRA), which is a member of the council, is weighing up what measures it could take to curb riskier borrowing.

One of the tools APRA could use is to make lenders subject to a cap on mortgage lending to borrowers with a ratio of more than six times debt to annual gross income – the point at which it considers the lending to be risky.

CoreLogic data released on Friday show Sydney house prices are now up 25.8 per cent since the year began, with Melbourne prices up 16.2 per cent.

In September, Sydney’s median house price soared by $18,000 to $1,311,641 – a stunning gain of about $600 a day. In Melbourne, the median jumped by $7750 to $962,250 – up about $260 a day.

Nationally, the monthly growth rate in prices slowed to 1.5 per cent, compared to its peak rate of 2.8 per cent in March.

The CoreLogic figures show house values are generally rising faster than unit values, a trend that has been evident throughout most of the COVID-19 period, especially in capital cities.

“There has been a shift by investors from units to free-standing houses,” says Doron Peleg, founder of RiskWise Property Research.

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Buying an investment property in a boom can be risky

investment property

I am a 45-year-old nurse earning about $120,000 a year, with living expenses of $27,000 and superannuation of about $213,000. I used to salary sacrifice to the maximum but stopped in the past three years, since I filed for bankruptcy in February 2019, due to a disastrous property investment in the mining town of Newman, Western Australia. I will be discharged from bankruptcy in February 2022. After discharge at age 46, I plan to buy a house for about $650,000 with a $140,000 cash deposit. I wonder if I should continue to salary sacrifice to the maximum of $27,500 a year, or should I focus on fully paying off my mortgage? I plan to pay it off in 6.5 years, earning about $150,000 from July 2022 onwards. I am single and have no children. After I pay off my mortgage at age 53, I can finally stop working night shifts and my income will come down to $95,000 a year. I plan to retire at age 60 – when I’m still healthy. L.L.

I always set two main goals for retirement: to stop working with a fully paid-off house and enough money in super to produce the tax-free income you need for living expenses. It is hard when starting from scratch – and not always possible.

At the end of the day, if both goals cannot be achieved, there is always the safety net of the age pension. So, that’s why I suggest giving priority to paying off your mortgage before salary sacrificing to top up your employer’s 10 per cent super contributions.

That’s sad news about your bankruptcy.

I am aware that house prices in mining towns peaked in 2011-12 during the mining boom. An ABC news report indicates Pilbara median house prices later fell more than 80 per cent when the boom soured.

It is a good lesson that buying an investment property in a boom can be risky, even though prices in Newman have since turned up.

I am aged 46, earning $190,000 a year and my wife, 47, is working four days a week and earning $120,000. We are both relatively healthy and have two children aged 11 and 9, due to go to private high schools at a cost of $40,000 a year each in 2023 and 2025, respectively. We own our home valued at $2.4 million and have $955,000 in joint investments, plus $556,000 in my super and $358,000 in my wife’s super. We also have an investment unit valued at $450,000 with a mortgage of $400,000. Our combined monthly income is $17,000. Our monthly expenses are $10,000 (excluding private school fees). We would like to maintain this lifestyle, or close to it, for the rest of our lives, adjusted for future inflation. We have both earned relatively high incomes for most of our working lives and have a relatively modest but comfortable lifestyle, prioritising the needs of our children. We both would like to retire at age 50. Are we on track? P. L.

If you retire at 50, your wife would have a statistical life expectancy of some 37 years and, as always, I add five years to that, assuming she is healthy and will live longer than the average.

If you then plan to spend $120,000 a year, indexed to 3 per cent for inflation, you could expect to go through savings of about $2.7 million. On top of that, you would spend about $500,000 on school fees, plus significantly more on sports plus any private tuition and then tertiary education.

I suspect you should plan on working until your children finish their education – possibly longer – while maximising your super contributions.

I purchased a unit in 2001 for $432,000 and moved out in 2007. It has been fully renovated with a new kitchen, bathroom, flooring, laundry and garage door. The total cost was $33,105 and other costs include stamp duty is $29,191. Over the years, I have claimed all council rates etc. I would like to sell the unit this year. The agent estimates it will fetch as much as $1.2 million. What is the best way to calculate the Capital Gains Tax (CGT)? M.W.

Step 1: Hire a good accountant.

Step 2: Give them the original sale contract for the property, as well as receipts for all your renovations, plus tax returns to show what you have claimed. This allows the accountant to determine your “cost base” and also how much, if any, could have been claimed, but wasn’t.

Let’s say you have spent $500,000 up to now and that your selling costs come to, say, $30,000, including agent’s commission.

If you sell for $1.2 million, your capital gain would be $670,000, half of which, or $335,000, would be added to your assessable income.

It doesn’t sound as though the property is held in joint names, so assuming no other income in 2021-22, the CGT would be about $128,000. Ouch!

  • Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions. 


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Super a great way to invest as you near retirement


A relation aged 25 is earning $150,000 a year in a construction job. He and his partner will be paying for a new house-and-land package next year. He asked me if he should be salary sacrificing to save tax. I told him I did not think that was wise in light of his proposed house purchase and all the costs associated with that. Your often mention salary sacrificing to superannuation rather than paying off a home loan, but am I correct in thinking this would only be applicable to somebody approaching retirement?

You are spot on. It would be crazy to be piling money into super at such a young age when they are planning to buy a house in the foreseeable future.

In any event, salary sacrifice into super is not a massive tax saver in his situation. His employer should already be paying $15,000 a year into super, which leaves only $12,500 available to be salary sacrificed.

The sum of $12,500 in his pay packet would lose tax of $4937, whereas money contributed to super would lose $1875. The tax saving of $3062 is relatively small.

It is a different matter entirely for someone aged 50 or more who wants to pour money into super, to make sure they retire with no mortgage.

My partner and I live in Melbourne and bought a house on the south coast of NSW for my daughter to live in, and for us to use for holidays. She owns 40 per cent of the house and we own 30 per cent each. I plan to leave my 30 per cent to my daughter in my will and my partner plans to leave his 30 per cent to his daughter. Will my daughter need to pay Capital Gains Tax (CGT) when I die? Would it be better to transfer my share to her before I die?

If you give it to her now, you would be liable for CGT.

However, if you leave your share to her in your will, no CGT would be payable and until she disposes of the property. This could be many years in the future.

Furthermore, provided the property continues to be her principal place of residence, the impact of CGT should reduce over time.

Your daughter should be thinking about ways to buy out your husband’s share, because the situation could be unsatisfactory if he dies and 30 per cent of the property is then owned by somebody else.

I am aged 60 and work full-time. I am trying to plan my finances for retirement in six years. I have recently come into an inheritance of $170,000 and am in a quandary as to where to invest it. I would like to be able to grow the funds but also to be able to access the money relatively easily after my retirement. The money is for travel and possible small renovations, as my husband’s defined-benefit super scheme generates payments of $2415 per fortnight, which covers our living expenses. We own our home and have a $300,000 mortgage on an investment property, valued at $850,000. I am thinking about either buying and renting another property – although would need to get a large loan – or perhaps buying shares or putting the money into my super, which is now just $60,000. I am also not sure about the tax implications of shares vs super. I welcome your comments on how best to invest the money.

I do not think taking out a large loan at your age is wise.

Super is the perfect place for you to invest the money, as accessibility would not not be an issue.

You have turned 60, which means you can withdraw money from your fund as soon as you retire from your job, or at age 65 – whichever is earliest.

The money could be contributed as a non-concessional contribution and there would be no tax on it or on any withdrawals.

Keep in mind that shares are a type of asset, whereas super is a vehicle that lets you hold assets in a low-tax area.

You could have each way bet by having your money in super, with a large part of the selected fund asset mix in shares.

I have been reading with interest your comments on what happens if a couple are on the age pension and one of them dies, leaving the surviving spouse over the single asset cut-off means test of just $593,000. Does replacing worn carpets and blinds come under allowable ways of spending money on renovations?

Yes, there are a number of allowable ways for a pensioner to spend money. These include renovations, replacing household items and travel.

  • Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions. 


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