If you thought you understood the housing market had to do with supply or planning or immigration you haven’t read this summary of the facts. Try this: if Australians lived the same way they did in the 1950s (in houses of about 100 square metres) the current housing stock could accommodate an additional 30 million people, more than double the current population of 26.7 million. This is a deep dive and one not one of our readers should miss.
Background
Most developed countries are experiencing a severe housing crisis and it’s getting worse. This has not happened by chance, it is the inevitable outcome of how we provide housing in the modern free-market economy. We have manufactured the housing crisis.
Spinifex is an opinion column. If you would like to contribute, contact us to ask for a detailed brief.
Despite high levels of political and media attention the problems are mostly misdiagnosed which means the solutions are misguided, providing band-aid responses to individual problems but doing little if anything to correct the underlying issues of the system as a whole.
And none of that considers the implications of the biggest crisis we are facing: climate change. Over the next few decades climate change will pose substantial additional challenges to all aspects of the housing system.
The objective of this article is to identify the real issues underlying the housing crisis, and in a following paper we will consider possible solutions. First it’s important to make the distinction between the housing system and housebuilding which are often muddled together.
Housebuilding versus housing system
Housebuilding is the physical activity of constructing a new residential unit, whether house or apartment. Just like every industry sector, housebuilding is subject to the economic laws of supply and demand.
This dictates what deals are struck between builder and supply chain during construction, and between builder and homebuyer at completion. Deals will depend on market conditions at the time and housebuilders are certainly experiencing challenging market conditions just now, but nobody is claiming the housebuilding industry is in crisis.
Architects Robert and Brenda Vale suggested that we should consider housing as part of our national infrastructure because of the critical role it plays across so many social and economic indicators.
The housing system is much broader, comprising all activities through which housing is provided and managed for the population as a whole. This includes housebuilding, alterations, maintenance and repair; residential zoning and infrastructure provision; planning and building regulations; finance and insurance; private versus public housing, the real estate buying and selling process; and options around owning or renting.
Most crucially, the housing system should ensure equitable access to houses of adequate standard in appropriate locations. Without a secure home: “people stop building families, building futures, putting down roots, developing, flourishing. They lose all perspective. Their lives are frozen” says Tamara Kuschel from Dutch charity De Regenboog.
Architects Robert and Brenda Vale suggested that we should consider housing as part of our national infrastructure because of the critical role it plays across so many social and economic indicators.
It is this housing system infrastructure that is in crisis.
2.
The Problem
The housing system is incredibly complex and blame for the housing crisis can and has been pointed at many different sources: planning delays, supply chain constraints, migration levels, lack of mortgage affordability, lack of rental availability, the impact of negative gearing. But these are symptoms rather than cause of the crisis, at most tilting the balance slightly from one stakeholder group to another.
We have abandoned the housing system to the free-market economy, letting it become a consumer product and an investment commodity with little recognition of its social role (or environmental impact)
The key problem is that we have abandoned the housing system to the free-market economy, letting it become a consumer product and an investment commodity with little recognition of its social role (or environmental impact). Instead of providing homes to live in, we are providing property to invest in.
The crisis includes availability and amenity but affordability is the key way this impact is manifest. Financial journalist Alan Kohler argues that:
“It will be impossible to return the price of housing to something less destructive without purging the idea that housing is a means to create wealth as opposed to simply a place to live.”
Our modern housing system has evolved over the last few centuries with cycles of boom and bust. Housing researcher Cameron Murray suggests we shouldn’t even be calling the current situation a crisis, that it is really just a return to more normal trading conditions. Murray also notes that the majority of people are not in a crisis situation, only a small proportion of the population are especially vulnerable.
But that doesn’t diminish the imperative of finding solutions – even if we are secure enough individually we ignore the broader social strains at our peril.
The current crisis has many compounding factors. We are experiencing a cost-of-living crisis and an energy crisis. We are still in post-pandemic mode and in many ways still recovering from the Great Recession, including global supply chain constraints driven by these two events. Official interest rates have jumped after a decade near-zero.
Most critically, we are at the end of a prolonged period where supply growth has been heavily outpaced by demand growth in almost all major cities.
In Australia, for example, the number of new houses built each year increased slowly but steadily until 1970, after which it levelled out to average 140,000 annually for the next four decades, followed by a spike after the recession and equally rapid fall after the pandemic.
The graph looks something like a wrecking bar, an apt metaphor. During that same period population rose sharply, especially in the cities. Last year alone Sydney grew by 185,000 people and Melbourne by 174,000, that’s annual growth close to 3.5 per cent.
Market Dominance by large corporates
Large corporate housebuilders have come to dominate the market. The UK provides perhaps the most extreme example: small businesses (usually defined as SME’s – small and medium enterprises) used to build about 40 per cent of new houses but that’s only 12 per cent now. Similar trends have occurred in most countries: in Australia the 20 largest companies build 25 per cent of new houses.
In the UK at the moment the Competition and Markets Authority (CMA) is investigating whether the eight largest companies have been colluding, and also assessing the proposed merger of two of these
This concentration of market share by fewer bigger players is not unusual, in fact it’s the typical outcome for any sector in a free market economy.
Their sheer scale influences how the supply chain functions to align with their business model rather than to the benefit of the market as a whole. For housebuilding this applies to the whole development process: the preference for larger sites and standardised housing types, contracting arrangements in the supply chain, the collateral to administer planning approvals and arrange finance. Smaller builders are increasingly at a disadvantage, unable to compete in the mass market at sufficient scale to challenge that market dominance.
Most countries have legislation to minimise the extent of market concentration, sometimes referred to as anti-monopoly. Housebuilding does not often feature for this, but in the UK at the moment the Competition and Markets Authority (CMA) is investigating whether the eight largest companies have been colluding, and also assessing the proposed merger of two of these.
Land supply
Take as an example the rate new-build houses are released to the market. Planning is often blamed for delays but that is wrong: planners cannot dictate how quickly houses are built, it’s the market that dictates the rate of release.
Large housebuilders will only release sites at the rate the local market can absorb without lowering prices and reducing their profits, that’s how the law of supply and demand works. They might have sites approved for thousands of new houses but only build in the hundreds and “land bank” the rest for future development.
There is not a limitless supply of land suitable for housing in any case. Residential land needs to be supported by public infrastructure: utility services, transport links, shops, schools and hospitals.
The land needs to be appropriate for residential use: not subject to natural disasters, prone to pollution from nearby industry, or pose a risk to the surrounding natural environment. Critically, land allocated to housing takes that land away permanently from other uses: public open space, industry, agriculture, or simply leaving it in its natural state (note that we are also in the midst of a biodiversity crisis).
Another aspect is densification. Alongside getting more land for houses we can also build more houses per land area, making a neighbourhood more densely developed.
This mostly means building new mid to high-rise apartments to replace existing low-rise houses. However research shows the value of the land increases in proportion to the density.
Mark Limb from the Queensland University of Technology undertook comprehensive research of the Brisbane housing market over a 20 year period and noted that zoned capacity for density “has no relationship to price across numerous regression models.”
So while densification increases availability it does not necessarily improve affordability. In any case, apartments are generally only built in locations that have a high land value to start with, that is how the additional construction costs are warranted, and because of the high construction costs this sector is even more dominated by the large corporate builders.
Government withdrawal from public housing
The large scale withdrawal of government from providing public housing has exacerbated this market concentration.
In the post-war period around1950-1970 phenomenal numbers of new houses were built across most developed countries, providing homes for returning soldiers and improving the general standard of accommodation.
Many European countries added 2-3 per cent to their housing stock each year, Australia averaged 3.5 per cent. A large proportion of this was public housing but governments have increasingly abdicated this task to the market.
In the UK in the late 1970s more than 40 per cent of new houses were built by housing associations or councils but this has halved to about 20 per cent.
Governments are still spending public money on the housing system but instead of investing this in public-owned assets or developing social capacity it is doing so by supporting private enterprise.
During the same period a lot of existing public housing stock was sold off through the “right-to-buy” scheme, introduced in 1980 to allow tenants to purchase their houses at discounted prices. More than 2 million houses have been sold to date, far outstripping the replacement rate.
The result is a net decline in available public housing by 1.4 million.
The story is similar in Australia, where the proportion of public housing has declined over the last 40 years from 4.9 per cent of the total stock in 1981 to 3.8 per cent today. In terms of new-build, the stock of public housing did increase but at close to half the rate of the total housing stock (64 per cent v 111 per cent).
Even when public money is still being put into building new public housing, public procurement processes tend to favour the bigger contractors. In England for example, most publicly-funded building projects are done through frameworks of pre-registered contractors, and these tend to be dominated by the corporate or larger private firms, referred to as tier one contractors.
Whilst the buildings get built in a cost-competitive manner, it is not necessarily money well spent. Industry expert Stuart Green recently commented that:
“The dominant business model of what we now refer to as tier one contractors is primarily an exercise in contract trading. They don’t do construction, they do contract trading. They’re set up to get the money in as early as possible and pay it out to the supply chain as late as possible.”
Governments have directed public funds to support the market in other ways. Subsidising first-home buyers is a common action, however it is widely recognised this has not reduced prices, merely allowed some additional people to get a foothold on the property ladder, and in doing so have helped to maintain the inflated market prices.
So governments are still spending public money on the housing system but instead of investing this in public-owned assets or developing social capacity it is doing so by supporting private enterprise.
Governments like to support housebuilding as part of construction activity generally, irrespective of social outcomes, because the construction sector is a key economic driver of GDP through employment, manufacturing and finance. It is easier to promote housebuilding knowing there will an economic boost from every house built rather than grapple with the complex issues of the housing system as a whole.
Demand
The causes on the demand side are demographic changes: population increase including immigration and urban drift; declining household size coupled with increasing expectation of amenity; and a steady rise in the number of houses not used as permanent residences.
These are, again, complex issues but in terms of their impact on the housing crisis they have one thing in common: they are driven by factors well beyond anything the housebuilding industry can influence.
To understand how multiple drivers compound demand let’s consider some data from Australia.*
- Occupancy rate: in 1954 this was 3.91 people per household but by 2021 it had dropped by a third to 2.64. This means occupancy of the current 10 million homes is 12 million people less than it would be at the historic rate.
- Unoccupied houses: in 1954 the census showed 4.62 per cent of houses were unoccupied but by 2021 it had more than doubled to 9.62 per cent. At the historic rate there would be 500,000 more houses permanently occupied with about 2 million people.
- House size: in the 1950s the average floor area of new-build homes was about 100 square metres but in 2021 this had more than doubled to 232 sq m – in theory every house could be subdivided in two. From 2000 to 2021 over 3.6 million homes have been built, implying a potential additional capacity of almost 16 million people at the historic occupancy rate.
So if Australians lived the same way they did in the 1950s the current housing stock could accommodate an additional 30 million people, more than double the current population of 26.7 million.
Immigration takes the blame
However, the issue that often takes the blame for housing demand is immigration. Looking at Australia again, net migration fluctuated widely from 1950 till 2000 but since then it has climbed consistently, albeit with a slump during the pandemic and sharp spikes after both the recession and the pandemic.
If we look again at the period from 2000 to 2021, total net migration is just short of 4 million people which would be 1.5 million households at the current occupancy rate, or just over 1 million at the historic rate.
How does that compare to the impact of the demographic changes since the 1950s? It is a tiny 3.3 per cent of the theoretical capacity based on the historic rates. We could have notionally accommodated this many people by reclaiming those half a million unoccupied houses and subdividing another half a million of the 3.6 million new-builds.
High levels of immigration undoubtedly play a role in demand growth, but the bigger problem by far is our over-consumption of housing resources.
It’s worth noting that Japan is one of the few developed countries that does not have a severe housing crisis at the moment, but it also does not have any pressure from migration, indeed the population is in decline.
Investment
It has also been a time when governments increasingly provided financial incentives for people to buy houses as an investment.
In a capitalist free market economy, anything that requires substantial capital investment invokes the dictum that financial returns should be maximised. This kicks in two drivers that are at odds with desirable social outcomes for housing provision:
- Ever escalating asset value, to provide confidence that a house can always be sold for more than was paid for it
- Attractiveness of housing as an investment, where the owner’s role as investor is more important than landlord
Whether this has had any significant impact on the number of new houses built, which was a key part of the rationale for the negative gearing provisions, is not clear. However, the effect has been to tip the balance of housing provision away from individual home ownership and towards renting.
Negative Gearing
In many countries this support has taken the form of negative gearing. An established part of investing in general is that where expenses (including loan interest) associated with an asset are greater than the income earned, this can be claimed as a tax deduction. They become a negative tax liability, hence the expression negative gearing.
Negative gearing has a particularly significant role for property investing. Financial institutions will loan a larger percentage of the money needed to buy a property, referred to as the loan-to-value ratio (LTV), than to buy something like shares, because property is considered low risk, typically around 80 per cent today.
There is no incentive for large corporate housebuilders to significantly increase supply if this will put downward pressure of sales prices, reducing their profit margins and hence the financial return to investors.
This means that interest payments will be a significantly larger part of the costs and hence more likely to result in negative gearing.
But the real security is not the house, it’s the land. Buildings depreciate over time, needing constant expenditure on maintenance, repairs and upgrades.
By comparison land reliably appreciates in value, and if the building gets demolished to allow higher density development the land value will appreciate even more (see the discussion on density). Sometimes landlords are content for buildings to sit empty and deteriorate rather than deal with the hassle of tenants whilst they wait for redevelopment.
Shareholders returns
It’s also worth noting that most large corporate housebuilders are publicly listed companies, and hence they are also an investment opportunity in their own right, separate to the houses they build. Like all listed companies there will be pressure to maximise financial returns to shareholders. The housebuilding sector is notoriously vulnerable, however research indicates that UK housebuilders have performed significantly better than the ASX average over a 3 year period – Visty Group by almost 20 per cent. The Interactive Investor website states:
“The good news is that current profit margins appear solid and generally above 10-year averages, with a couple of exceptions. It could be that inflationary pressures aren’t yet showing up in the financials of these firms, but solid double-digit margins should offer some protection when they do.”
This takes us back to the supply problem: there is no incentive for large corporate housebuilders to significantly increase supply if this will put downward pressure of sales prices, reducing their profit margins and hence the financial return to investors.
It is telling that profits by the large corporate housebuilders have increased significantly over recent years due to bigger profit margins rather than bigger numbers of houses built. This is not to criticise the companies, that is how the system works, but it clearly demonstrates how economic market forces do not align with desired social outcomes.
Conclusion
So who should we look at to bear responsibility for the current housing crisis?
- Concentration of market share by the large corporate housebuilders, and the resulting decline of SMEs, is the inevitable outcome of a free market economy in the absence of government regulations
- Land supply is often blamed but in reality the pace and cost of supply is set by the market (which is primarily set by the large corporate builders) and actions such as planning reform or densification, desirable as they may be for other reasons, are unlikely to affect this
- Withdrawal of government from public housing provision is a long term trend with few meaningful attempts to reverse it from any part of the political spectrum
- Demographic changes and consumer preferences account for the substantial increase in demand not population growth, which is consistent with global trends beyond anything that industry or government can readily change
- Immigration levels and urban drift add to demand but are only a small proportion of the impact on housing provision, albeit government does have a role to ensure public services keep pace
- Government incentives to invest in housing has tipped the balance away from homeownership towards renting, but is unlikely to have had any significant impact on the quantity (or quality) of new houses being built
Free market economics and government disengagement
The conclusion is stark: the current housing crisis is the inevitable result of modern free market economics and government disengagement from the housing system.
How inappropriate it is to abandon the housing system (as opposed to housebuilding) to economic forces without regard to its role as social infrastructure.
This has led to market dominance by the large corporate housebuilders and the balance being tipped away from individual homeownership toward rental investment, both of which (legitimately) prioritise financial return over social value.
What this highlights is, how inappropriate it is to abandon the housing system (as opposed to housebuilding) to economic forces without regard to its role as social infrastructure.
Land supply is an example of this intractable problem: supply simply cannot be readily increased in response to demand. Another is the changing demographics which has seen the new-build houses provide almost four times as much space per person as they did in the 1950s, a driver that is beyond anything the housebuilding industry can influence.
Fundamental rethinking of the housing system is needed. We believe part of that will include:
- Re-building a role for small housebuilding enterprises in the market
- Re-establishing the role of government to provide public housing
* These figures are derived from a mix of the five-yearly census data and quarterly economic statistics which cannot always be exactly matched, so are provided as an estimate pending more detailed analysis.
