Housing Affordability and Housing Investment Opportunity in Australia

Muharem Karamujic

• Publisher: Palgrave Macmillan
• Year: 2015
• Print ISBN: 9781349562909, 9781137517920
• eBook ISBN: 9781137517937
• Topic: Business
• Subtopic: Business General
• Index: Business

Contrary to other developed economies, Australia has experienced a long-term deterioration in housing affordability even between housing price booms. The house price boom that came after the global financial crisis has intensified the stress on Australian housing affordability to yet higher levels, and is likely to continue to be a concern for some time to come. This book reviews a range of available approaches for the measurement of housing affordability, and examines recent empirical evidence on housing affordability in Australia. It begins by explaining the relevance of housing to governments at different levels, the emergence of the housing affordability problem, and the global importance of housing affordability. It then explores the causes of the recent explosion in the number of institutions offering home loan products, analysing features such as the size, composition and changes in total lending and home lending in Australia. The author goes on to investigate the consequences of the two most recent rounds of financial deregulation, as well as the trends in interest rate and property prices, and recent changes in typical borrower behaviour. The book concludes by reviewing a range of available approaches in the measurement of housing affordability. It assesses whether there is a level of adjustment in housing affordability, and finally analyses which housing market segment represents the better investment opportunity during housing boom periods.

1

Introduction

1.1   Background

Due to its importance (discussed in detail in Chapter 2), the housing sector has always been the topic of much discussion. In recent times, it is even more so due to the global financial crisis (GFC) of 2007/09 and the lurking possibility of a global double-dip recession in 2015/16.

Among other things, the housing sector is well known for its cyclical behaviour (commonly expressed in terms of house price changes). The most frequently quoted initiating factors for the observed cyclicality are interest rate sensitivity and the intrinsic construction lags.¹ After defining the initiating point, the rest of the cyclical behaviour is attributed to housing supply being significantly more sluggish than housing demand. For example, an interest rate reduction can almost immediately increase the demand for housing; however, the supply-side cannot react in such a short time due to constraints such as build time and resources availability. Contrary to other developed economies, Australia has experienced a long-run deterioration in housing affordability even between housing price boom cycles. After the last housing price boom cycle (ending with the emergence of the GFC), housing affordability stress levels remained high because house prices did not fall back as in other countries (such as the USA and the UK) to the levels prevailing before the boom. According to Burke and Hulse (2010), the Australian housing market was barely affected by the GFC: “there was a slight hiccup and then borrowing, construction and house price inflation continued on its pre-crisis course”. The house price boom that came after the GFC (and started in late 2009) has ratcheted Australian housing affordability stress to yet higher levels.

Demographia (2009) in its measurement and ranking of housing affordability in English-speaking countries (Australia, Canada, Ireland, New Zealand, UK and USA) observed that over the 2008/09 period, house prices declined in all markets except Australia, causing housing affordability in those countries to improve. This is primarily caused by the fact that during the GFC, compared to other developed economies, the Australian economy proved much more resilient. The persistence of stable financial and banking systems and the prevalence of moderate interest rates have maintained mortgage activity, sustained overall consumer spending and, as such, supported Australian economic performance. In fact, a high level of concern existed in the Australian economy only in early 2009. This was short-lived owing to effective and efficient fiscal and monetary policy measures, so that by the end of 2009, economic momentum began to lift.

Given unwavering house price inflation, moderate-income growth and the demand for housing outstripping supply, housing affordability in Australia is likely to continue to be a concern for some time to come.² This is bad news for the Australian population for at least two reasons: (i) a deterioration in housing affordability has a substantial impact on living standards (housing costs take up an increasing share of the typical household budget) and (ii) reduced access to affordable housing yields a range of non-shelter social issues (Bridge et al., 2003).

The desire to own a home is not an Australian-centric phenomenon, but a well-recognised worldwide aspiration of the vast majority of people.³ It is therefore commonly recognised that an average household’s single largest expense is the purchase of a residential property, whether to live in it (owner occupied) or for investment purposes. Hence, it is not surprising that home loan affordability is seen as crucial for the well-being of an average family. Through its influence on a significant portion of the population, housing affordability greatly influences the whole economy. Consequently, providers of credit (lenders), construction companies and governments, among others, are keenly interested in housing affordability.

Housing is known to provide an ongoing stream of investment and consumption services i.e. a house concurrently serves two purposes: it is a home (shelter) and an investment. The equity that has accumulated in a home is typically the largest individual component of household wealth.⁴ Consequently, it is a widely accepted form of collateral for credit, not only for funding the purchase of a home but increasingly to fund consumption expenditure. In recent years, homeowners have borrowed large amounts against the equity in their homes. The major reason for using home equity as a security for funding consumption expenditure is that it represents a lower risk for lenders and lowers the interest expense and monthly repayment amounts for borrowers.

Everything we have said so far clearly demonstrates the global importance of housing affordability and, as such, the importance of research which examines housing affordability and its practical applications. Due to the fact that Australia has well-developed housing markets (a necessary condition for contemporary and comprehensive analysis of the issues considered), a well structured and stable financial sector, and the aforementioned peculiarities of its housing markets’ performance and overall economic performance, this book will utilise an Australian example for empirical analysis.⁵ With this in mind, in addition to having several supporting objectives (see the next section), this book has two main objectives, namely: (i) to review a range of available approaches to the measurement of housing affordability, and (ii) to show how all of it is relevant and functions in practice by examine the evidence on housing affordability in Melbourne, Australia, from 2001 to 2010. Overall, this book consolidates much of the work done by researchers in this field in recent years and focuses on those aspects that continue to be controversial despite many years of debate.

1.2   Objectives

The fundamental intent of this book is to contribute to the formal literature on the topic of housing affordability. This will be achieved by tackling the two main objectives plus a set of accompanying ones. As we have said, the two main objectives are: (i) to review a range of available approaches to the measurement of housing affordability and (ii) to show how all of it is relevant and functions by examining the evidence on housing affordability in Melbourne, Australia. The book is envisaged as a sequential exposition on pertinent, logically connected themes.

The book starts with a discussion of the importance of housing. To do this we consider a number of complementary topics. In addition to discussing housing trends, the following three topics are examined: the relevance of housing to governments at different levels, the emergence of the housing affordability problem and why housing affordability is important. Ultimately, the core purpose is to enhance our understanding of the complexity and importance of housing and, by doing so, to inform the discussion, to different degrees, of the other chapters in this book.

Having completed our exposition on the importance of housing, the subsequent generic research objective is to briefly explore the major reasons for the recent explosion in the number of institutions offering home loan products and in the number of home loan products offered in Australia. In doing so, the following topics are considered: the size, composition and changes in total lending and in home lending in Australia; the consequences of the two most recent rounds of financial system deregulation; trends in interest rate and property prices; and recent changes in typical borrower behaviour. This is relevant to this project mainly for the following three reasons: (i) the discussion will be a good introduction to the discussion in Chapter 4 of various contemporary home loan products and packages; (ii) it will enable a more comprehensive understanding of contemporary housing affordability measures (the focus of Chapter 5), especially those based on home loan repayments (Section 5.2: Home loan affordability measures); and (iii) it will, to a certain degree, inform the interpretation of the empirical portion of this book (the focus of Chapter 6).

Having covered the two more generic parts of the exposition, the focus is then narrowed to consider contemporary residential mortgage lending (home loan) products. The core purpose of providing a detailed account of various contemporary home loan products is twofold: (i) it will enable a more comprehensive understanding of contemporary housing affordability measures (the focus of Chapter 5) and (ii) it will aid the interpretation of the empirical part of this book (Chapter 6).

As previously outlined, this book has two main objectives: (i) to review a range of available approaches to the measurement of housing affordability and (ii) to examine the evidence on housing affordability in Melbourne, Australia. Having covered all the necessary background components of the book, we will be in a position to review a range of available approaches to the measurement of housing affordability. Despite the fact that it is widely accepted that affordability problems are commonly present, there is no universally accepted definition of affordability or of a threshold beyond which housing is deemed as not affordable. Instead there are a number of measures that attempt to measure housing affordability. Housing affordability measures are divided into: home-ownership affordability measures (home loan affordability measures and housing price-based affordability measures) and rental affordability measures. Both categories are discussed in detail.

After providing a review of contemporary housing affordability measures, the last major generic objective of this project is to empirically examine the geography of housing affordability and housing investment opportunity in Melbourne, Australia. More precisely, while tackling this generic objective, the study first seeks to unpack the geography of Melbourne’s affordability problem at the local level through understanding structural changes in housing affordability during the last decade. This is followed with an examination of whether housing affordability in different Melbourne suburbs converges or diverges, i.e. the study looks into whether the selected suburbs and the four suburb groups considered become more (converge) or less (diverge) affordable over the whole considered period and year to year, for people living in those suburbs. In other words, the question here is whether there is a level of adjustment of housing affordability to equilibrium or not. Finally, the study sets out to explore which Melbourne housing market segment represents the better investment opportunity during housing boom periods. The analysis examines both high and low interest rate environments. The exposition on which Melbourne housing market segment represents the better investment opportunity completes the study.

1.3   Outline

This book is structured as follows. Chapter 2 explores the importance of housing. Although not the direct focus of this book, a comprehensive understanding of housing is fundamental to understanding the complexities relating to the behaviour of all parties involved in the housing markets (such as the general population, government at all levels, construction companies, materials suppliers, financial institutions, etc.) and through this to a comprehensive understanding of the fundamental forces that determine the level of housing affordability. To achieve this, the chapter is structured into the following four sections: housing trends, the relevance of housing to government (at different levels), the emergence of the housing affordability problem and why housing affordability is important. This chapter provides the background to all the other chapters in the book.

The primary motivation of Chapter 3 is to briefly explore the major reasons for the recent explosion in the number of institutions offering home loan products and in the number of home loan products offered. While doing so, in addition to providing an outline of the size, composition and changes in total lending and in home lending in Australia, the chapter also examines the consequences of the two most recent rounds of financial system deregulation: trends in interest rate and property prices and recent changes in the typical borrower’s behaviour.

To enable a better understanding of contemporary housing affordability measures (the focus of Chapter 5), especially those based on home loan repayments (Section 5.2: Home loan affordability measures), it is necessary to comprehensively understand the various contemporary home loan product groups and packages. Chapter 4, therefore, provides a detailed and structured account of contemporary home loan products and packages. In addition to discussing home loans from the point of view of the type of offering (home loans can be provided as either stand-alone products or through various financial packages), home loan products are also categorised with respect to their major functionality (based on the lender’s point of view of the determining function of a home loan), major purpose type (what they are used for, e.g. owner occupied or investment), distribution segment (how are they distributed), interest rate structure (what kind of interest payments they have) and conformation status (whether they conform to typical home loan lending standards or not). All of the above home loan categories principally differ with respect to the number of features allocated to them. Typically, the higher the sophistication, the higher the gross margin the lender realises. Also important to note is that, normally, with an increase in gross margin and the level of sophistication comes an increase in the costs associated with the product.

Having discussed the importance of housing, the major reasons for the recent explosion in the number of institutions offering home loan products and in the number of home loan products offered and the major categories of home loans, the focus of Chapter 5 is on providing a review of the available approaches for the measurement of housing affordability. An introduction to the chapter is followed by an outline of home loan affordability measures, the housing price-based affordability measures and the rental affordability measures. The chapter ends with some concluding remarks.

After our review of contemporary housing affordability measures, the generic focus of Chapter 6 is on examining the geography of housing affordability and housing investment opportunity at the local level (suburban) in Melbourne, Australia, during the last decade. The focus of the empirical portion of the book is on understanding structural changes in housing affordability as measured by the Median Multiple indicator. The study also examines whether housing affordability in different Melbourne suburbs converges or diverges, i.e. the study will look into whether the selected suburbs and the four suburb groups considered become more (converge) or less (diverge) affordable over the whole period and year to year, for people living in those suburbs. Finally, the study sets out to explore which Melbourne housing market segment represents the better investment opportunity during housing boom periods.

The book concludes with Chapter 7, which provides a brief summation of the findings, identifies the study’s limitations and provides suggestions for future research.

2

Housing: Why is it Important?

2.1 Introduction

A thorough understanding of the importance of housing, although not the direct focus of this book, is vital for understanding the complexities of the behaviour of all interested parties engaged in the housing market (such as the general population, governments at all levels, construction companies, materials suppliers, financial institutions, etc.) and through this, for comprehensive understanding of the fundamental forces that determine the level of housing affordability. It is commonly accepted that the well-being of both individuals and families is substantially affected when th...

Table of contents

• Cover
• Title
• 1  Introduction
• 2  Housing: Why is it Important?
• 3  Major Reasons for an Increase in the Number of Institutions Offering Home Loan Products and in the Number of Home Loan Products Offered in the Australian Home Loan Market
• 4  Introduction to Contemporary Residential Mortgage (Home Loans) Lending Products
• 5  Contemporary Housing Affordability Measures
• 6  The Geography of Housing Affordability and Housing Investment Opportunity: A Case Study of Melbourne
• 7  Conclusion
• Notes
• Bibliography
• Index