Housing has been a hot topic at Australian barbecues for decades, but the rapid and unexpected changes in rents and prices since the COVID pandemic have boosted the public’s attention to the market. The latest communication from financial journalist Alan Kohler — a Quarterly Essay titled The Great Divide: Australia’s housing mess and how to fix it — is, therefore, a timely contribution from a master communicator, one who has probably done more to communicate economic ideas in his articles, newsletters and nightly ABC news segment than all of Australia’s university professors combined.
Like all of Kohler’s writing, it is also an enjoyable tale. We follow stories of his family’s home-buying experiences across the generations, get to the niche problems of renting with pets, and even delve into the puzzling difference between fixed-rate and variable-rate mortgages in Australia and the United States, which evolved from the formation of Freddie Mac and Fannie May financial institutions after the 1930s depression.
For a reader interested in housing markets, a comprehensive zoomed-out view of the housing elephant is always more useful than a collage of close-ups. But for a housing economist like myself who has also studied the elephant from every angle, there is also plenty about The Great Divide that resonates, especially on the politics of housing.
However, a few important economic questions remain. On the politics, I am in complete agreement with Kohler that we all too often jump to our preferred policy before we properly diagnose the problem. This is as true in housing as it is elsewhere. Kohler writes: “What are we trying to achieve? And does anyone who matters really want to achieve it?” Or more pointedly: “Is the big rise in house prices since 2000 good or bad?”
I call this problem the symmetry of property markets. To me, it’s the core unresolved issue that much of the public debate about housing ignores. So much so that it’s the central theme of my upcoming book, The Great Housing Hijack.
For Kohler, the aim of any housing policy change should be to “get the ratio of house prices to income down to what it used to be”. Today, prices are often around seven or eight times household incomes. From the 1950s to the 1980s, they were closer to three or four times. A return to the previous normal seems both reasonable and uncontroversial. We’ve done it before. Why can’t we do it again?
But this is where my views differ. I don’t think this can happen, the reason being larger economic forces in the economy that Kohler does not fully account for in his analysis.
High housing asset prices aren’t necessarily bad. Nor are cheap housing asset prices necessarily good. It’s been nearly four decades since the late 1980s, but we still hear complaints about the high-interest rates on home loans of that era. Yet house prices were much lower then, exactly in Kohler’s target range of three to four times household incomes.
What’s the deal?
Housing asset prices just aren’t that important when it comes to how cheap it is to be housed. What matters is the cost of occupying housing, which can be done in two main ways: you can rent a house from a landlord, or you can rent money from a bank to be your own landlord.
A $1 million home looks expensive at a 10% interest rate, costing $100,000 per year in interest. But it looks cheap at a 2% interest rate, costing only $20,000 a year in interest “rent”. The cost differs by a factor of five in each scenario. But for a household with a $125,000 income, the price-to-income ratio is eight times in both cases. Houses get cheap when the price of money (the interest rate) gets expensive.
This inverse relationship between the price of money and the price of homes is an economic force we manipulate to manage the macroeconomy. The higher interest rates of the past year have sought to achieve lower house prices, and they will eventually. Before that, the lower interest rates during COVID were meant to achieve higher housing prices. Which they did. And those low interest rates also encouraged a record number of first-home buyers into the market who realised that renting money was cheaper than renting homes.
We have the tools to make housing asset prices lower. I just don’t think anyone will be happy to have 10% mortgage interest rates, even new potential first-home buyers.
Another place I part ways with Kohler is on some substantive points about the supply side, which he explains in three sections of The Great Divide that respectively deal with public housing, cities versus regions, and council planning regulations.
Yes, there is a decline in public housing provision as an “outside option” to escape the private rental and home-buying market. I completely agree here and think that a better range of public housing options, drawing on workable systems from abroad, or even at home, like defence housing in Australia, should be greatly expanded.
On the idea that getting people out of cities and into the regions will make homes cheaper, I am wary. It might make some infrastructure provisions more efficient. But we saw what a flight to the regions was like during COVID, which made housing there more expensive in terms of rent and prices. Are higher rents and prices in the regions and lower rents and prices in the cities a good outcome? I’m not sure.
On council regulations, many are indeed outdated and wasteful. But I don’t agree that they are changing rents and prices on average. The rising price of housing assets during COVID and the recent trends of sharply rising rents are global phenomena caused by global changes in household incomes and financial markets.
To show why we should be hesitant to buy into the idea that councils are to blame, consider that Kohler suggests “housing is a cartel of the majority, with banks and developers helping them maintain high house prices with the political class actively supporting them”. Yet this cartel is broadly in support of removing council regulations, which apparently make homes cheaper.
Which is it? Does the cartel want prices to be higher? If so, they would support more council planning regulations, not fewer.
I think this puzzle is resolved when economic forces that are missing in Kohler’s big-picture view on the housing elephant are included. In this case, it is the market equilibrium forces that regulate how quickly homes are built by property owners who don’t want to undercut their future sales.
Overall, most readers will learn plenty about housing markets and policy from The Great Divide. Its attempt to provide a coherent zoomed-out picture of the housing elephant is useful. But I think we can further sharpen the picture by accompanying it with a zoomed-out and more comprehensive picture of the economic forces at work in the housing market.
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