While recent moves to limit interest-only mortgage lending will help to reduce financial stability risks in Australia’s housing market, it won’t help to address housing affordability, says Reserve Bank of Australia (RBA) governor Philip Lowe.
In a speech delivered overnight in Melbourne, Lowe made it clear that efforts to reduce demand-supply imbalances in Australia’s housing market, rather than tighter macroprudential measures, are the only solution when it comes to improving housing affordability.
“It is important, though, that we are all realistic about what these and other prudential measures can achieve,” said Lowe.
“The underlying driver in our housing market is the balance between supply and demand.
“The various prudential measures do not address the underlying supply-demand issues. But they can reduce the risk from the financial side of the housing market while the underlying issues are addressed.”
On the demand side, Lowe said that strong population growth — particularly in Australia’s largest cities — went someway to explaining recent gains in property prices in cities such as Sydney and Melbourne, noting that there was no initial supply response this increase.
“Underinvestment in this area is one of the factors that has pushed housing prices up,” he says
“Put simply, the supply side simply did not keep pace with the stronger demand side. The result has been higher prices.”
This, he says, helped to fuel demand from investors as a combination of lower borrowing costs and continued capital gains encouraged more people to enter the market, pushing up prices further.
“Rising prices have encouraged people to buy residential property as an investment in the hope of ongoing capital gains. With global interest rates so low, many investors have found it attractive to borrow money to invest in appreciating residential property,” he says.
“This has reinforced the upward pressure on prices.”
It’s a clearly acted as a feedback loop, with higher prices encouraging more investor activity. That, in turn has helped to lift property prices further, encouraging even more activity despite falling gross rental yields.
The end result is that investment decisions being increasingly driven by speculation over further price gains. And, in Lowe’s opinion, that’s been amplified by the tax system, noting that the current popularity of interest-only investor loans can be partially explained by “the taxation arrangements that apply to investment in residential property in Australia”.
He also pushed back against the view that interest rate cuts delivered by the RBA have been the main factor behind recent strength in house prices in Australia’s southeastern capitals.
“The availability of credit is undoubtedly a factor that can amplify demand, but it is not the root cause,” he said, noting that “this assessment is consistent with the observation that housing market dynamics currently differ significantly across the country, despite Australia having nationwide financial institutions and the level of interest rates being the same across the country”.
While true that house prices have not grown uniformly across the country in recent years, interest rate cuts have clearly helped to boost investor demand in Australia’s largest cities, particularly over the past 12 months.
The vast majority was concentrated in New South Wales and Victoria, states favoured destinations for investors in the past.
Although the timing of the Federal election may have played a role in the rebound given Labor was proposing limiting negative gearing to new housing, a factor that may have brought forward demand given it was proposing to grandfather existing tax arrangements, growth in investor lending grew even faster in the months following the election, leading to the recent policy response from APRA to limit interest-only lending to 30% of total new mortgage lending.
Looser monetary policy was clearly a factor, something Lowe alluded to earlier this year when he told parliamentarians that further rate cuts “would probably push up house prices a bit more, because most of the borrowing would be borrowing for housing.”
The track record speaks for itself. As interest rates have been reduced, housing credit has increased.
It explains why the RBA is reluctant to cut interest rates further at present despite weak labour market conditions, soft inflation and a spluttering household sector.
With the RBA hamstrung in helping to improve housing affordability, at least from a loan serviceability perspective, Lowe suggests that it’s now time for Australia’s politicians to do their part.
“It is hard to escape the conclusion that we need to address the supply side if we are to avoid ever-rising housing costs relative to our incomes and to avoid the attendant incentive to borrow that is created by rising housing prices,” he said.
“Nothing increases the supply of well-located land like good transport links.”
A none-too-subtle prod on the need for better transport infrastructure to help to reduce demand in areas where it is currently the most acute.
While Lowe’s answer to achieving improved housing affordability, like others, is to increase housing supply, building large-scale transportation infrastructure takes years to put in place.
And that’s if it is even considered given fiscal constraints at present.
Put simply, a supply-side, infrastructure-led response will do little to improve affordability now or in the medium-term. It will take years to put in place.
That means that if affordability is to improve, it’s demand-side factors that will need to be addressed here and now.
And while he didn’t devote much time to them in his speech overnight, Lowe gave a clear indication as to what he believes has contributed to persistent demand-side pressures: the tax treatment of housing and population increase.
Limiting tax concessions and reducing immigration levels are fraught with political danger from many perspectives, but of all the demand-side factors within the control of the federal government, those, along with changes to foreign ownership laws, would be the quickest to implement.
While limiting interest-only lending to 30% of all new mortgage lending will help to reduce investor demand at the margin, for a government currently under pressure to act on housing affordability, these too need to be considered.