Social Trends – Page 163 – Digital Finance Analytics (DFA) Blog

Tackling housing unaffordability: a 10-point national plan

From The Conversation. The widening cracks in Australia’s housing system can no longer be concealed. The extraordinary recent debate has laid bare both the depth of public concern and the vacuum of coherent policy to promote housing affordability. The community is clamouring for leadership and change.

Especially as it affects our major cities, housing unaffordability is not just a problem for those priced out of a decent place to live. It also damages the efficiency of the entire urban economy as lower paid workers are forced further from jobs, adding to costly traffic congestion and pushing up unemployment.

There have recently been some positive developments at the state level, such as Western Australia’s ten year commitment to supply 20,000 affordable homes for low and moderate income earners. Meanwhile, following South Australia’s lead, Victoria plans to mandate affordable housing targets for developments on public land. And in March the NSW State Premier announced a fund to generate $1bn in affordable housing investment.

But although welcome, these initiatives will not turn the affordability problem around while tax settings continue to support existing homeowners and investors at the expense of first time buyers and renters. Moreover, apart from a brief interruption 2008-2012, the Commonwealth has been steadily winding back its explicit housing role for more than 20 years.

The post of housing minister was deleted in 2013, and just last month Government senators dismissed calls for renewed Commonwealth housing policy leadership recommended by the Senate’s extensive (2013-2015) Affordable Housing Inquiry. This complacency cannot go unchallenged.

Challenging the “best left to the market” mantra

The mantra adopted by Australian governments since the 1980s that housing provision is “best left to the market” will not wash. Government intervention already influences the housing market on a huge scale, especially through tax concessions to existing property owners, such as negative gearing. Unfortunately, these interventions largely contribute to the housing unaffordability problem rather than its solution.

But first we need to define what exactly constitutes the housing affordability challenge. In reality, it’s not a single problem, but several interrelated issues and any strategic housing plan must specifically address each of these.

Firstly, there is the problem faced by aspiring first home buyers contending with house prices escalating ahead of income growth in hot urban housing markets. The intensification of this issue is clear from the reduced home ownership rate among young adults from 53% in 1990 to just 34% in 2011 – a decline only minimally offset by the entry of well-off young households into the housing market as first-time investors.

Secondly, there is the problem of unaffordability in the private rental market affecting tenants able to keep arrears at bay only by going without basic essentials, or by tolerating unacceptable conditions such as overcrowding or disrepair. Newly published research shows that, by 2011, more than half of Australia’s low income tenants – nearly 400,000 households – were in this way being pushed into poverty by unaffordable rents.

Thirdly, there is the long-term decline in public housing and the public finance affordability challenge posed by the need to tackle this. In NSW, for example, 30-40% of all public housing is officially sub-standard.

“Why the “build more houses” approach won’t work

A factor underlying all these issues is the long-running tendency of housing construction numbers to lag behind household growth. But while action to maximise supply is unquestionably part of the required strategy, it is a lazy fallacy to claim that the solution is simply to ‘build more homes’.

Even if you could somehow double new construction in (say) 2016, this would expand overall supply of properties being put up for sale in that year only very slightly. More importantly, the growing inequality in the way housing is occupied (more and more second homes and underutilised homes) blunts any potential impact of extra supply in moderating house prices. Re-balancing demand and supply must surely therefore involve countering inefficient housing occupancy by re-tuning tax and social security settings.

Where maximising housing supply can directly ease housing unaffordability is through expanding the stock of affordable rental housing for lower income earners. Not-for-profit community housing providers – the entities best placed to help here – have expanded fast in recent years. But their potential remains constrained by the cost and terms of loan finance and by their ability to secure development sites.

Housing is different to other investment assets

Fundamentally, one of the reasons we’ve ended up in our current predicament is that the prime function of housing has transitioned from “usable facility” to “tradeable commodity and investment asset”. Policies designed to promote home ownership and rental housing provision have morphed into subsidies expanding property asset values.

Along with pro-speculative tax settings, this changed perception about the primary purpose of housing has inflated the entire urban property market. The OECD rates Australia as the fourth or fifth most “over-valued” housing market in the developed world. Property values have become detached from economic fundamentals; a longer term problem exaggerated by the boom of the past three years. As well as pushing prices beyond the reach of first home buyers, this also undermines possible market-based solutions by swelling land values which damage rental yields, undermining the scope for affordable housing. Moreover, this places Australia among those economies which, in OECD-speak, are “most vulnerable to a price correction”.

While moderated property prices could benefit national welfare, no one wants to trigger a price crash. Rather, governments need to face up to the challenge of managing a “soft landing” by phasing out the tax system’s economically and socially unjustifiable market distortions and re-directing housing subsidies to progressive effect.

A 10-point plan for improved housing affordability

Underpinned by a decade’s research on fixing Australia’s housing problems, we therefore propose the following priority actions for Commonwealth, State and Territory governments acting in concert:

Moderate speculative investment in housing by a phased reduction of existing tax incentives favouring rental investors (concessional treatment of negative gearing and capital gains tax liability)
Redirect the additional tax receipts accruing from reduced concessions to support provision of affordable rental housing at a range of price points and to offer appropriate incentives for prospective home buyers with limited means.
By developing structured financing arrangements (such as housing supply bonds backed by a government guarantee), actively engage with the super funds and other institutional players who have shown interest in investing in rental housing
Replace stamp duty (an inefficient tax on mobility) with a broad-based property value tax (a healthy incentive to fully utilise property assets)
Expand availability of more affordable hybrid ‘partial ownership’ tenures such as shared equity – to provide ‘another rung on the ladder’
Implement the Henry Tax Review recommendations on enhancing Rent Assistance to improve affordability for low income tenants especially in the capital city housing markets where rising rents have far outstripped the value of RA payments.
Reduce urban land price gradients (compounding housing inequity and economic segregation) by improving mass transit infrastructure and encouraging targeted regional development to redirect growth
Continue to simplify landuse planning processes to facilitate housing supply while retaining scope for community involvement and proper controls on inappropriate development
Require local authorities to develop local housing needs assessments and equip them with the means to secure mandated affordable housing targets within private housing development projects over a certain size
Develop a costed and funded plan for existing public housing to see it upgraded to a decent standard and placed on a firm financial footing within 10 years.

While not every interest group would endorse all of our proposals, most are widely supported by policymakers, academics and advocacy communities, as well as throughout the affordable housing industry. As the Senate Inquiry demonstrated beyond doubt, an increasingly dysfunctional housing system is exacting a growing toll on national welfare. This a policy area crying out for responsible bipartisan reform.

Five Reasons Housing Is More Affordable Overseas

From The Conversation. Housing affordability continues to be an issue of importance to voters, with a recent Fairfax-Ipsos poll showing 69% of Australian capital city residents disagree that housing is affordable for prospective first home buyers.

Different countries have adopted varying approaches to improve access to affordable housing – with governments playing a central role in ensuring people are adequately sheltered, as well as being encouraged to buy housing where possible. In many countries there is an underlying desire by households to own their own home, although renting is the norm in others.

More than 84% of households in Berlin rent their home. exilism/Flickr, CC BY-NC-ND

In each case there are specific and sometimes unique-to-that-country approaches that have helped address the issue of affordability. Here’s five.

Government intervenes in the rental market

In some countries there is a general culture of renting for accessing accommodation, rather than assuming all households should achieve home ownership. At times, renting is cheaper than buying. In Germany most households (54.1%) are renters due to the long-term intervention in the marketplace by the government, as well as the accepted culture that renting is suitable over the long-term. In Berlin a total of 84.4% of all households rent. Providing this amount of rental accommodation is a major challenge without substantial government intervention and/or provision of housing.

For example, in Germany a housing allowance was paid to approximately 783,000 households in 2012, equating to 1.9% of all private households. However most of this funding was allocated to single person households (57%) unable to compete in the open housing market with multiple income households.

Other countries have acknowledged the gap between (a) the maximum amount of rent a tenant can pay and (b) the minimum level of rent a landlord will charge. For example in the US, this gap is bridged by the widespread use of a voucher system which subsidies the payment of rent to private landlords. This system is funded by the US government and ensures tenants can access a minimum quality of affordable housing.

Government provides affordable housing

In Singapore there is a high level of government intervention in the market with the HDB (Housing and Development Board) providing approximately 80% of all housing in the country. Approximately 90% of households in Singapore own their own home and there are also grants for first time buyers and second time buyers in Singapore.

In Hong Kong about 29.7% of residents live in PRH (public rental housing) provided by the Hong Kong government. In Scotland a large proportion of the supply of affordable housing is undertaken by housing associations and local authorities. This collectively equates to about quarter of total housing accommodation in the market. However the recent trend for many countries, including Australia, has been the provision of less direct housing by governments.

Cities embrace higher density housing

There are numerous examples of global cities making better use of limited inner-city land supply by encouraging higher density living in high rise units or condominiums, especially in Asian cities including Hong Kong, Macau and Singapore. The provision of affordable housing for purchase or renting is therefore more likely to be achieved in these circumstances due to minimal land use and higher densities. However high-rise living is not commonly accepted in many European cities or in locations with a resistance due to cultural preferences for detached housing.

Public transport allows residents to commute to less expensive housing

The main driver of where a household lives is the need to be close to their workplace. As more affordable housing is usually located away from the central business district, households can buy cheaper homes but the trade-off is additional commuting time to work. When this extended commuting time (e.g. up to 2 hours each way) is combined with improved transport infrastructure such as in Japan, it is possible to access affordable housing in outlying satellite towns and cities where land is more affordable. Therefore governments which improve road and public transport infrastructure also increase access to affordable housing.

Multiple person households are encouraged

Lower demand can be achieved by limiting population levels and underlying demand for housing. But while this may not be an option for many governments, another option is to encourage multiple person households which otherwise would remain as single person households. According to the ABS (2012) in 1911 the average persons per household was 4.5, decreasing to 2.7 persons per household by 1991.

List of countries by number of households

Wikipedia compiled from various sources.

Author: Richard Reed, Chair in Property & Real Estate at Deakin University

Online Business Activity Rises – Revenue Was $216 Bn Last Year

The recent ABS data relating on online business shows that whilst the total number of active businesses fell, online revenue grew by about 8%, compared with 4% the previous year. The number of firms fell from 770,000 to 757,000 (reflecting tough trading conditions, see our SME surveys). However overall internet generated income rose from $246 billion to $267 billion, which is about 15% of GDP.

Collection of data included in this release was undertaken based on a random sample of approximately 6,640 businesses via online forms or mail-out questionnaire. The sample was stratified by industry and an employment-based size indicator. All businesses identified as having 300 or more employees were included in the sample. The 2013-14 survey was dispatched in late October 2014.

The survey shows a significant rise in a social media presence up 18%, but this compares with a massive 44% increase in the prior year. We also see a rise in orders placed via the internet (up 4%), and fulfilled via the internet (up 10%). Almost all firms have broadband access.

Finally, average annual income for a small firm was more than $4,000, compared with a medium firm of $17,000. Larger firms generated more income, and the four largest employers generated on average $3.6 million.

Commerce through the internet is both mainstream, and likely to grow further, supported by the deeper penetration of smart phones and tablets, which enhance customer convenience, and innovation in terms of products and services. See our recent post. Many firms now see online as just another channel to market, but there are industry variations.

We see, for example that Information, Media and Telecommunications are some of the most active, whilst in finance and insurance, only 60% have a web presence, and 30% have a social media presence.

Australians are saving more, but are more comfortable with debt

From The Conversation. Australians know that adequate savings can help provide for a rainy day, help a family put down a deposit on a home, or ensure a comfortable retirement.

Debt also offers a way for households to make purchases that would otherwise be impossible and to achieve a higher current standard of living. Debt invested into an asset that will also grow in real value and is able to be serviced without placing too much ﬁnancial pressure on a household, is generally considered to be good debt.

The key is balance. Since the 2008 financial crisis, Australians have actually decreased their propensity to take on debt and have increased their savings. But debt rates still remain uncomfortably high and there is evidence that this savings discipline is beginning to fade. Have we grown too comfortable with debt?

Household debt is three times what it was 20 years ago. Image sourced from www.shutterstock.com

Saving more, but more indebted

Bankwest Curtin Economics Centre’s second ‘Focus on the States’ report, Beyond our Means? Household Savings a Debt in Australia finds Australians have more debt and are more comfortable with it.

While household savings portfolios have seen an increase of 54% in real terms since 2005, household debt has risen by 51% in the same period. Many households are able to access and service this debt, with higher debts associated with higher incomes. On average, Australia’s estimated 9.1 million households have savings in the form of ﬁnancial assets of $340,900 and debts of $148,700.

However, there is a gulf between those at the top of the distribution and those at the bottom. The inequality in the distributions of household savings and debt are considerably worse than the much talked about inequality in incomes.

The average household disposable income of the top 20% of savers is less than four times those in the lowest savings quintile. However, their savings at an average of almost $1.3 million is 200 times the bottom 20%. This top quintile may receive one-third of all income, but they own three quarters of the total value of savings in the form of ﬁnancial assets.

Average household savings by savings quintile, Australia 2015 (mean $‘000)

The trifecta of debts, low (or no) savings and low incomes presents many low economic resource families with an unenviable challenge to maintain an acceptable quality of life for themselves and their families on a day-to-day basis.

Since the global financial crisis, the household savings rate have risen, with households exhibiting discipline in their expenditure at a time when the economic outlook was uncertain. In an economic downturn income can decline quickly while reining in spending can be more diﬃcult, for both households and governments. Debts can quickly get out of hand and become unmanageable in this situation.

Becoming used to debt

While Australian households have decreased their propensity to take on debt and have increased their savings in the post-GFC period, household debt still remains three times higher now than what it was 20 years ago. Australians are now more comfortable with debt and currently hold debt equal to 1.5 years of income, whereas in the past they had only debt equivalent to six months of annual income.

The share of debt associated with investment property loans has tripled from one-tenth to three-tenths between 1990 and 2015.

Unlike previous generations accustomed to more rigid ﬁnancial products, current households can access a greater number of ﬁnancial products, which have arguably become more complex and more ﬂexible.

This flexibility delivers beneﬁts, but with complexity comes risk and it is important to promote good ﬁnancial decisions and encourage a longer term outlook. Mortgage equity withdrawal has become a popular tool to derive a higher current standard of living by using the family home as collateral.

More households now use these schemes to smooth consumption or relieve short-term ﬁnancial pressures. But this may have contributed to the average mortgage debt as a proportion of property values almost tripling over the last 25 years, rising from 10% to 28% since 1990.

Ratio of housing debt to housing assets, June 1990 to December 2014

Another issue is the use of superannuation savings to pay down mortgage balances, leading retirees to rely more on the pension.

So are we living beyond our means? With household debt to income ratios three times higher now than a quarter of a century ago, household debt up by over 50% in real terms over the last decade and the debt of those approaching retirement (55-64 year olds) up 64% in real terms, it would seem on the face of it to be true.

However, the reality is more nuanced. Household savings are growing faster than income and 8.5 cents in every dollar is being saved, and there is now $2 trillion tucked away in superannuation, while riskier investments are making way for more a more conservative approach. This is far better than we were 10 years ago, but with a note of caution that savings are again on the decline.

Authors: – Alan Duncan, Director, Bankwest Curtin Economics Centre and Bankwest Research Chair in Economic Policy at Curtin University and Rebecca Cassells, Adjunct Associate Professor, Bankwest Curtin Economics Centre at Curtin University

A home of your own: dream or delusion?

From The Conversation. The appeal of owning a home seems deeply embedded in the psyche of Australians. Yet psychologically, it is not clear the home ownership dream is entirely rational. Achieving the dream may not be all we might have hoped, and chasing it may even do damage.

We’d all like a castle of our own, one day. Image sourced from Shutterstock.com

The psychological reason Australians want to own their own home is perhaps best expressed by Darryl Kerrigan in the uniquely Australian film, The Castle. It continues to be celebrated globally for showing that the house is just a shell that holds heart. To own your own home has a strong sentimental value, as Darryl says: “You can’t buy what I’ve got.”

According to data on social trends from the ABS, the dream is not merely a distant aspiration, but one achieved by a majority of the Australian population. More than two out of every three Australians are living in their own home, a figure that has been maintained across a number of decades (see below).

Australian Bureau of Statistics ABS Australian Social Trends 6530.0 & 4102.0

However, the data also show that the proportion who own with a mortgage is increasing (and the proportion without is decreasing). So the dream continues to be made a reality even if home buyers need to borrow more money to achieve it.

Dare to dream

What harm can there be in having dreams? Well, there is a sizeable minority who perhaps do not achieve their dreams. And dreams that keep us awake at night are not good.

Joe Hockey’s recent remarks suggesting would-be home owners “get a good job” were labelled as insensitive and drew a great deal of ire.

The public reaction reinforced the fact that we have a strong attachment to the dream of owning our own home. But why this attachment? While we need a place to live, and housing is for many a form of retirement saving, the desire to own our own home goes beyond these needs.

It’s a global desire, judging by the substantial home-ownership rates around the world – from 98.7% in Romania to 44.0% in Switzerland.

Across cultures and across age groups, one of the motivations for possession of anything is to have the ability to control that possession. In the case of a house, this might be to nail up pictures, paint walls and remodel the place.

The real cost of ownership

But this desire to own, the wish to possess, comes at a cost. First, there is considerable research suggesting we tend to overweight the value of owning stuff as opposed to simply having access to use. Called the endowment effect, it describes the way in which we tend to place a higher value on an item that is owned than on an identical item which is not owned.

Surprisingly, and perhaps of greater concern, is that ownership of a home does not appear to necessarily make people happier. One researcher found that women who owned their own home were no happier than those who rented.

More generally, the rent vs buy debate seems to focus the issue on elements that turn out to be less relevant to our longer-term happiness. We make choices based on big differences (such as rent or buy) when the two dwellings are in most other respects, very much the same.

In this case, we are falling for the focusing illusion whereby we exaggerate the joys of home ownership. Psychologist Daniel Kahneman explains this concept with regard to the myth of California happiness.

And once we get to be a home owner, the pleasure we so anticipated can quickly disappear through the phenomenon of hedonic adaptation. We imagine that owning our own home will make us very happy, and while this may be true in the short run, our happiness levels return quickly to whatever they were before the event.

Hedonic adaptation diminishes both acute negative and positive experiences. And this may explain why home ownership rates and desires bounced back quickly in the US despite the punishing lessons delivered during the global financial crisis of 2008 when many held mortgages of greater value than their home.

We might be inclined to argue that home ownership is a good investment, that “rent money is money down the toilet”, but we may be engaging in a confirmation bias. That is, interest and council rates are a similar “waste”, but we discount this argument because we already believe home ownership is good.

In any case, the walls and roof within which we live do not make the home. While we may justify our dreams with reasons, the truth of the home ownership dream is probably closer to the heart than the head.

Author – Stephen S Holden Associate professor at Bond University

The Rise, and Rise, and Rise of Investor First Time Buyers

DFA has just released the latest analysis of survey results which shows that nationally 35% of all First Time Buyers are going direct to the Investment sector. However there are significant state differences, with more than fifty percent of transactions from first time buyers in NSW, and upticks in other states as the behaviour spreads. You can watch our latest video blog on this important subject.

Here is the data we used in the video. The first chart shows the national average picture, using data from the ABS to track owner occupied first time buyers (the blue area), data from DFA surveys to display the number of FTB investment loans (the yellow area), both to be read from the left hand scale, and the relative proportion of loans using the yellow line on the right had scale. About 35% of loans are going to investment first time buyers.

In NSW, the rise of investors has been running for some time, and as a result, more than 50% of loans are First Time Buyer investors. Note the growth thorough 2013.

In QLD, until recently there was little FTB investor activity, but we are seeing a rise in 2014, to a peak of 12%

The rise of FTB investors in VIC started in 2013, but is now growing quite fast, to about one quarter of all FTB activity.

Finally, in WA, where OO FTB activity is quite strong, we are now seeing the rise of FTB investors too. Currently about five percent are in this category.

There is a clear logic in households minds. They see property values appreciating in most states, yet cannot afford to buy a property for owner occupation in a place where they would want to live. So they choose the investment route. This enables them to purchase a cheaper property elsewhere by grabbing an investment loan, often interest only and serviced by the rental income. In addition they get the benefits of negative gearing and potential capital appreciation. Meantime they live in rented accommodation, or with families or friends. About ten percent of recent purchasers have received some help from “The Bank of Mum and Dad“. Finally, some see the investment route as a means to build capital for the purchase of an owner occupied property later, though others are now thinking more in terms of building an investment property portfolio. They are on the property escalator, with the expectation that prices will continue to rise.

There are some significant social impacts from this change, and there are probably more systemic risks in an investment loan portfolio, which should be considered. We are of the view that the recent APRA “guidelines” will only have impact at the margin, so we expect to see continued growth in FTB investment property purchases for as long as interest rates stay low and property values rise.

The Facts on Australian Housing Affordability – The Conversation

From The Conversation. Housing affordability, high house prices and rents are attracting plenty of media attention right now. The latest figures on house prices, mortgages, number of first time buyers and so on are dissected by journalists and commentators as if this is an issue of recent origin. In fact what we have here is a long-term structural problem that has been neglected for decades.

Back in 1982, the ABS Survey of Income and Housing revealed that 168,000 or 10% of home buyers spent more than 30% of their gross household income on housing costs. Nearly 30 years later in 2011 these numbers had soared to 640,000, equivalent to 21% of all home buyers.

The trends in housing cost burdens reflect rising real house prices. The history of house prices over this timeframe is one of booms in which real house prices escalate to higher levels than they peaked in the previous boom. Periods of house price stability punctuate these booms, and give household incomes some breathing space in which to catch up.

But at each peak in house prices, household incomes have fallen further behind. According to the same ABS data source, households in 1990 on average valued their homes at a multiple that was four times their average household income. By 2011 this multiple had climbed to nearly six times average household income.

A generational threat

It is therefore not surprising to find that young first time buyers are finding it increasingly difficult to purchase a home. As our first table shows, on a person basis the rate of home ownership in the prime 25 – 34 year age group has slumped from 56% in 1982 to only 34% in 2011. Delayed entry into home ownership is a factor, but it turns out that these declines have set in across all but the post-retirement age group. The “Australian dream” of home ownership is under threat.

Home ownership rate 1982-2011, in percentage terms

How have we reached this position? To be sure population growth, low interest rates, deregulation of mortgage markets and rising real incomes have helped fuel the demand for housing, and pushed up real house prices. But there are deep seated structural problems that contribute to an inflationary bias in land and property markets.

Fiscal concessions in the form of capital gains and land tax exemptions to home owners, negative gearing and concessionary capital gains tax for “mum and dad” investors, and asset test concessions to home owner retirees offer powerful incentives to accumulate wealth in housing assets. As a result, the supply side problems are not so much about a shortage of housing, but an inefficient distribution of the stock of housing.

According to the 2010 Household, Income and Labour Dynamics in Australia Survey, roughly 1 in 6 Australian households own two or more properties, and for 30% of these households the second property is a holiday home. Growing numbers of ageing “empty nester” households are deterred from downsizing and releasing housing equity by stamp duty, the taxation of alternative investments of the equity released, and the lack of suitable housing opportunities in the communities they would like to stay in.

Meanwhile according to the latest census more than 100,000 Australians are homeless, and many more than this are struggling to meet housing payments.

The supply issue

Back in the early 1980s these fiscal drivers did not matter so much, because there were ample greenfield sites on which new housing could be constructed. These sites still offered reasonable access to amenities and jobs. But such opportunities are drying up, and state governments have introduced curbs on urban expansion, as well as developer charges and fees that have increased the costs of construction on the urban fringe.

Adding to supply side problems are planning controls that impede higher density development in middle ring suburbs, as “insider” home owners understandably seek to protect the “leafy character” of their communities.

We are left with a problem that has wider ramifications because it has created a housing system saddled with growing indebtedness. In the 21 years illustrated in the chart below the average mortgage debt has soared relative to the average household incomes of mortgagors in all age groups.

Mean mortgage debt to income ratio

Moreover, the proportion of home owners with outstanding mortgage debt has increased, especially in the 55–64 year cohort that is typically approaching retirement (see chart below). Interest rates were much higher back in 1990 and so household incomes in 2011 can comfortably service loans that are larger relative to household income.

Percentage of home owners with a mortgage debt

Nevertheless repayment risks and investment risks (house values falling short of outstanding mortgage debt) loom more prominently, and for a larger number of precariously positioned households. These risks could test the resilience of local economies and the national economy.

The Australian housing system weathered the global financial crisis much better than did many of its counterparts in the developed world.

Does this suggest a resilience that we can bank on in the future? Federal and state governments might be well advised to introduce structural reforms to housing finance that strengthen that resilience.

Authors, Gavin Wood, Professor of Housing at RMIT University and Rachel Ong, Principal Research Fellow, Bankwest Curtin Economics Centre at Curtin University

Making Residential Rental Markets Work for Financial Stability

In an address by Stefan Gerlach, Deputy Governor (Central Banking) of the Central Bank of Ireland, at the Twenty-First Dubrovnik Economic Conference, Dubrovnik, he discussed the rise of the rental market, and the potential implications for financial stability, with specific reference to what happened in Ireland post the GFC. There are some important observation for Australia.

He concludes that economies that experienced boom-bust cycles in housing, such as Croatia and Ireland, suffered disproportionately in the financial crisis. There were numerous reasons for this large impact, many of which are, by now, very familiar. However, it is less frequently noted that those economies with deeper rental markets suffered less. While the specifics of housing policy are outside the remit of central banks, it is incumbent for us to draw attention to issues that relate to financial stability. To reduce the risk and the amplitude of future housing cycles, housing policy needs to consider also financial stability issues. In this regard, it seems particularly important to promote a well-developed rental market as a genuine alternative to ownership, and an attractive investment proposition for potential landlords. While many households may continue to buy rather than rent, we need to make sure that this choice reflects their preferences and does not merely reflect a poorly functioning rental market.

4. The role of mortgage debt in a financial crisisThere are of course also a number of social benefits from owner-occupancy which need to be kept in mind. For instance, owner-occupancy represents the purchase of an asset and, since mortgage loans are amortised in Ireland, therefore leads to wealth accumulation. This can be particularly helpful in retirement, when reduced income can be offset by the lower cost of outright ownership of housing. In addition, studies have shown that homeowners are more engaged in social and political activities, have more positive assessments of their neighbourhoods, better psychological health and higher educational attainments. Surveys in the US show that homeowners believe their neighbourhoods are safer and better places to raise children.

But while the benefits of owner-occupancy are well documented, there is a much less well-known flipside to this coin: the risks associated with financially vulnerable households taking on the financial burden of house purchase. Let me now discuss this issue.

In Ireland the burden of the current crisis has fallen squarely on the young, many of whom bought property at the top of the market. The perception that one must get “on the property ladder” as soon as possible that was a particular feature of the boom years, but also a consequence of the poorly functioning rental market in Ireland, has had implications for younger families. Many of these are now left with unsuitable properties for their housing needs (for example, one bedroom apartments that are not satisfactory for growing families), and with debts that they could no longer service when salaries declined and unemployment rose during the economic downturn. Moreover, negative equity and mortgage arrears may make it difficult for them to move in pursuit of new, or better paid, employment. While desirable and beneficial for many, homeownership does come together with important risks that many neglected before the onset of the crisis.

A particular concern in this regard is the fact that the risk of becoming unemployed or experiencing income losses is not evenly shared across society. Younger and less experienced workers, and those who work in industries that are sensitive to the business cycle, such as the construction sector, are particularly exposed to the risk of unemployment.

The crisis has disproportionately affected unemployment rates among younger age cohorts in Ireland. Graduate salaries have declined significantly since 2007, which has long-term implications for the earning potential of young people. Employment in the sectors most vulnerable to the economic cycle, such as construction, has been most adversely affected by the crisis.

Thus, the lack of a deep and well-functioning rental market forces all households, including those at a relatively high risk of unemployment, into the property market. While the great majority of borrowers are credit worthy and will service their loans, unemployment and income loss, which may be caused by the unemployment of a spouse or partner, have been important determinants of mortgage arrears in Ireland. Banks in economies with very high house ownership rates may therefore experience high credit losses in a downturn.

The resulting link between highly-indebted and financially more vulnerable households and the banking sector can create a cycle which is both self-reinforcing in good times with expectations of increasing capital values increasing equity and enabling greater indebtedness, and in bad times as both banks and households suffer losses.

What role can rental markets play? Buying a house using a mortgage is a risky leveraged investment that involves a household borrowing several times its annual income to buy an asset with an uncertain future value. Such investments should only be entered into by those that understand the risks and feel able to assume them. Moreover, the rental market can alleviate the risk of capital loss and negative equity, increase labour mobility and thus facilitate the adjustment following adverse economic shocks. From a financial stability perspective it is therefore important that households that worry about the risks of homeownership have the option, if they wish, to rent a property that provides the type and quality of housing, and security of tenure, that they require. Let me next turn to the rental market.

5. The private rental market

It is clear that in Ireland, in contrast to elsewhere in Europe, renting a home is not seen as a long-term option for households. Indeed, results from a recent survey show that over 70 per cent of private rental tenants would prefer to own their own property, and just 17 per cent wish to rent long-term. While this may reflect a cultural preference, or the benefits of homeownership, it seems more than likely that the type, quality, affordability and, in particular, security of tenure of private rented accommodation also plays an important role.

What can be done to make renting a more attractive long-term alternative to homeownership? I believe that there are three aspects to this problem: first, the rental market structure, particularly in terms of security of tenure, can play a role. Second, the investment horizons of landlords are important. A culture whereby the market is dominated by landlords seeking an income stream over the long term, rather than a capital gain in the short run, can help raise the attractiveness of renting in a number of ways. Finally, in many countries, policies aim to specifically incentivise homeownership, to the detriment of the rental market.

5.1 Security of tenure

A particular concern in Ireland is the absence of long-term rental contracts; while households may wish to stay for long periods in their accommodation, rental contracts in Ireland are predominantly of a year’s duration. This leads to a wide-spread lack of security of tenure. Indeed, a recent survey indicated that 23 per cent of private tenants in Ireland are afraid of losing their home. In addition, 32 per cent have no formal lease, even though more than half have been living in their current accommodation for more than two years. The risk and the associated costs of having to move may make households opt to purchase their own home and take on financial risks that they may feel they are not well placed to assume. Indeed, 29 per cent of tenants say that they would be more likely to rent long term if there was the possibility of a longer term lease. ¹⁴ Lengthening rental contracts therefore seems desirable. ¹⁵ Interestingly, research has shown that in countries with comparatively strong security of tenure and high rental rates, such as Germany and the Netherlands, security of tenure is seen to foster long-run demand for renting and rental investment, such that neither tenants nor landlords have sought to weaken security.

Why are rental contracts in Ireland of such short term nature? Ireland’s history of high and variable inflation and the lack of institutional investors in the rental market must both be important. In economies with a history of inflation, banks protect themselves by lending at flexible interest rates. In turn, with mortgage costs varying over time, renters protect themselves with short term contracts. In contrast, in economies with a history of low and stable inflation, mortgage lending tends to be for long maturities and rental contracts tend to be longer term.

Of course, Ireland’s history of inflation is now over. But lending arrangements change slowly. Overall, housing markets and financial stability in Ireland would benefit from borrowers having a wider choice of fixed rate loans.

5.2 Incentives of landlords

The lack of institutional investors in the rental market is also important. The Irish rental market is dominated by private households who let a single property. The fact that they may need the dwelling for a family member, or may wish to sell it, is another factor that makes for short-term contracts and concerns about the security of tenure. Furthermore, buy-to-let properties have the highest rate of mortgage arrears. The latest figures from December 2014 show that over 25 per cent of buy-to-let mortgages are in arrears. Indeed, survey findings suggest almost 50 per cent of all landlords cannot cover their loan repayments with rental income. Overall, 29 per cent of landlords intend to exit the market as soon as possible.

In contrast, institutional investors, such as pension funds and insurance companies, have very long investment horizons and have strong preferences for tenants who stay for an extended period of time, since finding new tenants and refurbishing apartments for them is costly. Institutional investors can bring a standardised, professional approach to the management of entire buildings of apartments, aiding the supply of suitable accommodation in popular areas. This suggests that attracting more institutional investors would promote a well-functioning rental market that is so important for financial stability. ²¹ Furthermore, these investors are likely to be less leveraged and have more diversified portfolios than individuals owning one or two rental properties, and are thus better able to withstand an economic downturn.

There is a wide variety of government intervention in rental market, from the direct provision of social housing to the regulation of the private rented sector. Because moving is costly and disruptive, the tenant-landlord relationship is inherently asymmetric. Regulation, if designed well, can therefore improve outcomes. That said, poorly thought out regulation, in particular rent controls, can have adverse effects by reducing the supply of rental properties and discouraging new construction and the maintenance of existing rental properties. Getting housing regulation “right” – a task outside the central bank’s remit – is important.

5.3 Policies favouring home-ownership

Home-ownership brings many benefits, and it is understandable that there are policies in place to enable house purchase; I have already outlined the potential benefits in terms of asset accumulation and social advantages associated with home-ownership. However, some policies aimed at enabling people to gain from the benefits of home-ownership have the effect of worsening the situation of those who either choose not to be homeowners, or cannot afford to be so.

One important issue that influences households’ choices between buying and renting property is tax policy. In many countries it is generally favourable towards homeownership. Examples of favourable taxation treatment of housing include the exemption of imputed rental income on principal homes from income tax calculations, tax relief of mortgage interest payments, exemptions of capital gains from the sale of principal homes, and the use of outdated housing values for property taxes.

A favourable tax treatment of homeownership risks encouraging excessive leverage and housing investment, leading to the development of macroeconomic and financial imbalances. ²³ It can also tempt households that are worried about the risks inherent in mortgage borrowing into house ownership. Overall, it seems desirable for tax policy to be neutral between homeownership and renting. To this end, it is important to note that tax relief on mortgage payments have been phased out since the crisis, and a recurrent property tax has been introduced, in Ireland.

The Hidden Victims of Rising House Prices

Australia needs to have a housing conversation that isn’t just about housing “bubbles”, profits and investment properties says an article in The Conversation.

Sadly, we punch well above our weight in international measures of poor housing affordability, and increasing numbers of Australians can’t afford their rents or mortgages.

Even a modest increase in house prices will make things even tougher for these Australians – but importantly, do we reliably know who they are, where they live, and how extreme their affordability problems are?

Our new research reveals some poorly understood distinctions in unaffordable housing. Some people appear to be “slipping” in and out of housing affordability problems, while others remain “stuck” with them for long periods, or even a lifetime.

When we look at housing affordability in this way and compare these two groups of people, these “slipper” and “sticker” groups are shown to be very different within Australian society, with different intervention needs implied.

Limitations of the 30/40 rule

To address housing affordability and target assistance we usually rely on data on the prevalence and nature of unaffordable housing. The most widely used measures of housing affordability are based on simple ratios, for example, the 30/40 measure. This approach classifies people as being in unaffordable housing if they are in the lower 40% of the income distribution and their rent or mortgage payments exceed 30% of their income.

Such a simple, straightforward measure – that classifies people as being either in unaffordable housing or not – is undoubtedly useful, and outside of the housing research community, data using these measures are rarely questioned. But it’s useful to think about that data a little more critically.

The picture of housing affordability portrayed by most of the measures we (and policy makers) rely on is a snapshot – a point-in-time collection of people’s ability to afford their housing (on Census night for example). Importantly, it’s a very blunt measure. In fact, when we look more closely at people’s experience of affordability problems we see that the snapshot is a pretty poor predictor of longer-term unaffordability.

For a great many households, both income and housing costs – and where they sit relative to other households – change a lot over time. This causes people to slip in and out of unaffordable housing. In a large Australian sample, we see that hidden within the segment of the population classified as being in unaffordable housing in any one year, fewer than half were classified in the same way the next year. Because the total number of people counted in unaffordable housing is stable, it points to a limitation in the way that we measure housing affordability.

Slippers and stickers

By following people’s income and housing costs each year for a five year period, we classify stickers as being in unaffordable housing (using the 30/40 rule) in every one of the five years. To be classified as a slipper, people must have made at least one transition into, and one out of, unaffordable housing over the five year period. Slippers outnumber stickers three to one, and therefore affordability initiatives may be more concentrated upon the needs of slippers.

Compared to slippers, stickers have much lower incomes and employment rates. Around 60% of stickers have a disability, and twice as many are carers for other people in their household. Looking deeper, three quarters of those stuck for long periods in unaffordable housing are women, they also tend to be much older than slippers, and more likely to live alone.

This description points to what some might call a vulnerable group of people or even an “underclass” perpetually facing housing affordability issues and, most likely subject to the consequences of this, such as limited financial resources and stress.

It is interesting to note that the characteristics of the sticker population are very similar to those of Australia’s public housing tenant population, but because public housing largely addresses affordability by rent capping, stickers are most likely to be private renters and low income mortgage holders.

This means that, in addition to being highly vulnerable, many stickers are likely to receive little or no government assistance with their housing costs. It also implies a pressing need to improve the supply and affordability of housing in the private sector – via the taxation system or the land supply system.

Rather than looking at housing affordability as one problem, the distinct differences observed between Australia’s slippers and stickers imply a need to focus particular attention and interventions on stickers. We also need to better understand how people enter and exit unaffordable housing and what we can do to prevent people becoming stuck.

In the bigger picture our findings describe real social inequalities in Australia that are present and persistent. It reminds us that the conversation we need to have about housing affordability in Australia isn’t just about the positives of “housing bubbles”, but also needs to be about how to address the serious affordability problems of the growing group of (often already vulnerable) Australians who are stuck.

By Emma Baker Reader in Housing at University of Adelaide and Rebecca Bentley Senior lecturer at University of Melbourne.

DFA Household Finance Confidence Index Up A Bit In May

The latest edition of the DFA Household Finance Confidence Index was released today. The latest data to end May shows there was an improvement over the last month, partly in response to the budget and the RBA rate cut, but the overall score is still well below a neutral setting. The score moved from 91.87 to 94.6.

The results are derived from our household surveys, averaged across Australia. We have 26,000 households in our sample at any one time. We include detailed questions covering various aspects of a household’s financial footprint. The index measures how households are feeling about their financial health.

To calculate the index we ask questions which cover a number of different dimensions. We start by asking households how confident they are feeling about their job security, whether their real income has risen or fallen in the past year, their view on their costs of living over the same period, whether they have increased their loans and other outstanding debts including credit cards and whether they are saving more than last year. Finally we ask about their overall change in net worth over the past 12 months – by net worth we mean net assets less outstanding debts.

Looking at the drivers of the index, for all Australia, we see that costs of living are rising, with 37.64% of households seeing a rise in the last 12 months (up from 37.2%), and more than half seeing no improvement in costs of living. Elements which are driving this include fuel costs, rising council charges and costs of imported goods.

Turning to income 3.8% of households have seen a real increase in the last year, compared with 5.5% last month. 39.9% of households have experienced a fall, compared with 38.4% last month, and 55.5% of households stayed the same compared with 55.8% last month.

Looking at household debt, 12.3% of households are comfortable with their debt levels, up from 11.4% last month. Households who are uncomfortable with their debt levels fell to 25.8% from 27.2% last month. The change was directly linked to the RBA Cash Rate cut in May, and an expectation that rates will fall further. Those with high credit card debts were significantly more likely to be is the less comfortable category. Those households with interest only mortgages were disproportionally more comfortable than those with a p&i loan.

Turning to savings, those who are more comfortable fell from 13.9% to 13.7%. We saw a rise in households who were less comfortable (from 30.4% to 30.9%) and more than half saw no change. One element of note was that households are tapping to their savings to fill the gap left by slow income growth, against costs and spending. Low deposit rates are encouraging some households to spend some of their savings.

On job security, there was a slight rise in those feeling more comfortable (from 16.2% to 16.8%). Interestingly those employment in small businesses saw a significantly larger positive swing, offset by lower levels of security in larger companies. The worst deterioration were in WA and QLD.

63.1% of households saw their net worth rising, up from 60.5% last month, thanks primarily to further rises in real estate (especially in Sydney and Melbourne) and shares. A slightly smaller proportion of households saw their net worth falling (down from 14.2% to 13.86%), the majority of those households who reported a fall were not property active, living in rented accommodation, and more reliant on Centrelink support than average. We also note a skew to rises in net worth in the main urban centres on the east coast, and higher than average income. Households in WA scored the highest fall this month.

So overall, we see the continuing trend of lower income, higher costs, those households with property and shares enjoying offsetting net worth growth, but others not participating to the same extent. The budget may have moved the dial a bit, but the RBA rate cut had more impact.

Note that this data is averaged across the states, though we note some significant differences between WA (overall confidence lower) and NSW (overall confidence higher), thanks mainly to differential movements in house prices and employment prospects. We do not published the detailed segment and state based analysis in this post. This detail is available to our paying clients!