Affordability up, but access to housing market to worsen as interest rates fall

One of the four reasons house prices started rising at twice the rate of incomes and GDP around the turn of the century was that the Reserve Bank cut interest rates six times in 2001 without a recession.

Now it’s happening again: five cuts this time (probably) and no recession; in fact, unemployment is 4.1 per cent, not the 6.5 per cent it was in 2001.

Interest rates were cut in 2001 because a recession in the United States had followed the dotcom crash of March 2000, and it was a fair enough precaution by the RBA, in part to stop the exchange rate rising too much.

That didn’t work — the Australian currency appreciated more than 50 per cent between 2001 and 2003 as global speculators took their money out of the US stock market and a commodity boom got started as China joined the global trading system.

The other three things that happened around the same time were the 50 per cent capital gains discount at the end of 1999, the return of first home buyer grants in 2000 and the huge rise in immigration in the mid-2000s.

House prices rise as history repeats

The doubling and then tripling of immigration began with the removal on July 1, 2001, of the distinction between “gazetted” and “non-gazetted” countries in the issuing of foreign student visas.

That system had been in place since 1990 as a way of controlling the influx of students from China (a non-gazetted country) following the Tiananmen Square massacre in 1987 and Bob Hawke’s subsequent granting of permanent residency to 40,000 Chinese students.

The welcome end of discrimination against students from certain countries led to a boom in students from both China and India, which was further supercharged in 2006, when hairdressing and cooking were added to the tertiary courses that were given preferential treatment for visas.

The combination of those four things — rate cuts, capital gains tax discount, first home buyer grants and a boom in immigration — produced a sustained lift in housing demand that was not matched by any increase in housing construction or infrastructure.

It took house prices from around 3-4 times average income to 8-9 times over 25 years and led to the crisis that now dominates the economy, politics and, importantly, the relationship between generations.

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And now, population growth is back at 2 per cent a year, as it was in the late-2000s, first home buyer grants are back, tax is still payable on only half of any capital gain, and the RBA is once again in the middle of a cycle of interest rate cuts with no recession.

The average increase in house prices in the two years following the start of the past 10 rate cutting cycles has been 20 per cent, although that’s distorted by the massive 60 per cent rise in house prices when the cash rate was cut from 18 per cent to 7.5 per cent after January 1990.

Remove that aberration and the average rise in house prices when interest rates are cut is still 15 per cent.

A problem of accessibility, not affordability 

What seems clear is that when interest rates are cut, home buyers add the savings in mortgage repayments onto the price they’re prepared to pay for a house, but when interest rates rise again, they don’t sell the house but cut back other spending, so there’s little downward pressure on prices to offset the rise.

The result is that the decline in house prices when rates are rising is always much less than the increase that accompanies rates being cut.

So, what can we expect this time, given that housing is already “unaffordable”?

Well, prices have increased 1.4 per cent in the past three months in anticipation of the rate cuts, which is 50 per cent more than the average increase in incomes of 0.9 per cent over the same period, even though housing was already apparently unaffordable in January.

It obviously wasn’t.

The thing is that housing affordability is a function of both price and borrowing capacity, so it’s probably better to describe the problem as one of accessibility rather than affordability, which rises and falls inversely with interest rates.

After all, if housing was genuinely unaffordable, prices wouldn’t rise … but they are! Obviously, it’s affordable for some.

They have increased by 17 per cent since April 2023, even as interest rates went up another three times.

No short-term solution

A better measure of the housing problem may be the time it takes to save a deposit, which has gone from six years to at least 12 years, which means housing ownership is now effectively accessible only to those who can get money from their parents or elsewhere.

The share of 25- to 29-year-old owner-occupiers is declining — from 43 per cent in 2001 to 36 per cent now.

And with affordability now improving again as interest rates come down, accessibility is likely to worsen further as prices rise some more.

Here we go again.

Note that the four things that happened around the year 2000 to make house prices rise faster than incomes and sow the seeds of the current crisis were all about demand, not supply.

Yet, government policy, at both the state and federal level, to deal with the problem is now all about supply, not demand, apart from some (so far) ineffective attempts to reduce immigration.

Will supply respond sufficiently to government efforts to increase it, and lead to an oversupply of housing so that prices don’t rise? Doubtful. At best it’s a long-term solution — there’s none in the short-term.

Removing the capital gains discount and negative gearing would probably lead to the sale of a lot of investment properties, but that won’t increase the supply of housing — it will just mean a lot of tenants get booted out while the number of houses stays the same.

In the meantime, consumer price inflation is under control so that the Reserve Bank feels comfortable cutting interest rates, which means that house price inflation is on the march again.

Alan Kohler is finance presenter and columnist on ABC News and he also writes for Intelligent Investor.

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