Why is housing so unaffordable – or is it?

Many young Australian families are having difficulty getting a foot on the rungs of the property ladder and the common catch cry is “property is unaffordable”. Some blame the high cost of housing on greedy developers while others blame wealthy investors who use tax dodges like negative gearing.

But is that really the case?

There is no doubt housing in our capital cities is expensive, but is it really unaffordable? Let’s have a look.

Why are house prices so high?

House prices are obviously made up of the land component and cost of the dwelling on it.

The cost of building a new house has hardly moved (in inflation-adjusted terms) over the last 20 years, however, land prices have skyrocketed.

By restricting the amount of land available on the urban fringes of our cities, in part to cap urban sprawl and the associated costs of building infrastructure, state governments have sent the price of entry-level housing through the roof.

I’ve heard it said that Australia does not have a housing affordability problem; it has a land affordability problem.

How much of the cost of a new home goes into taxes?

If I asked you how much of the cost of a new home goes toward paying for various taxes, what would your guess be?

Would you guess 5%? Or maybe 10%?

Well, you would be way off the mark. It can be as much as 44%.

Research by the Centre for International Economics, commissioned by the HIA, found that Sydneysiders paid about 44% (or an average of $268,000) in various taxes when they built new homes. In Brisbane the figure was about 36% (or $191,000) and in Melbourne taxes accounted for 38% of the cost of new homes.

In other words, new housing is one of the most heavily taxed sectors of the Australian economy.

Are houses really unaffordable?

Having said that, do today’s first homebuyers really have it tougher than their parents did?

Is it all really as bad as what many commentators and the media would have us think?

I know when I bought my first property close to 40 years ago, properties were unaffordable.

My first mortgage was for $16,000 and I had no idea how I was ever going to pay it off over the 20-year term. Remember, I was only getting $12 a week rent from my tenant back then in the 1970s.

According to the ANZ’s head of property research, Paul Braddick, those looking to get their foot in the proverbial property door are no worse off today than purchasers from the 1980s.

Contrary to popular belief, Australian property prices have increased in line with rising incomes and lower interest rates over the past thirty years. Over the last few decades, increasing income and falling interest rates have been capitalized into house prices.

The increased number of households with two wages, as well as higher average incomes for women, has put buyers in a better financial position than they were in three decades ago. And recently flat or falling house prices plus falling interest rates have made properties more affordable for many.

A reality check

Before we complain too much about the cost of new housing, let’s not forget that the type of property many first homebuyers expect today is very different to what their parents started off in. In fact, they expect to start off in the type of house it took their parents 30 years to be able to afford.

Today’s first-home buyers are looking for bigger homes on a large block of land with an ensuite, probably a double garage, all the modern conveniences including air conditioning, a dishwasher and let’s throw in a media room for good measure.

It’s also worth noting that today around 70% of people own their own home and just 30% rent. In 1911 those figures were reversed; at that time the typical house would have only had one bathroom (an outside toilet).

By the way, did you know Australia can lay claim to having the largest homes in the world? The average size of our new homes is 214.6 square metres. While US home-builders have been building smaller homes over the last few years, Australian homes have continued to get larger.

So what is affordable?

There are many ways to measure housing affordability and many of the models used by overseas economists are not really relevant to Australia.

To me the key question is: do households in 2013 have more or less disposable income after buying a home and paying down the mortgage than their predecessors?

Last year the RBA found that, contrary to popular myth, today’s households actually have more disposable income than at any other point since they began their analysis in 1993.

Of course, there are some good explanations for this. Per capita disposable income has been growing very strongly, and has outpaced house price appreciation, over the last 7-8 years.

Over the longer term, we have had a structural decline in the unemployment rate from the double-digit peaks in the early 1990s to just over 5% today. And then we have had the rise of multi-income households thanks to a secular increase in the female participation rate.

Last month, the Reserve Bank assistant governor Christopher Kent presented the following chart, which shows that payments on new housing loans now represent less than a quarter of disposable income due to the property price correction we experienced in 2011 and the in first half of 2012 (a time when the cash rate fell from 4.75% to 3.00%).

On the other hand, wages continued to grow across Australia last year by an average of 3.4%.

In summary

Currently, interest rates are at record lows and may even fall a little further at a time when incomes are likely to keep rising as our economy chugs along. This will make housing even more affordable for many this year.

Now may be as good a time as any to buy your next property.

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. A best-selling author and one of Australia’s leading experts in wealth creation through property, he also writes the Property Update blog.