The high price of housing is undermining society and the economy

Alan Kohler’s The Great Divide: Australia’s Housing Mess and How to Fix It

There is widespread agreement that the housing market in Australia has developed serious problems. Houses and apartments are too expensive, too hot, and often too far away. There is a shortage of stock, and too few new ones are being built. Opinions on both causes and solutions range from economically irrational to unrealistically ambitious to unhinged optimism, and usually reflect one or another of the many vested interests involved. Federal and state governments have their targets, political parties have their competing policy platforms, developers, builders, banks and manufacturers have their industry associations, owners, tenants and consumers have advocacy groups. Local councils are typically spear carriers for the not-in-my-backyard (NIMBY) movement, but recent elections have seen yes-in-my-backyard (YIMBY) candidates. It is not just the market that’s a mess, the debate over housing policy is as well.

Into this cacophony Alan Kohler is trying to introduce a note of reason with his book The Great Divide. He is a journalist and former editor of the Australian Financial Review, and while not a vested interest he declares himself one of the home owners who have benefited from the increase in house prices over the last few decades. He says that ‘escalation in house prices is a pain that has altered Australian society. It has increased inequality and profoundly changed the relationship between generations – between those who have a house and those who don’t. It has caused a rental crisis, a dearth of public housing and a mortgage crunch’.

The first three chapters outline the problem. Fundamentally, this is because the median house price in Australia has doubled as a multiple of average weekly earnings in the past 25 years, from three to four to seven or eight times, increasing household debt from half to twice average disposable income and from 40% of GDP to 120%. ‘This is the most important single fact about the Australian economy’. Chapter two has data on the housing market and chapter three the history of housing policy. In chapter seven he argues for U.S. style 30 year fixed rate mortgages. Although Australia has the world’s highest house price to income ratio and the 66% of total lending for residential real estate by bank levels is also the world’s highest, Australian banks only provide floating rate mortgages. There are also chapters on homelessness and the global nature of the housing crisis. In this review the focus is on Kohler’s analysis of supply and demand for Australian housing, which includes all types of dwellings (detached and semi-detached houses, town houses, low and high-rise apartments).

The Supply Side

Three chapters are on supply problems, covering public housing, Australia’s ‘crowded sprawl’, and state and local governments. In 1945 the Commonwealth State Housing Agreement provided federal funding for public housing, ‘the first and only serious housing policy in Australia’. Between 1947 and 1961 governments built 24% of new housing and home ownership increased from 53.4% to 71.4%, due to war service loans to veterans and the Menzies Government forcing the states to sell public housing. Under Menzies ‘public housing increasingly became a matter of welfare and social services’ rather than the ‘right of every citizen’ as in the 1945 Agreement. The ‘disappearance of public housing removed what had been a steady flow of affordable housing’. Today’s governments are not going start building houses themselves, as they used to [1], but relying on developers to increase housing supply and improve affordability ignores the basics of the business model of profitable property development, which is to meet demand but not flood the market with new stock.

The second supply problem is the ’crowded sprawl’, the Australian pattern of settlement and urban development. We are crowded into a few large cities despite living on a large continent with a lot of space, 40% of people are in Sydney and Melbourne and over 90% are in capital and regional cities, and our cities are low density, sprawling outwards from a single city centre with houses on large blocks in new suburbs that were built without public transport after cars became affordable.

Finally, while the federal government and banks encourage demand for housing, state and local governments restrict supply through their zoning and planning laws. The local councils and residents of the new post-war suburbs immediately became NIMBYs, and made it impossible for developers to get both sites and permission for medium density town houses and four storey apartments. Australia’s ‘archaic planning laws’ have created cities with high rise apartments around the city centre and low rise to the fringe, and the missing middle of town houses and low-rise apartments ‘remains as much a problem today as it was forty years ago’. While there are many potential sites in existing suburbs that could deliver new homes that aren’t 12 or 20 storey apartment buildings, developing them will need different planning and tax rules.

What is missing from Kohler’s analysis is increasing supply using modern methods of construction, like prefabrication and offsite manufacturing. These reduce the time it takes to complete onsite work, and so can increase the number of houses delivered without needing more workers. Currently this is typically used for buildings like schools and hospitals and social housing, for example QBuild in Queensland is manufacturing 600 new houses this year for regional centres, and NSW and Victoria have started prefab social housing programs. Although not the solution to the housing crisis, more government built or purchased prefab for social and affordable housing could play an important role in addressing the problems of homelessness and affordability for low income households if the barriers to adoption were lower and production capacity was increased.

The Demand Side

Chapter eight is on the explosion in demand as four factors increased demand for housing after 2000. First, in 1999 the Howard government cut the capital gains tax (CGT) introduced by the Hawke Government in 1985 by 50%, and second, in 2000 reintroduced first home buyers grants. Third, in 2001 the Reserve Bank reduced interest rates, and fourth, between 2003 and 2009 net migration tripled. These boosts in demand were not matched by an increase in the supply of houses.

Australia has a unique system of negative gearing, that allows deduction of interest payments and losses on an investment from other income. The Hawke Government banned negative gearing in 1985 but, after a determined campaign, reinstated it in 1987. ‘The halving of CGT was the kerosene on the smouldering coals of negative gearing and the lack of an inheritance tax, and turned property investment into the leaping flame of everybody’s tax avoidance scheme’ as the 50% discount to CGT led to an immediate surge in investor demand for housing. In other countries investing in real estate is for rental income, but in Australia its ‘about getting an income tax deduction and then a capital gain’, and because institutions don’t get the tax deduction they can’t compete to buy sites and there is no build to rent market providing long leases here either.

Adding more fuel to the flames were interest rate cuts by the Reserve Bank in 2001, after a US share market meltdown in the ‘tech wreck’, and investors bought property funded by cheap debt. Also, the Howard government reintroduced first home buyers grants in 2000, also adding to demand. Since then first home buyers grants have been provided by both federal and state governments, but these are ‘political attempts to appear to be doing something while making things worse’. The Homebuilder programme during the COVID pandemic was a particularly egregious example [2].

Another of the causes of the housing affordability crisis is excess immigration, and the problem with immigration is that the government doesn’t control it. Most of Australia’s migrant intake has been outsourced to universities and colleges, who see new arrivals as customers rather than migrants. The foundations of this were laid in 2001, when two changes were made by the Howard government when Philip Ruddock was Immigration Minister. First, entry from ‘non-gazetted’ countries like India, Pakistan and China, was opened up and streamlined, and second, there was a more transparent and open pathway to permanent residency for foreign students. The foreign student changes took a few years to get going, but between 2005 and 2008 Australia’s overall migrant intake tripled to more than 300,000 a year. Keeping Australia’s population growth to something approaching the actual capacity of the construction industry to build houses by reducing immigration is not going to be easily done.

The outcome of CGT breaks and negative gearing, lower interest rates, first home buyer grants, and more immigrants, was that after 2000 the ‘nitro of a surge in demand mixed with the glycerine of existing restricted supply to create an explosion that has blown up’ both Australia’s society and economy. There are three other important demand side factors not discussed in the book. The first is the decline in household size, which has fallen from an average 2.9 people in the mid-1980s to less than 2.5 people now, with an increase in the number of one person households. Over the last ten years this trend has increased the number of households by over one million, and thus added a million houses to demand. The second factor is short stay rentals like Airbnb. While these are estimated to account for only 2.2% of long term rental accommodation, in regional towns with limited housing they have had a major effect on both availability and affordability. A third factor is stamp duty acting as a barrier to downsizing from large family homes with empty bedrooms.

Solutions

The most important chapter in the book is on potential solutions to the housing crisis. What is striking about Kohler’s ideas is that they are not the standard mix of demand side reforms to tax, or supply side reforms to regulation and planning. He describes their advocates as Tribe 1 and Tribe 2, who have spent the last few decades arguing between themselves for their preferred reform option/s without affecting the housing market or house prices. ‘Solutions by the dozen have been proposed’ but he asks ‘what’s the aim, exactly … what’s the real national mood, and therefore the politics?’

The politics are simple. A majority of homes are owned (65%) so two-thirds of the population wants to restrict supply, and owners, banks, developers and state and federal politicians all want house prices to rise for their own reasons. ‘Renters don’t stand a chance.’ Any attempt to address affordability and the shortage of rental accommodation ‘would have to contradict the interests of a majority of citizens and those with the most power.’ And that is why governments have targets that ‘are never actual promises to build anything, just aspirational forecasts’.

Improving housing affordability by returning the house price to income ratio back to three to four times, instead of the current seven to eight, would take 20 years of oversupply and stable prices. However, as Kohler says, house prices are not going to halve, so they ‘need to stay put for a while and allow incomes to catch up’. This is difficult when ‘Half of Australia’s home owners are locked into a wealth-creation partnership with a bank’ and ‘everybody regards housing as an appreciating asset’. As a result ‘there is no consensus there is a problem … let alone how to fix it’.

What can be done? First, limit negative gearing to new builds and reduce CGT to 25%. Second, link immigration to construction industry capacity, at around 2.5 times the number of housing approvals. Third, pressure local councils within 30 kilometres of the CBD using both carrots and sticks to increase density. Fourth, increase the cost of holding undeveloped land so developers cannot landbank so profitably. And fifth, extend cities and increase the supply of well-located land (i.e. with access to jobs and services) by building fast trains so commuters can live in regional towns and get into the city in an hour. Not a mythical ‘very fast train’, but a good fast train travelling at 100-150kph would double or triple the commutable distance from the capital cities.

For many years this has also been my preferred solution to the housing crisis. The reason houses are so expensive is that urban land in and around capital cities is expensive, it is not due to the cost of building a house or block of apartments. Cheap land means cheap housing. Currently, government policy on housing affordability is to increase density by building apartments on expensive land near existing train stations because it costs less than building new regional railway lines and train stations.

For whatever reason, Kohler does not include any discussion of financing regional fast trains through betterment taxes, also known as value-capture taxes. These are used to fund projects from the increased value of land when new infrastructure is provided. For example, governments can establish a levy before the preferred routes and sites of train stations and other infrastructure are announced and land values increase. In the ACT, a betterment tax is levied at 75% of the uplift in land value after a site is rezoned, an important point not included in the book. Another, more difficult, option is to allow a private sector consortium to build the railway and finance it through development rights on a corridor of adjacent land.

Conclusion

As a journalist who has been covering financial markets and economics for four decades Kohler’s writing is clear and concise, and the measured tone of the book will be familiar to anyone who listens to his nightly finance segment on ABC News. But there is an undertone of anger throughout the book, he argues housing is a ‘stunning failure of public policy’ at all levels that has changed Australian society for the worse. He says ‘My view, and the basis of this book, is … that the high price of housing is undermining social cohesion and the proper functioning of the economy and the nation’. The cost of housing has created a generation of insecure renters and working poor, because the supply of housing is so inadequate.

To solve the housing problem needs a policy with a clear, explicit aim. Kohler argues this should be improving affordability by increasing supply in and around the capital cities. ‘Merely bringing the rate of increase in house prices back to the rate of growth in incomes isn’t enough – that ratio needs to come down so it isn’t a stretch to buy a place to live’. NIMBYs, consumer preference for houses, and construction costs, make building new high-rise apartments in existing inner suburbs difficult, which is why he believes the solution to more housing supply must be fast trains to regional areas that open up cheap land for subdivision. This would be expensive and require federal funding, but ‘every other solution looks too hard.’

Over the decades hundreds of reports and research papers on Australian housing have accumulated. However, although Kohler has used many of them, his book is very much a personal statement. He is not an advocate for any industry or other interest groups, but believes the high price of housing is undermining society and the economy and this is a problem that needs to be addressed effectively and quickly. Solving Australia’s housing mess ‘requires true political leadership – that is, doing something right that’s unpopular’. Like so many other key points made in this book, that is both correct and deeply troubling.

Coda

After governments shifted the cost of infrastructure like roads, water and sewerage to developers in the 1990s, this is now included in the price of a house instead of the tax system. The GST in 2000 added another 10%, and state governments have increased stamp duty. As a result, 30 to 40% of the cost of a new house is now government taxes and charges.

Tax reform is essential. Housing should be regarded as a right, and on the list of essentials excluded from GST. Halving the CGT discount and restricting negative gearing will reduce demand. Self managed superannuation funds should be limited to a maximum of 50% investment in property. States could reduce or exempt new housing from stamp duty to reduce prices, and windfall gains from rezoning and new infrastructure should be taxed.

Supply can be increased through innovation, lowering regulatory and financing barriers to modern methods of construction, and streamlining the planning and approvals process. Governments should also address inconsistent national occupational licensing systems and improve support for apprentices to increase labour supply.

Developing and constructing housing requires compliance with layers of regulation by three levels of government on where housing can be built, how housing should be built, and what housing should look like. Other regulations are indirect, such as environmental regulations. These regulations are necessary to ensure safety and quality, but increase the cost of houses, and at a minimum should be reviewed to improve consistency across approvals, certification, compliance and enforcement.

In some places housing policy is based on an assessment of the need for different types of housing, however Australia’s housing targets are for a total number (i.e. total need). But they could be set with different numbers for social rented housing, intermediate rented housing, market rented and built-for-sale homes.

Many European cities zone certain areas with minimum, non-negotiable amounts of affordable and social house building. France requires municipalities to ensure 25% of their housing stock is available for social renting and fines them if they don’t. Vienna has a zoning programme which only grants building permits on condition of builders meeting affordable and social percentages. These rules get incorporated into the value of land in the zoned areas, which acts to make higher levels of social housing viable.

Currently, residential development land is valued on the basis of maximum profit, and social housing is added in afterwards. Construction costs are high, but it is the cost of the land which makes social housing unaffordable. However, land value is set by what is allowed to be built, and although enforcing a high level of social housing would cut developer profits, the land will be cheaper. The planning system could also require public land which is being repurposed for residential housing be retained by the public sector for social housing developments, instead of being sold off to the highest bidder.

A national tenancy code with 10 year leases and levies on short-term rentals is essential. Other options are removing stamp duty for downsizers, increasing the depreciation allowance on new residential buildings, and taxing developers with undeveloped sites who landbank approved projects. There is no one simple solution to the housing crisis, but there are many ways it could be addressed and incremental small steps might be the only way to make progress.

Alan Kohler, 2023. The Great Divide: Australia’s Housing Mess and How to Fix It, Black Inc.

[1] The Albanese Government’s Housing Australia Future Fund is intended to deliver 40,000 social and affordable houses over 5 years to 2030, in collaboration with Community Housing Providers and other organisations that provide social housing.

[2] A previous post was on the Homebuilder program

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