October 25, 2016

The sky’s the limit

By Jamie Hall
The sky’s the limit
How can we make housing more affordable? The answer will make a lot of people unhappy

Recently I met an economist friend after work in the city. We had a few refreshments, and then the conversation turned to the housing affordability problem in cities like Melbourne, Sydney, and San Francisco.

We agreed it had gotten crazy. “And you know,” he said, “when you walk through these really expensive neighbourhoods, they’ve got one obvious thing in common.”

“I know what you’re going to say,” I said.

“They've all got so much spare, uh, what do you call it—”

“Airspace,” I nodded.

“Airspace! Mate, the airspace!” he said.


Economists have been having versions of this conversation for the last fifteen years. To economists and their allies in “market urbanism”, the answer to housing affordability is clear: there isn’t enough housing, so we should build more. As another researcher put it to me: “Population is growing, incomes are growing, and zoning means that the dwelling supply is close to fixed” – he gave a Gallic shrug – “so it shouldn’t come as a big shock that dwelling prices shoot up.”

The impact of those conversations on actual housing policy has been very limited. There are many reasons why, but the most important one is the same reason that the government’s new interest in housing affordability is virtually guaranteed to achieve nothing: real change will mean taking money away from the people who own the airspace, and who control the land below it.

Improving housing affordability means making dwelling prices lower. In the short term, that’s bad for anyone who currently owns a house, and it’s horrifically bad for anyone who owns several. Housing speculators are regularly praised in the newspapers for their financial wizardry, which is puzzling because their strategy – borrowing huge amounts of money on the assumption that the market will go up forever – would have any corporate finance officer laughed out of the boardroom. People’s judgement goes a bit funny when it comes to real estate. In any case, housing speculators are a key constituency for the Liberal party, so it’s important for the current treasurer, Scott Morrison, that he be seen to do something about housing affordability without actually doing anything.

As Sean Kelly pointed out yesterday, the politics of housing policy have shifted in the last year, so now there’s some pressure on Morrison to say something positive. But he must absolutely not follow the ALP in pledging to wind back negative gearing and the discount on housing capital gains tax, because that might cause house prices to stall and would certainly cause speculators to make a loss. He has taken on the task of doing nothing with eager enthusiasm, even resurrecting the Property Council’s long-debunked talking point that removing the negative gearing subsidy would cause rents to rise and the economy to crash.

Stopping investors from squeezing out first-home buyers would only be the start of a real solution, though. The more difficult task is on the supply side, and Morrison is right to call on state governments to do more. In fact, according to press reports, he “put the states on notice”. That sounds impressive, and I can imagine Rob Sitch in The Hollowmen delivering the line with relish.

Morrison will collide with reality at the next COAG meeting, when state governments point out that they already are doing more on the supply side than the housing sector has seen for two decades. The number of apartments under construction in Sydney and Melbourne now is larger, as a percentage of the existing stock, than any new development since the ’90s. Most of them are due for completion in the next 18 months and real-estate markets on the east coast are bracing for Apartmentgeddon. It’s not certain what the impact will be, but an overall dwelling price fall of about 10% would be a reasonable guess.

The trouble is, that’s nowhere near enough. If we want a household with a typical income to afford to buy or rent somewhere reasonably close to the centre of Melbourne or Sydney, then we need dwelling prices to fall by something more like 25%, then stay flat for a decade while wages catch up. But property developers, who are crucial to the supply of new apartments, are usually unwilling to build while prices aren’t rising. And I doubt that the NSW and Victorian governments’ recent interest in higher density neighbourhoods would survive long in a real-estate downturn.

If federal and state governments were serious about housing affordability, they would start by abolishing negative gearing and capital gains tax exemptions, then follow the Henry Review’s recommendation and replace stamp duty with a broad-based land tax. On the supply side, they would make sure that Apartmentgeddon was just the start of a new era in residential building by offering financial incentives for sustainable high-density construction, aggressively rezoning inner-ring industrial land for high-density dwellings, and making it much easier for suburban homeowners to subdivide and generate medium-density infill development.

That’s a tough sell. We’re not talking about a policy to fix a coordination problem, like universal public childcare, that would leave everyone better off after it’s implemented; or even a policy like free trade, where the losers could be compensated in a way that improves everyone’s standard of living. Morrison seems to be under the impression that boosting housing supply will fix affordability while leaving everything else the same. That’s mathematically impossible. As mentioned, every existing homeowner would be made worse off in the short run.

So a real housing affordability policy would be a difficult programme to implement. Existing homeowners would fight it vehemently in order to keep house prices high, usually while telling themselves that their only interest is in protecting the “village atmosphere” or “heritage quality” of their suburbs. Town planners would need to work overtime to figure out how to squeeze in as much density as possible, while stopping neighbourhoods becoming sterile Le Corbusier nightmares. At the political level, there is little institutional support for higher density. The Property Council advocates for it consistently, but everybody hates them. And welfare advocacy groups, who should be supporting it, choose to spend their time on small scale fine-tuning measures like inclusionary zoning. Meanwhile, some commentators will continue to fret that the only reason for high house prices is that we’re in a real-estate bubble, despite the fact that rents are also ridiculously high. And in the background we will have a few economically illiterate Baby Boomers offering patronising explanations of budgeting, choices, and trade-offs, as though the options facing young homebuyers were unavoidable and not the deliberate outcome of explicit policy choices.

Why would a politician bother? Solving housing affordability is complex, not supported unanimously, and would hurt every homeowner in the short run. The reason it’s essential is that continuing on our current path would hurt everyone, deeply, in the long term. If house prices keep rising, even at a slow rate, then the relative price of housing will have to adjust through labour migration and increases in the cost of living. In other words, life in Sydney and Melbourne will steadily become shittier and more expensive until enough people decide that they can no longer take it. Creative workers, crucial for productivity growth in a modern economy, will be the first to go. Under the pressure of housing costs, many who stay will be more reluctant to take risks like starting a business or retraining for a new career. And as Philip Lowe has argued, most of the “wealth” created in land values is illusory, in the sense that it leaves society no better off in total, only transferring capital from renters to homeowners and from younger generations to older ones. It’s also a waste of resources, since every dollar someone saves for a mortgage deposit is a dollar they don’t invest in something productive.

As we drift towards this future, I alternate between depression and impotent rage. The cities I love are gradually being hollowed out. It will take a talented politician to save them, someone with the technical policy skills to implement a complicated reform package and the ability to persuade the country to go along with it. After a year in the job, our current federal treasurer is clearly not that person. We can only hope that state governments decide to go beyond their tentative experiments with high-density housing, and show their federal colleagues how it’s done.

Jamie Hall
Jamie Hall is a data scientist and former Reserve Bank modeller. @jamie_hall

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