Re-blogged with kind permission from Macrobusiness.com.au
Posted by Unconventional Economist in Australian Property on June 4, 2013
As argued previously, the sharp escalation of Australian home prices since the mid-1990s has been caused primarily by a surge in land values, which roughly doubled in size relative to the size of the economy, as measured by GDP (see next chart).
The explosion of land values is also reflected by the below chart showing the growth of house values (including both structures and land) far outstripping the growth of the ABS project homes index, which measures the cost of building new dwellings (excluding the land):
On Friday night, Prosper Australia released a brand new long-run dataset on Australian land values, which has been painstakingly developed by Philip Soos, who is a research Masters candidate at Deakin University as well as a researcher for Prosper Australia. The data has been pulled together from a variety of public and private sources, including from economists Robert Scott, Doug Herps, Alan Taylor, Terry Dwyer and Nigel Stapledon.
While there is lots of useful data in the series, my favourite dataset is illustrated by the below chart showing the ratio of Australian land prices (residential, commercial and rural) to GDP:
As you can see, land prices relative to GDP doubled between 1996 and 2010. And while land values have deflated somewhat, it would appear they have much further to fall.
My long held view is that residential land prices (and by extension house prices) will experience a “slow melt” whereby values relative to GDP deflate back to their mid-1990s (pre-boom) level. The big question is whether this deflation will occur via prices falling outright or by GDP growth outstripping price growth. With any luck (from a financial stability perspective), the adjustment will take place more through real price reductions than nominal price falls. But the process could take a long time.
Soos’ land price dataset can be downloaded from here.
The prices only look like they have a long way to fall if you expect a straight line graph. Since population pressure must determine the demand for housing where are the graphs of population in this analysis? There must also be allowance for aging population and the shift towards larger houses/smaller blocks.
Experience in Europe (UK compared to say Germany) shows that the major determinant of land prices is new land releases. Where these are tightly controlled they restrict supply and drive up prices. The impact of rising prices caused by artificial shortage of new land for development can be observed in both London and Auckland as well as most Australian cities.
Australia is not short of land to cope with new immigration, unless insufficient new blocks are released on the market.
Fly from Sydney, Brisbane or Melbourne across to Asia, or even Perth, and for 15 minutes you have the urban housing sprall around the major cities. Then for the next 4 hours you will barely see a house, let alone an entire town. Definitely not short of land, so the supply/demand curve is very valid. Note also, how house price charts over the decades follow commodity prices and the Aud$ and interest rate and national economy figures. What is the current strong trend in efery one of those? Down!
Australia is not short of land and indeed land and houses are relatively cheap in small country towns – and in particular if they have falling populations. But land is in short supply within a few kilometres of our capital cities. Although there is no ‘new land’ being produced, governments are rezoning land from industrial to residential in inner city areas as industry moves out to cheaper and larger facilities with better transport connections which has the effect of creating new supply. But if you want to live in Manly or Bondi in Sydney or Brighton, Elwood or St Kilda in Melbourne you will find yourself competing for a strictly limited product with a growing number of prospective purchasers. The end result is higher prices.
Changes in population, demographics and perceived household wealth are the key to what an Australian will pay for a house and indirectly what the authorities will direct should be included in new developments and dwellings. This includes everything from public open space, community facilities, energy ratings, water treatment and recycling. Finally, the area of land occupied per dwelling and the size of the dwelling are critical to the end cost. Some of this is controlled by the authorities and some is market driven.
Housing Wealth/Disposable Income is a good measure of housing affordability, removing cyclical interest rates and focusing on incomes and house prices. Lowering interest rates can stimulate a temporary boom in housing but will set us up for another bust when rates rise from their artificial lows. The only long-term fix for the housing construction industry is to improve affordability, with efforts concentrated on reducing land prices.
I suspect that when the huge cohort of baby boomer’s in Australia, most of which are now also empty nester’s, start to retire in earnest and find that their super savings isn’t hardly enough to sustain them for the next 20 or more years, houses will come onto the market in a gargantuan wave. Conversely the generation behind them (the baby busters) and would be buyers who are considerably fewer in number lack the financial resources to pay these dizzying inflated prices. What goes up can and will eventually go down. I say we look at Japanese real estate over the last 20 years as a guide to where Australian real estate is heading. I see this as being a very long and protracted down turn and I’ll stick my head out on a limb here and predict that it won’t end until we hit 1980’s prices – which is when I bought my first house and yes I am a baby boomer.
The cost of raw land that is subsequently subdivided into housing lots constitutes in the order of 10% of the cost of the finished house and land package (even less for high rise apartments). So it is not the cost of the land that is driving up prices. Why are prices higher in Australia – local government delays and costs, GST, house sizes, construction requirements, energy and safety standards, labour costs, etc. While we are experiencing a growing population and relatively low unemployment, the only thing that will push prices down is an excess of supply. The constraints of planning approval and the tight control that our banks have exercised over development finance has meant that this has not occurred in the major cities for many years (the exception being high rise apartments on the Queensland Gold Coast). Maybe Australians have been conned into being house proud via TV reality shows on the subject and smart marketing by builders and developers? However, once you look at the market above basic entry level dwellings, it is the purchaser that determines how much that they spend. Whether they are getting good value for their money is a consideration that they must make when allocating their cash resources to their lifestyle priorities. Who are we to say that they are spending too much money on a dwelling, ‘branded’ motor vehicle, designer label clothing, etc.
“The cost of raw land that is subsequently subdivided into housing lots constitutes in the order of 10% of the cost of the finished house and land package (even less for high rise apartments)”
That does not agree with the graph presented where construction costs represent less than 50% of total house prices.