Australia's Future Tax System

Final Report: Detailed Analysis

Chapter E: Enhancing social and market outcomes

E4. Housing affordability

E4–2 What is housing affordability?

At its most basic level, housing affordability means ensuring that low-income households can access an adequate standard of housing without unduly compromising their other spending needs. Concern over housing affordability extends beyond this to whether people across a range of incomes can purchase housing without facing undue financial stress.

Studies of housing affordability do not settle on a single definition or way of measuring housing affordability (for example, Robinson et al. 2006; Gabriel et al. 2005). Different measures often reflect different conceptions of what is the most important aspect of housing affordability. Concern may focus on low-income earners' access to housing (often as renters), the degree of home purchase capability enjoyed by moderate-income or first home buyers, or the ongoing cost of sustaining a mortgage for those on average incomes (see Box E4–1). However, what is common through all of these benchmarks is a measure of the price of housing and a household's means to pay for it.

Box E4–1: Different measures of housing affordability

Several measures of housing affordability focus on low-income earners.

'Residual' measures of affordability record the remaining income available to households after deducting the cost of a level of housing (for example, see Harding & Szukalska 2000; Burke & Ralston 2003). This approach can indicate whether households enter housing poverty through rising housing costs or falling income.

'Ratio' measures of affordability compare the costs of housing to household income (for example, see ABS 2002; Harding, Phillips & Kelly 2004). Under this approach, housing is agreed to be unaffordable when housing costs exceed 30 per cent of income for households with incomes in the bottom 40 per cent of the income distribution (for example, see the National Housing Strategy 1991).

The affordability of housing for wider groups in society can be measured in other ways.

A simple measure that reflects the cost of purchasing a dwelling is the ratio of median house prices to average household income.

Several measures assess the ongoing costs of home purchase of a dwelling through a mortgage. The Reserve Bank of Australia compares the cost of repaying a mortgage — based on 80 per cent of the prevailing median house price at the prevailing variable mortgage rate — with average household income (see Richards 2008). HIA-Commonwealth Bank applies a similar approach to the median house purchase price for first-home buyers (see HIA 2009). While there is no single view of when housing is affordable using such measures, affordability is often interpreted as being at low levels when repayments exceed 30 per cent of income.

Other measures of purchase affordability reflect the up-front cash required for a deposit on a mortgage and are often used to describe the degree of first home buyers' access to the market. For example, the 'deposit gap' records the difference between typical house prices and the maximum mortgage available on a typical household income (Yates and Milligan 2007).

Developments in housing affordability in Australia

Current measures of housing affordability indicate that Australia faces significant challenges in providing sufficient affordable housing.

Median house prices have risen from around three times average household earnings in the early 1990s to around five times today (see Chart E4–1 Panel A). Higher prices affect access to housing in a range of ways. Under the Reserve Bank of Australia's measure, loan repayments are only just under 30 per cent of income (see Chart E4–1 Panel B). Houses are more affordable now than during 2007, but the recent improvement reflects interest rates falling to 'emergency lows' to combat the global financial crisis. These low rates are likely to be unwound as the economy recovers. Higher housing prices also meant that the deposit needed by first home buyers reached record highs during 2007 (Richards 2008). Higher house prices may also delay access to home ownership by younger Australians. The proportion of Australians under 35 who own their own home declined from 44 per cent in 2001 to 38 per cent in 2008. Similarly, higher house prices may mean fewer people own properties outright. The proportion of Australians aged 55 to 64 with mortgages has increased from 13 per cent in 1996–97 to 30 per cent in 2007–08. The National Housing Supply Council (2009) also noted that there is a spatial dimension to the affordability of dwellings; 27 per cent of dwellings in different population centres were found to be 'unaffordable' in 2006, while none were in 2001.15

Chart E4–1: Housing affordability for owners

Panel A: Median house price to disposable household income

Chart E4–1: Housing affordability for owners - Panel A: Median house price to disposable household income

Source: REIA 2009, ABS (2009a) and Treasury estimates.

Panel B: Housing Loan Repayments

Chart E4–1: Housing affordability for owners - Panel B: Housing Loan Repayments

Source: RBA unpublished.

Importantly for many low-income earners, or transfer recipients, higher house prices reduce rental affordability, as rents need to increase if investors are to maintain their rental yield. The ratio of rents to average weekly earnings has risen to its highest level since the late 1980s (see Chart E4–2 Panel A). As at 5 June 2009 there were 418,000 individuals and families paying more than 30 per cent of their income in rent even after receiving Rent Assistance; 129,000 of these were paying more than 50 per cent of their income. Many of these people, especially age pensioners and disability support pensioners (who make up around one-quarter of Rent Assistance recipients) are likely to have limited capacity to increase their incomes. The number of Rent Assistance households paying more than 30 per cent of their income in rent is at its highest level since 2000.

Chart E4–2: Housing affordability for renters

Panel A: Rents to average weekly earnings

Panel B: Rental stress

Source: REIA 2009 and ABS (2009e).

Panel B: Rental stress

Source: REIA 2009 and ABS (2009e).

  1. Proportion of households in the bottom two income quintiles, whose rental costs are more than 30 per cent of gross income.

Source: Richards (2008).

The price level of any market good or service is set by its demand and supply. The Productivity Commission (2004) and Reserve Bank of Australia (2003) attribute the increase in house prices around the start of the decade primarily to strong growth in demand. This demand reflected a range of factors, including growth in average household incomes, increased credit availability and relatively low interest rates. In the short term, when housing supply is relatively fixed, price increases are an inevitable response to strong demand.

A persistent gap between housing supply and underlying demand (or the 'need' for housing based on population growth and trends in household formation) indicates that there are problems on the supply side of the housing market. Strong population growth in recent years has led to relatively strong underlying demand for housing. However, the supply response has not been able to keep pace. Over the past five years, the population grew on average 1.7 per cent a year, while housing completions fell on average 2.0 per cent a year.

Thus sustained high levels and strong growth of housing prices are only possible when housing supply cannot increase to meet movements in demand.

There are a range of indicators of tight supply in the current housing market. Rental vacancy rates are currently around the record lows experienced during 2008 (see Chart E4–3). The National Housing Supply Council estimated that there is a substantial shortage of housing in Australia, with an unmet need of 85,000 dwellings in 2008, and construction levels falling short by around 20,000 to 30,000 a year. If the Council's medium growth estimate of underlying demand and medium supply projection were met, there would be a cumulative gap by 2028 of 431,000 dwellings. Annually, the gap would increase by around 23,000 dwellings until 2016, when the annual shortfall would decrease consistent with an ageing population.

Of course, in markets demand always equals supply so long as prices can adjust. The Council's projections should be seen as an indication of the degree of likely price pressures and the subsequent challenges facing the community.

The growth in house prices largely reflects increasing prices of existing houses, rather than growing costs of construction (see Chart E4–3 Panel B). Land has made up a growing share of house prices, increasing from 53 per cent to 61 per cent in the 15 years to 30 June 2009.

Chart E4–3: Constrained supply

Panel A: National rental vacancy rate

Chart E4–3: Constrained supply - Panel A: National rental vacancy rate

Source: REIA (2009) and Treasury estimates.

Panel B: House prices and construction costs

Panel B: House prices and construction costs - Panel B: House prices and construction costs

Source: RBA (unpublished).

The responsiveness of housing supply is influenced by a range of factors. Even in ideal conditions, dwellings take a long time to plan and construct, which will mean that the supply of housing is unlikely to be as responsive as supply in other markets. Currently, difficulties in securing finance for the development of multi-unit developments are a consequence of lending practices changing in response to the global financial crisis. There are, however, many public policy choices that can have a long-term impact on housing supply and housing affordability. As well as tax settings, housing supply and prices are influenced by planning and zoning laws, building regulations, environmental regulations, infrastructure provision and pricing, the availability of skilled labour in residential construction, and even transport policy. As a consequence of achieving other public policy objectives, these policies may affect housing prices.

15 This is based on the UDIA/Matusik Affordability Measure (2008), which characterised an area as 'unaffordable' when a household spending 30 per cent of the average income in that region on repayments (and with a 10 per cent deposit) could purchase less than 15 per cent of the houses in the region.