Ric Battellino: Housing and the economy
Remarks by Mr Ric Battellino, Deputy Governor of the Reserve Bank of Australia, to the
6th National Housing Conference, Melbourne, 25 November 2009.
* * *
I have been asked to focus my comments on the economic aspects of housing. In keeping
with this, I will start with a few words on the economy and then discuss the implications for
the housing market. In the course of that, I would like to look at three specific questions:
•
are we building enough dwellings?
• is there enough housing finance? and
•
why are dwelling prices in Australia high relative to income?
The economic context
The Reserve Bank has published a lot of material on the global and Australian economies
recently, including the November Statement on Monetary Policy, the minutes of Board
meetings and various speeches.
I won't go over that material in detail, but it is worth drawing out a few highlights.
The first point is that the global economy is clearly growing again after some very sharp falls
in activity late last year and early this year (Graph 1). Virtually all economies recorded growth
in the September quarter, and the information available so far for the December quarter
indicates that the expansion has since continued
Graph 1
Industrial Production*
January 2008 = 100
Index Index
Emerging Asia***
North Atlantic countries**
110 110
100 100
90 90
80 80
2007 2008 2009 2007 2008 2009
* Weighted using GDP at market exchange rates
** Canada, Denmark, euro area, Norway, Sweden, UK and US
*** China, Korea, India, Malaysia, Philippines, Singapore, Taiwan and Thailand
Sources: CEIC; RBA; Thomson Reuters
It is also clear that the economies of the North Atlantic are lagging behind those in other
parts of the world, particularly those in Asia where the economic recovery has been quite
rapid. It is not surprising that the North Atlantic economies are lagging, as they were at the
centre of the financial crisis. Many of the banks in that region are still at the early stages of
balance sheet repair, which is limiting their capacity to lend.
Banks elsewhere are in much better shape. While they were caught up in the squeeze on
global money markets that flowed from the events in the United States late last year, they
generally did not experience severe credit losses. Once the liquidity pressures passed,
financial intermediation in these countries has tended to normalise. This is certainly the case
in the Asian region. More generally, economies in the Asian region have responded well to
accommodative macroeconomic policies and economic activity has rebounded.
This is positive for Australia as Asian countries are our major trading partners. While the
world economy as a whole is forecast to remain relatively sluggish next year, economic
growth for the group of countries that comprise our major trading partners is expected to
recover to a relatively normal pace.
Some commentators question the capacity of Asia to continue to grow if the developed
economies of the North Atlantic remain weak. While there is no doubt that weakness in the
developed economies would have an adverse effect on Asia's growth prospects, we should
not lose sight of the fact that most of the growth in the larger Asian economies comes from
their own domestic demand. In the case of China, for example, domestic demand contributed
on average close to 9 percentage points per annum to growth over the past decade, while
net exports contributed about 1 percentage point (see Table 1). Importantly, the authorities in
most of these countries have plenty of scope to pursue policies that sustain domestic
demand.
Table 1: Average Economic Growth*
Annual Average Growth
Contribution from:
1999-2008 (%)
Domestic demand Net exports
(% points) (% points)
Japan 1.3 0.9 0.4
China 9.7 8.7 1.1
India 7.1 7.5 -0.4
Korea 5.2 4.5 0.7
Indonesia 4.7 4.1 0.6
Taiwan 3.8 1.6 2.3
Singapore 5.6 4.6 1.4
* This calculation abstracts from the fact that some of the growth of domestic demand has come from increased export
income.
Sources: CEIC; Thomson Reuters; RBA.
The Australian economy in 2009 has held up much better than had been expected earlier in
the year. Australia is the only developed economy where year-ended growth in GDP has
remained positive during the past year. It is now 18 years since Australia has experienced a
negative in year-ended GDP growth, a very prolonged economic expansion (Graph 2). With
the economy having only recently entered a new upswing, it is reasonable to assume that we
will see this growth extended for a few more years yet.
Graph 2
Over the next few years, Australia is also expected to see a further expansion of the
resources sector, including the development of some very large gas projects. Mining
investment, which is already at record levels as a share of GDP, could rise substantially
further in the next five years or so (Graph 3).
Graph 3
If this scenario eventuates, it will have powerful and broad-ranging implications for the
economy. Glenn Stevens and Ken Henry have addressed these recently. I won't go over all
that ground again today but, as far as the housing market is concerned, the key implications
are that:
•
the rate of growth in the population, which has already picked up in recent years, is
likely to remain strong, as demand for labour will encourage continued high
immigration;
•
household incomes are likely to rise solidly, which will help underpin the demand for
housing; and
•
the construction industry is likely to face substantial competition for workers from the
mining sector.
While this suggests a generally positive environment for the housing sector, it will not be
without its challenges.
Are we building enough dwellings?
As Glenn Stevens mentioned recently, one of the key challenges will be to ensure that the
supply of housing is able to respond adequately to the increased demand for
accommodation. There is a broad consensus that in recent years Australia has not built
enough dwellings. A good indication of this is the very low vacancy rates in rental markets.
This shortfall in housing, however, is not because, as a nation, we have cut back on
investment in dwellings. In fact, the opposite is true: over the past decade dwelling
investment has been higher - around 6 per cent of GDP - than it has typically been in the
past (Graph 4).
Graph 4
Private Dwelling Investment
Five year averages, current prices, per cent of GDP*
% %

New dwellings
 Alterations and additions
6 6
5 5
4 4
3 3
2 2
1 1
0 0
1984 1989 1994 1999 2004 2009
* Last observation uses data to June 2009
Source: ABS
So how do we square up the seemingly contradictory evidence that overall investment in
housing is relatively high, yet there seems to be a shortage of dwellings? I think four factors
help to explain this contradiction.
•
First, Australians are on average spending a lot more on each new dwelling. Real
expenditure on each new dwelling built is now 60 per cent higher than it was around
15 years ago (Graph 5). This is due to improvements in quality and increases in
size.
•
Second, a high proportion of dwelling investment is in the form of alterations and
additions - i.e. upgrading existing houses rather than building new ones. Almost half
of all dwelling investment has been accounted for by alterations and additions in
recent years.
• Third, a higher proportion of the new houses built are simply replacing existing
houses that have been demolished. We estimate that between 2001 and 2006,
around 15 per cent of new houses built replaced houses that had been demolished;
10-15 years earlier, that figure was less than 10 per cent.
Graph 5
•
Fourth, a significant proportion of dwelling investment appears to have gone into
holiday homes or second homes. Census data show that the number of dwellings
built has exceeded the increase in the number of households by a large margin. As
a result, the ratio of the number of dwellings to the number of households has been
rising over time; as at 2006, there were 8 per cent more dwellings in Australia than
there were households. Presumably, most of this surplus reflects holiday houses
and second houses (Graph 6).
Graph 6
In short, the apparent contradiction between the shortage of dwellings and the high
investment in dwellings arises because a high proportion of dwelling investment is going into
improving the quality of existing dwellings and building accommodation additional to primary
residences. If as a nation we want to continue to do this, while at the same time providing
enough dwellings for the growing population, the overall amount of dwelling investment
undertaken will need to increase relative to GDP. That would raise important challenges for
the housing industry in terms of its capacity to meet that demand. It would, of course, also
raise the question of which of the other expenditure components of GDP should bear the
offsetting fall in share.
Is there enough housing finance?
Let me now turn to the question of housing finance.
Over the past couple of years, there has been a significant change in the structure of the
housing finance market, with lenders that were funding themselves through securitisation
cutting back substantially on their new lending. Increases in the cost of funds for these
lenders made it largely uneconomic for them to lend. Their declining market share has been
picked up by the major banks, which now account for about 80 per cent of all new housing
loans.
These developments have led to concerns that borrowers may not have sufficient access to
loans or that the cost of new loans may increase. However, to date at least, the evidence
does not suggest that we should be overly concerned.
On the question of cost, margins on standard housing loans have, if anything, narrowed a
little over the past couple of years, even for the major banks. Two years ago, the interest
rates charged by the major banks on new variable-rate housing loans were about 190 basis
points above their cost of funds. The margin today is slightly narrower. To the extent that
there has been a widening in banks' margins it has been on their business lending. So far, it
appears that there is still sufficient competition in the housing loan market for lenders not to
have been able to widen their margins.
The Government has helped to sustain that competition by putting in place arrangements to
encourage the continued securitisation of housing loans. The Australian Office of Financial
Management (AOFM) has been buying mortgage-backed securities from these lenders at
yields that, during the crisis, were well below those in the secondary market (though still very
attractive in absolute terms). This helped keep the cost of funds to these firms at levels that
allowed them to continue lending, albeit at a much reduced rate from that of earlier years.
The Government has recently announced an expansion in the AOFM program. At the same
time, issuers of mortgage-backed securities are finding that, with market spreads having
narrowed substantially in recent months, it is again becoming economic to issue securities
into the market.
As my colleague, Guy Debelle, said last week, the Australian securitisation market, like
securitisation markets everywhere, has suffered reputational damage from the events in the
United States. However, Australian mortgage-backed securities have not experienced credit
problems. I am confident that this fundamental point will eventually see the local
securitisation market return to being an important source of funding for housing loans.
In the meantime, increased lending by banks means that total new loan approvals are
relatively high. In fact, new loan approvals are at levels which indicate a degree of
homebuyer activity that has typically been associated with rising house prices (Graph 7). At the
same time, however, existing borrowers are continuing to take advantage of the low level of
interest rates to make accelerated loan repayments, which is restraining the overall growth of
housing credit. Even so, housing credit is growing at an annual rate of 7-8 per cent, a pace
which is more than adequate to fund the new investment in housing that is needed.
Graph 7
Housing Loan Approvals and Prices
% %
Year-ended housing price growth
(LHS)
2.0
20
1.8
15
1.6
10
5 1.4
0 1.2
Housing loan approvals*
(RHS)
-5 1.0
-10 0.8
1994 1997 2000 2003 2006 2009
* As a share of the value of the dwelling stock; excludes owner-occupier
refinancing and investor approvals for new construction and by 'others'
Sources: ABS; APM; RBA
Why are dwelling prices high in Australia relative to income?
There is a common perception that house prices relative to household income in Australia
are high both compared with other countries and with our own history.
It is certainly the case that the ratio of house prices to income in Australia is higher now than
it was 20 years ago. However, this is largely explained by the fact that the fall in inflation over
that period has allowed nominal interest rates to cycle around a lower average level now
than was the case earlier. That is, lower interest rates have allowed households to take out
bigger home loans, without increasing housing loan repayments (Graph 8). In turn this has
given households more buying capacity in the housing market, which has been reflected in
house prices.
Graph 8
Housing Loan Repayments*
As a percentage of household income
% %
40 40
30 30
20 20
1984 1989 1994 1999 2004 2009
* Housing loan repayments calculated as the required repayment on a new
80 per cent LVR loan for the median-priced home; household disposable
income is before interest payments. RBA estimate for September quarter 2009.
Sources: ABS; RBA; REIA
International comparisons of the relativity between house prices and income have been the
subject of considerable research over the years. One of the complications faced by people
working on this topic is to ensure consistency in the data that underlie the comparisons. Do
the figures relate to capital city prices, or the prices across the whole country? Do they cover
all dwellings or just detached houses? Is income measured as average weekly earnings or
average household income? It is not always possible to get entirely consistent data across
countries, so we need to be careful in interpreting the results of these comparisons.
Most people do agree, however, that the ratio of house prices to incomes in Australia is
higher than in the United States. One explanation that has been put forward for this is that
the Australian population is more concentrated in a few large cities, where house prices are
higher, even relative to income. This seems like a plausible explanation, but there must also
be a financial explanation, otherwise we would expect to observe that housing stress among
Australians was higher than in the United States, and this is clearly not the case. Arrears
rates on housing loans in Australia have typically been lower than those in the United States,
despite the higher ratio of house prices to income.
There are a couple of reasons why Australian households seem to be able to sustain a
higher ratio of house prices to incomes. First, Australians seem to spend less of their income
on non-housing consumption than is the case for US households, with a significant part of
this difference explained by lower health costs in Australia. Australian households therefore
have greater capacity to service housing loans. Second, the level of gearing in the United
States housing market is noticeably higher than in Australia. This may reflect the fact that
Australian households are more active in paying down their loans after buying a home,
possibly because owner-occupied mortgage interest rates are not tax deductible here as they
are in the United States. The faster pay-down of mortgage debt in Australia reduces the risk
of borrowers subsequently getting into financial difficulty.
Overall, the experience of the last few years suggests that the Australian household sector
as a whole appears to have the financial capacity to sustain a relatively high ratio of housing
prices to income. That capacity may not, however, be evenly distributed through the
population. Many 50-60 year olds, having benefited from the prolonged economic expansion
over almost 20 years and the accumulation of superannuation savings, are in a strong
financial position. This has encouraged a change in financial behaviour, with many
households in this group being more inclined to stay geared up later in life, using the funds to
upgrade or expand dwelling investments. It is likely that this changed behaviour has been a
significant factor in the housing developments we have seen over the past 10-15 years.
In contrast, the typical first-home owner cohort - those under 35 years of age - has
experienced a noticeable decline in home ownership over the past 10-15 years (Graph 9). It
may be that this is being driven by demographic factors - such as the fact that young people
are staying in education longer and delaying the formation of new households - but it may
also be financially driven.
Graph 9
Home Ownership Rates in Australia
% %
Total
60 60
Under 35 years
40 40
20 20
1984 1988 1992 1996 2000 2004 2008
Source: ABS Survey of Income and Housing (SIH)
A particular problem for first-home owners is that the rise in the ratio of house prices to
income has substantially increased the deposit needed to get into the market. On plausible
assumptions, the deposit needed by first-home owners may now be around one and a
quarter years' income, almost twice what it was 15 years ago. At one stage, lenders were
responding to this by lowering the deposit requirement, but this carried the risk of buyers
subsequently getting into difficulty. Also, various governments have sought to provide
concessions to first-home owners through grants or tax relief. However, while these
measures assist the first wave of buyers who are able to take advantage of them, the
benefits diminish over time to the extent that these concessions become capitalised into
higher house prices.
Conclusion
I am conscious that I have raised a lot of issues and provided very few answers.
Nonetheless, I will stop here, and leave it for your discussions over the next couple of days to
resolve some of these issues.