. at that time, a general increase in incentives for first home buyers ( for both new and existing dwellings ), and the support provided for a time by lower interest rates, led to a sharp run - up in construction in new south wales, queensland, victoria and western australia ( graph 10 ). further evidence that the supply of land is not the whole story can be found by looking across different regions within the states. if supply has been the critical constraint, we might have expected construction trends to have been very different across inner and outer parts of cities and the regional areas beyond the cities. for example, development in the outer suburbs tends to be on greenfield land, while development in the inner suburbs tends to be higher - density dwellings on brownfield land. however, for victoria at least, the pick - up in building activity in 2009 and 2010 was relatively broad based across these different areas ( graph 11 ). for new south wales, it does appear that there was a larger and more sustained pick - up in approvals in the inner and middle regions of sydney, than in outer sydney and the rest of the state. this may have reflected some limitations in access to land on sydney ’ s fringes, but nonetheless, there was a relatively rapid pick - up in approvals in 2009. even so, this doesn ’ t mean that supply - side issues have not had an important bearing on the housing sector. this point was made in research published in one of the bank ’ s bulletin articles last year. 5 many public reports and the bank ’ s own liaison with industry participants pointed to a range of supply - side impediments in the australian housing market. these included the length and complexity of the planning process, the provision and funding of infrastructure, land ownership and geographical constraints, as well as the challenges for development within those city regions that are already well developed. while these factors may impose some constraints on the cost and responsiveness of new supply, it is less clear that they have been restraining the level of new construction more so now than in the past. one way that is often used to assess the possible outlook for dwelling construction is to compare the number of dwellings that have been built over a period of time with a measure of what is termed “ underlying demand ”. the notion is that if we can assess the prospects for the average number of people living in each household, then we can gauge the strength of “ underlying demand ” by looking at what ’ s happening to population growth. the problem

with this sort of analysis is that the average number of people in each household changes over time in response to a range of things, including the cost of housing. over the 20th century, demographic and social factors, such as a declining birth rate and rising separation rate, were accommodated by growth in the dwelling stock outpacing that of the population. in other words, there was a downward trend in the number of people in each household ( graph 12 ). a very similar change was also evident across advanced economies. however, over the past decade or so, these trends have abated and we ’ ve seen the average household size stabilise. indeed, the higher level of house prices and rents ( relative to see hsieh w, d norman and d orsmond ( 2012 ), “ supply - side issues in the housing sector ”, rba bulletin, september, pp 11 – 19. bis central bankers ’ speeches incomes ) may have been somewhat of a constraint on household formation and therefore demand for new housing. this leads me to what i think is arguably a better way to judge the strength of demand versus supply, which is to look at what prices and rents have been doing. what this suggests is that demand has shown some signs of strengthening relative to supply. in particular, housing prices are no longer declining relative to incomes ( graph 13 ). also, the rental market appears to be relatively tight. vacancy rates have been quite low since 2006 in comparison to the average since the early 1990s, and ( with a small delay ) this has led to rents rising relative to incomes and remaining relatively stable at around levels seen during previous cyclical peaks ( graph 14 ). the growth in rents has also meant that conditions for investors have become more favourable, with ( gross ) rental yields increasing across the capital cities. our liaison with the housing industry confirms that demand for new housing has been more positive over recent months. at the same time, however, our contacts note that conditions still remain relatively subdued in most states. in particular, they report that prices for the construction of new dwellings have been held down in response to weak demand, with discounting still reported across the market, including for new developments. not surprisingly, developers have found a lack of buyer urgency during the earlier period of declining dwelling prices. in addition, they note instances of some earlier sales made off the plan falling through ahead of settlement, apparently due to caution by lenders regarding valuations and strict lending practices for new developments. summary let