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Housing policy

Executive Summary

The Sydney housing market is currently beset by several challenges; house prices have grown beyond sustainable levels such that they have severely excluded potential new home buyers and caused a massive expansion in household debt. Our households are now overexposed to changes in financial conditions as are those who lend to them. This is a precarious and dangerous situation which is undermining the future economic prosperity of our community.

In simple terms, this has occurred because an insufficient supply of housing has been snatched up by surging demand off the back of investor speculation and low interest rates. This policy statement explores these primary themes – supply and demand – and illustrates a policy vision for how we can overcome these challenges.

I argue for a number of policy reforms for both demand and supply including:

Demand:

  • A variable loan-to-value ratio for investor mortgages to be controlled by the Australian Prudential Regulation Authority
  • Superannuation home mortgage policy
  • Homeowner’s hedge policy
  • Superannuation offset account policy

Supply:

  • Co-ordination of federal, state and local housing policy & the development of long-term housing objectives
  • Infrastructure to link new housing developments with existing settlement
  • Regional de-centralisation partnered with high speed rail

These policies represent a comprehensive attempt to tackle the root causes of the challenges faced by the housing market. Together they have the potential to re-invigorate our economic potential and ensure the prosperity of generations of future Australians.

 

Demand Issues & Recommendations

Context

The Sydney property market has seen strong demand from both owner-occupiers and investors in recent years. This is the result of several factors, most notably; sustained low-interest rates & favourable tax policy.

For the last few years the Reserve Bank of Australia (RBA) has kept interests rates at historic lows in an effort to boost growth.  This has had the dual effect of improving the ability of investors and households to increase their borrowing and purchase property. Accordingly, household debt has increased to more than 150% of GDP.[1]  While cheap credit has made borrowing more affordable for some, households are now more exposed to future increases in interest rates or a downturn in economic conditions.

Household debt growth has also occurred in part because of the favourable opportunities offered to investors by negative gearing policy. Our existing framework reduces the taxable portion of capital gains by 50% and allows individuals to claim losses incurred by property against other streams of income such as wages. This strongly incentivises the acquisition and negative gearing of investment properties to profit from capital gains. In conjunction with the cheap credit currently on offer, investors have snapped up housing stock with the hope of profiting from the capital appreciation. This has pushed up house prices to unattainable heights and dangerously overheated our lending market.

Therefore fears of a speculative ‘bubble’ in the Sydney housing market have merit. Rental yields have remained at record lows for successive quarters while demand for housing continues to grow. The disparity between the weak returns on property assets and rising prices is a clear sign that speculative investment is pushing up prices. In response to fears of a growing ‘asset bubble’ the Australian Prudential Regulation Authority (APRA) tightened lending restrictions in 2015 and maintained that prudential lending standards are adhered to by banks and other Authorised Deposit-taking Institutions (ADIs). Indeed, Australian ADIs are required to perform ‘stress-testing’ on debt obligations to determine whether their borrowers can service debt at higher interest rates. In 2015, APRA introduced a 10% cap on growth in investment mortgage lending which reduced the proportion of investment loans as a percentage of total housing loans from 54.3% to 43.9% and encouraged tighter prudential lending standards, including a lower loan-to-value (LVR) ratio. Since then, investment loans have once again continued to grow, back to 49.6% of total loans.[2]

Discussion of a Sydney housing ‘bubble’ should be considered in the context of sustained low-interest rates as well as tax policy favourable to investors. Fears of this bubble ‘bursting’ are only likely to be realised if economic conditions seriously deteriorate such that debtors could no longer service their obligations and the housing market collapses. Similarly, substantial interest rate increases could damage the property market by increasing mortgage costs for over-leveraged investors and home-owners.

Policy recommendations

It is evident the government needs to approach the housing market with two suites of policies to tackle these challenges. The first suite must stabilise the market in the short to medium term by rolling back excessive investor speculation. This will calm house price growth and return the market to a sustainable footing. Once this has occurred, the government can employ a second suite of policies designed to assist first home buyers and owner occupiers into the market. The second suite of policies must take effect after the market has been stabilised otherwise we are only likely to compound the problems we currently face by injecting more debt and therefore more liabilities into the financial system. However, when appropriately implements these two suites of policies will keep the housing market stable and encourage home-ownership in the long-term.

First suite of policies:

  • Enhancing APRA’s regulatory function

Second suite of policies:

  • Superannuation home mortgage policy
  • Homeowner’s hedge policy
  • Superannuation offset account policy

First suite of policies:

Enhancing APRA’s regulatory function via the introduction of an adjustable loan-to-value (LVR) ratio for investor mortgages

The Australian Prudential Regulation Authority is responsible for maintaining prudential lending standards for Authorised Deposit-taking Institutions (ADIs). In 2015 strong growth in investment mortgage lending prompted APRA to encourage tighter loan-to-value ratios (LVR) for new mortgages (most new mortgages sit at 80% LVR) and cap residential property investment loan growth to 10%.

It has been noted that this decision has moderately cooled the property market and slowed lending to investors. It is evident from this experience that APRA should be in possession of a greater set of macro-prudential tools to reduce overzealous lending in periods of sustained low-interest. Introducing a variable LVR for investor mortgages that is adjusted by APRA alongside interest rate changes will provide a counterbalancing mechanism to offset interest rate changes. With this tool, APRA could take preventative steps to tame excessive investor speculation. When investor loans grow at too fast a pace and crowd out owner-occupiers, APRA can tighten LVR ratios and therefore reduce the amount of investors in the market. This policy has the positive side effect of improving the quality of loans made to investors because loans taken out with tighter LVR ratios expose banks to less risk should the loan default. This policy would leave owner occupiers and first home buyers in no worse off position as they will not be affected by the variable LVR ratio.

Alternatively, the Council of Financial Regulators could be the body which oversees this lever. This committee meets monthly and could be requested to examine the housing market, and then offer a recommendation to the Treasury for the appropriate LVR. This recommendation would then be enforced by the Treasurer, removing the need for a change to the mandate of APRA or a similar body, while still keeping the advice independent and expert driven.

Second suite of policies:

Homeowner’s hedge policy

This policy is designed to protect homeownership when the Reserve Bank decides to raise interest rates. As we have entered a period of sustained low interest rates it is inevitable that in the future the rates will rise.

The fallout from interest rate increases is that home ownership is put under stress and defaults increase commensurate with increase of interest rates. While low interest rates have also facilitated the purchase of homes by many who previously could not, there is concern about their capacity to cope with any increase in mortgage rates. While provision have been enacted by lenders that require borrowers to be able to sustain an increase in interest rates of up to 7%, no doubt there will be those who will have obligated these funds for other purposes during this period of sustained low interest rates.

As the current tax system does not allow for the deductibility of the interest component of mortgage payments for homeowners the impact of rate rises is increased as the additional funding must be paid with after-tax dollars.

The home hedge policy would allow for the deductibility of the increased cost on mortgage payments that result from an interest rate rise. This measure would provide a significant hedge against an increase in mortgage payments which would now be paid from pre-tax dollars rather than after-tax dollars. This benefit to assist the home owner retain ownership should be repaid with interest from the proceeds of the sale of the property. There is no net cost to the budget as all hedging is repaid on the sale of the house.

Superannuation Home Mortgage Policy

Under current arrangements, property can only be purchased through superannuation as part of a Self-Managed Super Fund (SMSF). This superannuation fund regards acquired property strictly as an investment for the purposes of retirement and as such it cannot be occupied or rented by any members or related parties of members of the SMSF. SMSFs are currently very expensive products that incur a range of initial and ongoing costs such as set-up fees, legal, taxation and investment advice; accordingly, they are out of reach for many ordinary Australians.

This policy recommends a simple tax structure, independent of SMSFs whereby the home buyer may access a portion, or the total sum, of their superannuation fund for the purchase of a home which they may occupy as a primary residence. The amount of money borrowed from super as a percentage of the property’s purchase price is retained as a component of the superannuation account. If the property is sold prior to the preservation age of the super account then the super account must claim back its percentage of the property at the sale price.

Example (1):

James purchases a $600,000 property using $30,000 from his superannuation account.

Thus James’s superannuation account owns a 5% stake in his property.

In ten years’ time, James sells the property for $1.5 million dollars. At this point the superannuation account is obliged to take 5% of the sale price – 5% of $1,500,000 = $75,000 – and return it as a preserved part of the superannuation account.

 

 

If the super account reaches preservation age, then the percentage owned by the super account is cancelled as the property is now a component of retirement income.  In this way, the super account maintains its purpose as a vehicle for retirement income but also allows the property to act as an investment contribution to superannuation.

Example (2):

Elizabeth purchases an $800,000 property using $50,000 from her superannuation account.

Her super account owns a 6.25% stake in her property. However, she decides not to sell her property. Upon reaching preservation age, she cashes in her superannuation and the 6.25% stake in her property is dissolved as the property and superannuation account are her retirement income.

 

The superannuation home mortgage policy also allows individuals to access their superannuation account after the purchase for the purposes of paying off the mortgage principle. The amount borrowed from superannuation as a percentage of the property’s value (at the point of borrowing) is then owned by the superannuation account.

Example (3):

Edward currently owes a $600,000 mortgage on a property currently valued at $1,000,000. He wishes to pay off a part of the principle using his superannuation.

He borrows $50,000 from his superannuation account to reduce his mortgage principle to $550,000.

Because the amount he borrowed ($50,000) as a percentage of the property’s value ($1,000,000) is 5%, his superannuation account owns 5% of his property.

 

It is possible for an individual to borrow from the superannuation account for the initial purchase of a home and to make further borrowings to pay off the principle. These can be at the discretion of the home-owner, and can occur at any period of time. This would enable investors to make ongoing monthly or weekly payments from their superannuation account into their mortgage. In effect, this would allow individuals to direct all superannuation into paying off property.

In this case, the percentage owned by the superannuation account is cumulative.

Example (4):

Anthony purchases a $1,500,000 home by borrowing $75,000 from his superannuation account

Hence his superannuation account owns 5% of his property.

The value of his home is $1,500,000.

He continues to deposit his monthly superannuation payments ($1500 per month) into paying off the principle on his mortgage.

If the value of the home stays the same for the next 12 months and Anthony continues to deposit $1,500 from his superannuation into paying off his mortgage principle every month then by the end of the 12 month period:

His superannuation account owns a further 1.2% of his home’s value.

After purchasing his home and paying off the principle on his mortgage with monthly deposits for 12 months his superannuation account has a cumulative ownership amounting to 6.2%:

 

 

 

Additionally, when an individual retires, if the property has been financed in anyway by superannuation funds (either for initial purchase or paying off the principle) then the property must be included in the home assets test for a pension, even if the property is a primary residence. While this might exclude some from the pension, those individuals are instead able to access a reverse mortgage to release the equity in their home for a retirement income.  This is a more equitable arrangement as only those with sufficient equity in their home will be excluded from the pension. This policy has the added benefit of reducing the cost of pensions from the federal budget by limiting eligibility conditions to those who really require it. This is a much needed reform which promotes home-ownership and reduces excessive pension payments.

 

Benefits of the Super Home Mortgage Policy:

The superannuation account preserves its role as the individual’s retirement fund. Because the money borrowed from the superannuation account is expressed as a percentage of the property’s value, an increase in the value of the property also increases the value of the superannuation account. In other words, the borrowed money generates returns equal to the appreciation (or deprecation) of the property’s value. In this way, it functions as an investment. Moreover, because the funds must be returned to the super account upon sale of the property, the super account is left strictly for retirement. The ability to borrow from superannuation is an additional tool designed to assist people when they require it. As with all aspects of the superannuation home mortgage policy, individuals are not compelled to use this policy. It is employed at an individual’s discretion. This provides owner occupiers and first home buyers additional options for purchasing a home without locking them into unsuitable financial obligations.

Superannuation Offset Account Policy

An offset superannuation account policy is designed to assist homebuyers and owner-occupiers by reducing the interest rate on an outstanding mortgage by forgoing interest in a linked ‘offset’ account. This policy allows individuals to withdraw funds from their superannuation account prior to preservation age and deposit them in an offset account which is linked to their mortgage. The amount deposited in the offset account determines the degree of discount on the interest rate of the mortgage. The greater the amount deposited in the offset account, the higher the discount on the interest rate.

This tool does not compromise the integrity of the superannuation account as the offset account enables the individual to pay off their mortgage quicker and therefore the property acts as a vehicle for retirement savings. For an individual who has used the superannuation offset account policy, their superannuation balance at preservation age will be lower than had they not used the policy. However, they are instead able to access a reverse mortgage to release the equity in their home for a retirement income. This policy is not compulsory and must be voluntarily entered into by the individual. It will provide individuals another option to finance their property and in doing so will promote sustainable and growing levels of homeownership.

 

Supply Issues & Recommendations

Context

The substantial increases in Sydney house prices since 2013 have occurred as a result of several factors; among them is the insufficient amount of completed dwellings to satisfy strong demand in the housing sector. The undersupply of housing has contributed to a record median high of $1.077 million, 12.2 times the median household income.[3] Ordinarily, a price increase sends a signal to the market to construct more housing. However, strong investor demand and delay between the beginning of construction and the dwelling entering the market means Sydney has faced a protracted affordability crisis as supply lags behind strong demand.

Dwelling commencements were at record levels in 2014/2015 and 2015/2016.[4] However, the increase in supply is only now beginning to filter through the Sydney market and strong investor appetite continues to buoy prices.  Indeed, Sydney’s median house price is projected to continue climbing through 2017, although at 4.5%[5] rather than the double digit increases common in previous years. The outlook for the Sydney housing market represents a “textbook residential market cycle”[6] as chronic undersupply leads to increasing construction activity; the completion rate on new dwellings eventually exceeds underlying demand for housing. The resulting slowdown in prices sets the conditions for the next upturn and the cycle continues.

As the Sydney case study demonstrates, the lag between supply and demand causes painful cyclical contractions and expansions. As prices increase many marginal buyers are excluded from the possibility of owning a new home. As prices decrease so does the wealth of home-owners substantial portion of the community. Government has the potential to play a constructive role in housing supply by facilitating sustainable and cost-effective housing development.

Key recommendations:

  • Co-ordinate federal, state and local housing policy & develop long-term housing policy objectives.
  • Invest in infrastructure to link new housing developments with existing settlement.
  • Begin a process of regional decentralisation partnered with high speed rail to encourage settlement in our under-utilised regional communities.

 

Key recommendations:

  • Establish a permanent body responsible for co-ordination of federal, state and local housing policy and develop long-term housing objectives.

 

The Australian population is set to expand significantly to 48.3 million by 2061[7]. Such a substantial increase in population requires new homes and new infrastructure. Without this investment our cities will be overcrowded, expensive and unpleasant. There is a clear need for the federal government to play an active role in the planning and construction of our future communities. We must develop a long-term settlement plan that maps the projected increases in the Australian population and pairs these with long-term transport investment and infrastructure development. The federal government must stay ahead of our growing population and guide its settlement, instead of playing catch up.

 

The federal government should act as a convener for the three tiers of government (federal, state and local) to create long-term housing objectives and plan what investment is needed and where. This will allow government to master plan the future of Australian settlement and maximise spending to where it is needed most. Such an agreement will clearly delineate the roles and responsibilities of each tier of government and stipulate funding sources and revenue streams. The federal government can therefore take an active role in the long-term planning of Australian communities and ensure a timely and efficient stock of housing and associated infrastructure.

 

  • Infrastructure investment to accompany long-term housing policy objectives

 

The development of new housing on a large scale basis requires commensurate infrastructure investment to ensure new development is economically viable and connected to existing settlement. As previously noted in recommendation (i), transport and infrastructure investment are critical to the success of new settlement. Without these foundations our cities will become more disconnected and we will forgo valuable economic opportunities.

 

Without substantial investment in transport infrastructure we risk several problems:

 

  • Overcrowding

When larger populations are forced to use insufficient transport infrastructure it will add to transport times, increase repair costs and diminish living standards.

 

  • Limiting economic opportunity.

Without fast and reliable transport infrastructure we limit individual’s ability to make reasonable commutes to and from work.

The federal government must take appropriate steps to ensure there is a continuum of new transport infrastructure and expansions of existing infrastructure concurrent with housing development. In line with recommendation (i), the federal government should devise infrastructure packages in consultation with state government so that infrastructure projects are targeted to where they are needed most.

 

  • Regional decentralisation & high speed rail

The absence of a long-term infrastructure policy in the past has contributed to Australia’s profound settlement imbalance between the city and country. Our cities have incrementally expanded for generations, building on existing settlement and increasing urban sprawl. This piece-by-piece development has led to costly congestion, inefficient transport systems and has acted as a drag on sustainable growth.

It is evident that the federal government should make a concerted effort to rebalance our settlement and encourage growth in our vital regional communities. This can be achieved through the creation of high speed rail to link our major capital cities. Such a project would enable regional community’s access to existing settlements, and therefore make regional living a more viable option for many who currently live in cities.

This policy would also enable the construction of new regional settlements along the train line. The growing population pressures faced by major capital cities are contributing to over-crowding and at a substantial cost to revenues. It is evident there needs to be a more structured and innovative approach to dealing with our growing population. Encouraging new settlements along the high-speed rail network will enable these growing populations to take advantage of low-cost housing (see below) and better planning and development. New settlements are not encumbered by poor patchwork infrastructure developments and can utilise the un-developed spaces to create a more efficient and cost-effective settlement. Partnered with business and commercial interests that can deliver new housing and other services, high speed rail has the potential to develop new regional communities and encourage strong new settlement.

One of the main advantages of this policy is that it can alleviate pressures on capital city housing markets by taking advantage of the low cost of land in regional areas. The median house price in regional NSW sits at $440,000[8] – substantially cheaper than the Sydney median price of $1.077million. This attractive housing opportunity – in conjunction with smaller commute times and greater economic opportunity – will incentivise settlement in our regional centres. In turn, demand for housing in capital cities stems as people migrate to our regional areas. Thus settlement rebalance has powerful potential to assist in the stabilisation of the housing market.

[1] http://www.smh.com.au/comment/how-can-australian-households-get-away-with-the-biggest-debts-in-the-world-20160922-grlsoc.html

[2] http://www.smh.com.au/business/the-economy/investor-home-loans-the-fly-in-the-ointment-for-rba-board-as-weak-economy-points-to-rate-cut-20170205-gu5sq2.html

[3] Chung, “Sydney housing world’s second most unaffordable” News, January 2017 http://www.news.com.au/finance/real-estate/buying/sydney-housing-worlds-second-most-unaffordable/news-story/c721c685e1ef2d616c3c89cb3009496f

[4] QBE, “Australia Housing Outlook 2016-2019” Oct 2016, 7 https://www.qbe.com.au/campaigns/housing-outlook

[5] Wilson, Andrew “House prices surge but booms to fade” Domain, Jan 26 2017, https://www.domain.com.au/news/house-prices-surge-but-booms-to-fade/

[6] QBE “Australia Housing Outlook 2016-2019” Oct 2016, 7 https://www.qbe.com.au/campaigns/housing-outlook

 

[7]Australian Bureau of Statistics, “Population projections, Australia 2012 (base) to 2101” November 26th 2013 http://www.abs.gov.au/ausstats/abs@.nsf/mf/3222.0

[8] https://www.domain.com.au/news/forget-sydney-investors-have-their-eye-on-a-new-booming-hotspot-in-nsw-20161108-gsl0fb/