On an inflation and quality-adjusted basis, house prices in Australia have increased by around 2-3% per annum since 1970. This is enough to yield a doubling in real house prices every 30 years or so, underpinning a long-term decline in housing affordability and the homeownership rate.
Far from being an asset price 'bubble,' this increase in real house prices is well explained by economic fundamentals. A major influence has been the decline in global real interest rates since the early 1980s. Australia's real mortgage interest rates have also declined, from around 10% in 1990 to around 3% today. This long-term decline has boosted asset values and, together with increased competition in housing finance, the borrowing capacity of households.
Unless global real interest rates rise significantly in the future, the gains in house prices associated with this long-term decline in real interest rates are unlikely to be unwound.
Income and population growth are the other main drivers of housing demand. While these growth rates are subject to considerably short-run variability, they represent permanent changes to the overall level of demand.
Demand suppression policies are thus unlikely to improve long-run housing affordability. The central bank has little influence over real interest rates in the long-run. Tightening accessibility to housing finance might be justified on financial stability grounds, but won't change the overall demand and supply balance in housing markets when only 37% of Australian households are owner-occupiers with a mortgage. Suppressing income and population growth or immigration in the name of housing affordability would be a perverse public policy response.
An unfortunate and increasingly common response to rising house prices has been to scapegoat some buyers, such as domestic and foreign investors. But they are no more responsible for rising house prices than the typical first homebuyer.
The problem is not too much demand, but too little supply to prevent upward pressure on house prices.
In most markets, rising prices would induce new supply, containing or even lowering prices in the long-run. Unfortunately, the supply of new land and new homes in Australia is largely determined by regulation, preventing housing supply from responding quickly enough to rising prices.
Dr Stephen Kirchner is a research fellow at The Centre for Independent Studies, and author of Eight Housing Affordability Myths, released this week.