While inflation might be incredibly low, the same cannot be said for house prices. And despite record low interest rates, housing remains as unaffordable as ever.
One of the common complaints about inflation is that it doesn’t measure house prices – but this is not quite true. The consumer price index has since 1998 measured the price of dwelling purchases by owner-occupiers. Crucially though this measure does not include the cost of property.
The reason is that property is about assets and wealth, not consumption.
It also means that the dwelling prices measured in the inflation figures are much less likely to increase as do actual residential property prices:
This doesn’t make the inflation figures wrong – just that when we are talking about low inflation, that does not mean asset prices are also growing slowly.
In fact, as we have seen over the past decade, far from it.
Since 2010, overall inflation has grown 21%, while residential property prices have gone up 44% – well above that of wages and average earnings:
All of which is to say that, while we might be experiencing record low inflation, we are not experiencing slow housing price growth.
Thus it was rather odd that Christopher Joye in the Financial Review last week would suggest that “contrary to popular myth, there is no housing affordability crisis. Quite the opposite, in fact: housing has not been this affordable in a very long time”.
Joye is right to acknowledge the cheap interest (and government inducements) are allowing first home buyers to borrow and get into the market. But just because low interest rates are making it more attractive to put all your savings into the wealth accumulation of a house, it doesn’t mean it’s actually more affordable.
In reality, the cost of buying a house, and even then paying off a mortgage, remains higher than in the past – and much higher than 20 years ago when Gen Xers like me were first buying a home (let alone the Boomers 20 or 30 years before then).
The key is the comparison with household incomes.
Unfortunately, we don’t get a regular update of either the median or average household incomes, so we have to make do with a proxy.
A combination of average male earnings and half of women’s average earnings gives us an annual household income currently of $106,704. That actually lines up pretty well with the most recent estimates for the median household disposable income for a family with two adults and two children.
When we compare this measure of household income in each state with the median established house prices in the capital cities we see that in Sydney, for example, the median house price is now around 9.2 times the annual income of a median household – some 23% above the 7.5 level it was a decade ago:
In Melbourne, the ratio has gone from 4.6 times in 2002 to now 7.1.
Yes, the price of housing is somewhat more affordable than it was in 2018 in most states, but that really is not saying much.
While house prices are an important metric, what is also relevant is the size of the mortgage needed to be borrowed and the deposit hurdle.
In Sydney, for example, based on needing a 20% deposit we can estimate that the average deposit for buying a new or established home is $153,200 – some $55,000 more than a decade ago.
In 2002, the average deposit for a home in Sydney was the equivalent to around 11 months’ worth of a median household’s income; now it is around 17 and half months’ worth:
But interest rates are lower now!
That’s certainly true – but while interest rates have gone down, mortgages have gone up. That means the average home buyer in Sydney is now paying interest on a mortgage that is around $240,000 larger than it was a decade ago.
So despite interest rates falling, mortgage repayments over the past decade have essentially remained flat as a percentage of household income:
Now yes, the average mortgage repayment is currently a fair bit less onerous than it was when someone took out an average home loan back in 2010, when you were likely paying around 7% interest rather than 2.1% now.
But remember – you don’t keep paying that 7%.
Variable mortgage rates mean someone who took out a home loan in 2010 is now getting the same rates as someone who takes out a loan now, but their overall mortgage is still that $240,000 smaller.
So the real impact of lower interest rates massively assists those who did happen to borrow when rates were higher:
And this is the other side of the “cheap lending equals housing affordability” coin. For those taking out home loans now, this is pretty much as good as it is going to get. There really is not much lower for interest rates to go.
That means unlike those who took out a loan a decade ago, those taking out loans now cannot expect a reduction in mortgage repayments – and more likely they will go up (at least sometime in the next decade).
Housing is affordable?
Unless you have someone to help you pay your deposit, and have no problems with interest rates rising – nope.