Debunking the Australian Housing Shortage

The argument that Australia is experiencing a chronic housing shortage has been used consistently by mainstream Australian economists, the property industry, and the government to justify Australia’s high house prices and to counter claims that we are experiencing a house price bubble. According to this argument, house prices will continue to be pushed higher in Australia by the growing gap between supply and demand as a result of a rapidly growing population.

Australia’s housing situation is also said to be in direct contrast to the experience of the United States, which many observers characterise as having been subject to significant overbuilding during their recent housing boom, and whose house prices have fallen over 30% since the end of 2006 (see chart 1).

Take, for example, the following press release from the Australian Housing Industry Association (HIA) on 18 March 2010, which discusses the findings of its Housing to 2010 report:

“The report finds that if current building trends persist, then Australia’s cumulated housing shortage would reach 466,000 dwellings by 2020…Housing to 2020, which focuses on future housing demand and the number of dwellings required in meeting this demand, highlights a current housing shortage that already numbers 109,000 dwellings”.

And what will be the impact of such a shortage? The HIA press release goes on to say:

“If we don’t get a comprehensive supply response to the accumulated housing shortage then the lack of affordable and appropriately located rental properties will only increase…”

The HIA’s report was followed in April 2010 with the release of the Government’s Housing Supply Council State of Supply Report 2010, which makes similar predictions of a chronic housing shortage in Australia. Some of the key findings of this report are:

• There was an estimate cumulative shortage of dwellings of 178,000 in June 2009; 
• Over the five years to 2014, the overall shortage is projected to grow to 308,000 dwellings;
• By 2029, the shortage is projected to reach around 640,000 dwellings; and
• The lack of affordable housing in Australia is the “direct result of the ways in which housing supply shortages play out in the market”.

So there you have it, Australia is apparently not building enough houses and, as many commentators claim, this so called housing shortage will continue to put upward pressure on house prices and prevent Australia from experiencing the same house price deflation undergone in the United States and elsewhere.

The housing shortage claim is not supported by evidence 

So if Australia was experiencing a chronic housing shortage, then you would expect the number of people per household to have been increasing sharply, since there are not enough houses to go around and people are forced into share accommodation. Well let’s look at the Australian Bureau of Statistics (ABS) data on average persons per dwelling (Chart 2):

Doh! According to the ABS, the average number of people per dwelling has fallen significantly, while dwelling size, as measured by the average number of rooms per dwelling, has been increasing.

In fact, the number of people per dwelling in Australia has fallen steadily for the past 50 years, from 3.6 in 1960, 2.75 in 1990, 2.62 in 2000, and 2.56 in 2008. So the growth in the number of dwellings has actually outstripped the increase in the population and, therefore, the average number of occupants per dwelling has fallen considerably. Only in the past year or so has the rate of new building fallen behind population growth, as evidenced by a small increase in people per dwelling in 2008.

What if we, instead, examine the rate of population growth versus new dwelling construction? Well Steve Keen, Associate Professor of Economics and Finance at the University of Western Sydney, has done so (click here). Professor Keen found that:

“Over the period 1985 to 2009, an average of one residential dwelling was built per 1.75 new Australians…This build rate is well in excess of the current ABS ratio of 2.55 persons per occupied dwelling”.

Australia’s housing utilisation is below the United States!

Chart 3 compares the average number of people per household in Australia against that of the United States, Canada, and England. All information has been sourced from the relevant government statistical bureaus using data for 2006, which is the latest available international data and just happens to be the period immediately prior to the recent global house price crash.

So in 2006, at the height of the US Housing Bubble, Australia’s housing utilisation level, as measured by the number of people per dwelling, was well below that of the United States (and roughly equivalent to Canada). This data suggests that the housing shortage in the United States was actually more acute than in Australia!

Why then is there universal agreement that there has been significant overbuilding in the United States, resulting in a large quantity of homes now sitting vacant?

Interestingly, the common consensus prior to the onset of the Global Financial Crisis (GFC) was that the United States was experiencing an acute housing shortage, similar to the claimed shortage currently being experienced in Australia. Consider, for example, the following article on the California housing crisis, written in February 2006 just as prices in Southern California peaked. Prices have since fallen around 40%:

"The California Building Industry Association (CBIA) continues to express alarm over what it calls an ongoing housing crisis in Southern California. Alan Nevin, the association’s chief economist, projected in a 2006 CBIA Housing Forecast that only 185,000 to 205,000 building permits will be granted this year, far short of the 240,000 new homes needed each year.”

"Southern California has been experiencing a massive population boom in recent years and it's believed that 6 million new residents will be living in the region by 2020. The population increase, coupled with the housing shortage, has the CBIA worried that it will be increasingly difficult for first-time homebuyers to find a moderately priced unit."

Sound familiar? Read the article for yourself here.

So how can an acute housing shortage in the United States suddenly turn into a massive oversupply? The answer lies in the way economists measure housing demand.

Demand ain’t what it used to be
 
‘Underlying demand’ is the common methodology used in calculating whether there is a housing shortage. Put simply, underlying demand estimates what the demand for newly-built housing might be given the growth in population, trends in household size, demand for second (or holiday) homes, and economic conditions (e.g. employment, interest rates, etc). Underlying demand differs from ‘effective (actual) demand’, which is the quantity that owner-occupiers, investors and renters are actually able and willing to buy or rent in the housing market.

Underlying demand is an inherently flawed concept, since it is calculated by extrapolating earlier trends (i.e. reductions) in household size, and ignores the impact of higher housing prices on housing demand. Take, for example, the Housing Supply Council’s approach to measuring the level of housing shortage in its State of Supply report, which “implicitly assumes that household formation decisions are taken without regard to housing market conditions”. Yet, as house prices rise to unaffordable levels - as they have in Australia - you would naturally expect the number of people per house to increase as children stay at home longer and those living in shared accommodation rises. Put simply, while high house prices decreases effective (actual) demand, it does not affect the level of underlying demand.

Equally, general economic conditions can dramatically affect the level of housing demanded. For instance, as a country’s economy deteriorates, and unemployment rises, the number of people per dwelling will rise as they group together to reduce their housing costs. This most likely explains the current situation in the United States. Despite supposedly experiencing an acute housing shortage prior to the onset of the GFC (measured using underlying demand), there is now a large oversupply of housing brought about by a deep recession.

Vacant homes everywhere

The final nail in the coffin of the housing shortage argument lies in the number of vacant houses identified in the last two Australian Censuses. As shown in Chart 4, between 6 per cent and 8 per cent of homes in capital cities were identified as vacant on Census night in 2001 and 2006. To put this into context, the overall number of capital city vacant homes in 2006 (387,000) is equivalent to around 2½ years of total Australian housing supply (around 150,000 new dwellings per year)!

The reason behind this massive supply of vacant homes is unknown. However, it might be the case that because rental returns are so low (with net rental yields of around 2 ½ per cent), owners would rather keep their houses vacant and ‘collect’ the capital gain rather than deal with the drawbacks from renting, including potential property damage, having to deal with tenants, etc.

The risk is that if the expectation of future capital growth disappears, or there is a significant fall in house prices, then many owners that have kept their homes vacant might put these on the market, leading to a sudden oversupply of housing.

‘Undersupply’ is not a bullish indicator for the Australian housing market

The bottom line is that the argument that the housing shortage in Australia will continue to drive Australian house prices higher and prevent the kinds of house price falls experienced overseas is not credible. The economic reality is that the demand for housing is changeable depending, largely, on the prevailing economic conditions. A significant deterioration of the Australian economy is likely to significantly reduce the level of housing demanded and cause the number of persons per dwelling to rise as Australians group together in order to reduce their housing costs. When coupled with a potential flood of vacant properties onto the market as house prices begin to fall, then the perceived shortage of houses in Australia could easily turn into an oversupply, just as it has in the United States.