The housing affordability crisis in Sydney and Melbourne is close to the worst in the developed world. As of 2017, the ratio of median house prices to median household income in Sydney was 12.9 and in Melbourne 9.9. Only Vancouver and Hong Kong were as bad or worse on this metric.

The result is an intergenerational divide in which the young people have diminishing prospects of attaining the housing their parents’ generation enjoy. Property owners are feasting on extraordinary capital gains at the expense of the young residents of Sydney and Melbourne, most of whom cannot even get a foothold on the property ladder.

In Sydney, the share of households headed by 30-34 year olds who were renting jumped from 48 per cent in 2011 to 53 per cent in 2016. In Melbourne the increase in this share over the same years was from 43 per cent to 48 per cent.

It was not supposed to be this way. Following the end of the resources investment boom in 2012, Australia’s political and economic elites (including the Reserve Bank) devised a transitional strategy to sustain Australia’s economic growth. It was to drive economic activity by promoting city building and housing construction. One part of this strategy was to maintain high immigration levels.

Though the immigration commitment would add to the demand for housing in the already overheated housing markets of Sydney and Melbourne, these elites believed that their parallel policies to promote housing supply would prevent further price escalation. They expected that the drop in interest rates, the maintenance of incentives to investors (including negative gearing) and the reassurance of strong migrant driven demand would prompt a vigorous supply response.

It is all gone horribly wrong. Instead of the expected boost to new housing construction, the great majority of the huge increase in mortgage debt held by Australia’s banks since 2012 has gone into established houses purchased by investors and upgrading owner occupiers.

Investors and upgrading owner-occupiers have been bidding in this market in a context where the number of available detached houses in each city is actually contracting each year. This is a result of the large baby boomer cohort (born between 1950 and 1965) which is replacing a much smaller cohort of households born before 1950. Few realise the significance of this ageing effect. The result is that the number of available detached houses in Sydney and Melbourne is contracting by about 15,000 a year. By 2016 some 56 per cent of all separate houses in Sydney were occupied by households aged 50 plus and 53 per cent in Melbourne.

In addition net overseas migration is adding some 19,000 to 20,000 migrant households each year to both Sydney and Melbourne’s population. This is equivalent to around 64 per cent of the annual overall growth of households in Sydney and 54 per cent in Melbourne’s.

Not surprisingly, housing prices in Sydney and Melbourne have escalated to the level described above.

What to do?

The answer, according to the federal and state governments and most planners and commentators is to reinvigorate supply incentives. They propose to do so by eradicating most of the remaining restrictions on medium density housing in established suburbia.

All ignore the demand side of the problem, including the immigration component.

In Sydney, the Greater Sydney Commission (GSC) is setting the pace. It is requiring all municipal councils to prepare plans for additional medium-density dwellings. Meanwhile the NSW State government has implemented a new medium-density planning code which will allow developers to put more than two dwellings on each detached housing site that they can procure.

This initiative has received the backing of the Grattan Institute and the Reserve Bank. Both want to see it implemented in Melbourne as well. They assert that the result will be an increased supply of family friendly units and town houses which will meet the needs of households unable to afford detached houses.

Will the zoning initiative work?

It is unlikely to work. It has already failed twice. On the first occasion, in both cities, large tracts of land in the inner city and around activity centres were rezoned for high-rise apartment blocks. Huge numbers have been constructed, yet prices for detached housing continue to rise in both cities. The reason is that most new households (including migrants) want family friendly housing. Apartments are unsuitable. Our analysis of occupants of high-rise apartments shows that barely four per cent of these apartments in inner Sydney and Melbourne as of 2016 were occupied by couples or singles with children.

The second failure concerned zoning changes introduced by the 1990s in both cities. These allowed two dwellings to be built, as of right, on most suburban housing sites. However despite this zoning initiative, relatively few such dwellings have been constructed.

Why? The answer is increasing site costs – due to the escalating price of detached houses in both cities. Developers cannot put two family friendly dwellings on most inner and middle suburban house sites in Sydney and Melbourne for less than $1 million per dwelling. The result is that the relatively limited output, especially in Sydney, is focussed upmarket product.

The proposals to abolish remaining zoning constraints represent the last throw of dice for supply-side advocates. However, they will have a limited impact, for much the same reason that the first zoning initiative largely failed. The new initiative will add further pressure to site costs because developers will now have to pay even higher prices for detached houses. This is because of the extra value of the site now that more than two dwellings can be constructed on it.

In Sydney, the GSC seems to be acknowledging the limits of its zoning strategy. It is proposing that the city be extended to new growth areas around Penrith to the north-west and Campbelltown to the west, both of which are some 51 kilometres from the Sydney CBD.

There are other proposed solutions with more merit, including government assistance for the construction of affordable rental dwellings.

The problem with the social housing initiative is that it is unlikely to generate more than a fraction of the annual number of new dwellings needed each year to cope with projected housing needs in Sydney and Melbourne.

A reduction in the demand side of the equation offers the best solution. This should come in part from a reduction in the negative gearing and capital gains incentives to investors and owner-occupiers. It will also require a contraction in the net overseas migration influx to Sydney and Melbourne.

Bob Birrell and Ernest Healy are with The Australian Population Research Institute. The full report, entitled, Immigration and Housing Affordability in Sydney and Melbourne is available at http://tapri.org.au/wp-content/uploads/2016/04/immigration-and-housing-affordability-crisis-july-2018.pdf

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