Housing costs account for much of Australia’s cost-of-living crisis, and affordability will not improve unless governments increase housing supply where people need to live, including through greater urban density.
The cost of living is by far today’s number one political issue. However, housing affordability is also important, and the two issues are closely related.
Nationally, more than a quarter (26 per cent) of Australian households spend over 30 per cent of their disposable income on housing, placing them in financial stress. Mortgage holders are the most affected, with nearly 45 per cent spending more than the 30 per cent of their disposable income to cover their housing costs. While about 28 per cent of renting households are above the 30 per cent stress threshold.
Furthermore, mortgagees and renters together account for around two thirds of all households, or about a third each, and that is why more than a quarter of all households are experiencing housing stress.
Thus, if we are worried about the cost of living, by far the most important issue to confront is the cost of housing.
The fundamental problem is not the recent rise in interest rates. It is that housing prices have risen much faster than incomes, especially in the last two decades or so.
According to research by the Grattan Institute, average dwelling prices represented around 2-3 times average disposable incomes in the 1980s and early-1990s. By comparison, today the national median dwelling price is approximately 8.2 times the median, or typical, annual income. While in Sydney – one of the most unaffordable housing markets globally – the median house price-to-income ratio is 13.8.
The conclusion is therefore that if we want to bring down the cost of living we need to make housing more affordable and that means reducing the price of housing. But the best way to do that must be based on a consideration of why housing prices have risen so much faster than incomes.
Some commentators say that the cost of building housing has played a major role in increasing housing costs. However, as can be seen from Table 1 below, dwelling construction costs have always risen faster than consumer prices generally, but the difference is not that big, and certainly doesn’t explain the increase in dwelling prices relative to incomes. Indeed, the rate of inflation in construction costs has been less in the last 19 years that in the previous 20 years, but it is only in the latter period that housing has become unaffordable.
Table 1 Dwelling construction compared to consumer price increases
Average annual percentage increase
| Dwelling Construction Costs | Consumer prices | |
| 1985-86 to 2005-06 | 4.9 | 3.5 |
| 2005-06 to 2024-25 | 3.5 | 2.6 |
Source: ABS National Accounts
An increase in interest rates will also make it more difficult to service a housing loan, but in the longer-term higher interest rates will tend to put downward pressure on housing prices. Furthermore, the reason why interest rates make it so much more difficult to service a loan these days, is not so much the increase in interest rates, but that fact that the loans are so much bigger relative to incomes.
Thus, if we want to make housing affordable again, we must reduce dwelling prices relative to incomes. That will inevitably take time, because unless productivity growth accelerates, incomes cannot increase any faster than in the past without unacceptable inflation.
So realistically the only way to restore housing affordability and reduce cost of living pressures is to substantially increase the supply of dwellings. In addition, that increase in dwelling supply must also be where people want to live and can readily access their work.
The political problem is that the existing population in these inner and middle suburbs, however, are most reluctant to agree to increasing the population density of these suburbs. These NIMBYs argue that their quality of life will be spoiled by additional dwellings and population, but another key factor is the impact on their wealth.
Housing accounts for around half of Australian household wealth, and because of the relatively rapid rise in house prices relative to incomes, household wealth has increased much faster than incomes. In addition, the distribution of this wealth is much more unequal than the distribution of household incomes.
As Saul Eslake pointed out in a recent P&I article, housing used to be thought of as something necessary to meet the basic human need for shelter. All governments wanted people to be homeowners, because as Menzies put it “the home is the foundation of sanity and sobriety” and the health of the home “determines the health of society as a whole”.
Today, however, housing has become the principal way in which a majority of the population accumulate their wealth, and many people therefore welcome an increase in dwelling prices and certainly don’t want them to fall.
Indeed, much of the criticism of the recent budget changes to the capital gains tax and negative gearing came from those who feared that it would lead to lower house prices and thus their wealth. The fact that that wealth was effectively being concessionally taxed was never acknowledged.
Anyway, these tax changes will not make much difference to dwelling prices. Certainly, the recent small drop in dwelling prices since the budget in Sydney and Melbourne is much more likely to be due to the increase in interest rates rather than a shift by property investors to other non-housing investments.
Since it was elected the Albanese Government has worked closely with the states and have agreed to a target of 1.2 million new homes from mid-2024. Measures taken to support delivery of this target include:
- Assisting in the financing of local infrastructure to enable the development of more homes where they are needed, with $6.2 billion spent since the Government was elected. A further $5.9 billion is still available.
- This money is also meant to act as an incentive to the states and local governments to make the necessary approvals to increase housing density and make them more quickly and cheaply.
The problem, however, is that the government is likely to fall well short of meeting its target for 1.2 million new homes, in which case housing affordability will continue to be a major problem.
The state governments of NSW and Victoria have grasped the policy nettle and have sought to over-rule local opposition to increasing housing density in our two largest cities – Sydney and Melbourne. In Sydney, for example, the state government is pressing for major increases in population density around transport hubs, and that makes a lot of sense.
But if we really want to solve the housing affordability issue and reduce the cost of living, governments must accelerate these changes to density. The present opposition from the “haves” to increasing the density of our cities will therefore have to be overcome.
That will, however, only happen when governments get much more on the front foot and make the case publicly why these problems will never be resolved until we accept that housing density must increase in our major cities. After all, the population density of Toronto in Canada is significantly higher than the population density of Sydney, but the quality of life in both cities is much the same.
Finally, the opposition parties should be challenged to say where they stand on these issues. They cannot continue to complain about the cost of living, while slowing down the only way to make a significant difference by increasing population density to make housing more affordable.
Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet, Finance and Employment, and Industrial Relations. He is presently a visiting fellow at the Australian National University.