Home ownership has become increasingly unaffordable because land prices have increased so much under population pressure. The only way to restore affordable housing is to increase urban density.
The cost of housing is by far the main source of cost-of-living pressure, at least for the two-thirds of households who have a mortgage or who rent.
Median house prices have risen from about four times median incomes at the beginning of this century to around 8.5 times today, and around 10 times in Sydney. Although house prices have recently started to fall in Sydney and Melbourne, nationally house prices are up by around 55 per cent since 2020.
Mortgages are therefore now much bigger, and interest rates on home loans have also doubled compared to the first two decades of this century. As a result, around half of all mortgage holders are now spending more than 30 per cent of their disposable income to cover their housing costs – a sure sign of housing stress.
Home ownership rates have therefore fallen among all ages, but especially among young people, with the latest available census data showing that the home ownership rate for 25–34-year-olds fell from more than 62 per cent in 1981 to 44 per cent in 2021 and is almost certainly even lower today.
How best to reduce housing costs
Obviously we need to bring down the cost of housing to make it more affordable. How best to do that, however, depends upon an analysis of why the cost of housing has risen so much relative to incomes.
As can be seen from the table below, median dwelling prices increased much faster than construction costs, especially in the first two decades of this century, when dwelling prices increased more than twice as fast as construction costs. Construction costs also rose more slowly than incomes most of the time, and construction costs are therefore not a reason why housing has become less affordable.
Comparison of dwelling construction costs, dwelling prices and disposable income
Percentage change
| Dwelling construction costs | Median dwelling prices | Disposable income per capita | |
| 1980 – 2000 | 202 | 350 | 337 |
| 2000 – 2020 | 94 | 250 | 166 |
| 2020 – 2025 | 36 | 50 | 32 |
In addition, while homes are slightly larger over the last 20 years, the increase in floor space only represents an increase of 1.4 per cent. So that too does not explain the increasing cost of housing relative to incomes.
Furthermore, relatively more people now own an apartment, which is smaller and costs less, as the solution to their housing problem. So that reduces the average cost of construction per dwelling.
In short, construction costs and changing dwelling sizes do not explain why housing prices have risen so much faster than incomes over the last 45 years or more. Instead, it must therefore be the increasing value of land in our cities, as an increasing number of people compete for dwelling space, that accounts for the fact that the cost of housing has risen so much faster than incomes, and to the point where for many young people home ownership has become unaffordable.
But better home affordability will require lower dwelling prices. Just stabilising dwelling prices and then relying on wage increases to catch up with dwelling prices would take far too long.
For example, if annual wage increases were limited to a non-inflationary 3 per cent and all we did was to freeze dwelling prices, then it would still take more than 20 years to get back to an affordable ratio where dwelling prices were only 4½ times annual incomes.
And the obvious way to reduce the cost of land per dwelling is to increase urban density in the inner and middle suburbs of our major cities by building upwards instead of more urban sprawl.
Indeed, Australian cities are remarkable for their low density relative to most other cities internationally. For example, the population density in Sydney is significantly higher than any other Australian city, but compared to Toronto – in most ways a very similar city and culture – Sydney’s density is about 45 per cent lower in the inner 15 km.
Furthermore, according to the Grattan Institute, “many people would prefer a townhouse, semi-detached dwelling, or apartment in an inner or middle suburb, rather than a house on the city fringe, if more of those housing options were available in our biggest cities”. Indeed, work by Infrastructure Victoria found that up to one in three Victorian households would trade house and land size to live in an established suburb in a medium-density home, if it was available at a more comparable price.
On the other hand, of course, many existing homeowners will oppose any change that reduces the value of their home. Indeed, the opposition has been quick to criticise the recent changes to the taxation of capital gains and negative gearing on the grounds that these changes are alleged to have lowered dwelling prices.
Realistically, however, a reduction in housing wealth should not be a problem. The prime purpose of a dwelling is to provide a home and a way of life, and that doesn’t change if the sale price of our home declines. And even if the owner decides to sell their dwelling, it is usually to buy another which will then be cheaper also.
In addition, first home buyers will then be less dependent on their parents for assistance, and the fact that they may inherit less should not matter at all.
Finally, one other objection to a rapid fall in house prices is that it will lead to some borrowers falling into negative equity in their own home, where they owe more on their housing loan than the value of their property.
However, according to the Reserve Bank governor, less than 1 per cent of Australian households are presently in negative equity despite the recent fall in house prices. Even if house prices fell by 20 per cent, the RBA modelling shows that only about 5 per cent of households would end up with negative equity.
It is also worth remembering that households who borrow more than 80 per cent of the value of their dwelling normally have to take out lenders mortgage insurance, which protects the lender and means that the borrower is not pursued for any missing funds. And most importantly, most borrowers do not need to sell immediately, in which case any negative equity has no immediate effect, and they may well return to positive equity before they need to change dwellings.
People’s quality of life is not dependent on the sale price of their home, but it is dependent on their ability to pay for that home, and that will only be improved by a fall in house prices.
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.