On Saturday evening, we were enjoying lively conversation with other parents at our 18 year old’s Year 12 graduation dinner when talk turned to the inevitable topic of Sydney house prices.
“I am a very conservative investor” shared the gentleman next to me. “So I only invest in property. After all, with Sydney’s population growth, and the persistent housing shortage, house prices can only go up”.
Heads nodded around the table.
It is a popular view. But is it right? Is there a direct link between population growth, dwelling supply and housing prices?
The nature of housing markets
Let’s start by looking at the dynamics of the housing market. Many people regard property as a conservative investment, where prices are relatively stable. In contrast, most are more concerned about losing money in the share market.
In short, they regard the housing market – compared with the share market – as being far less prone to bubbles.
Yet, according to The Economist, many economists take the opposite view. They argue instead that bubbles are more – not less – likely to develop in housing markets than in share markets.
“Property markets, both residential and commercial, are inefficient. They are illiquid, trading is infrequent, assets are heterogeneous (both by location and by type), transaction costs are high, and information is imperfect because there is no central exchange”.
The Economist concludes that it is these market imperfections which make property bubbles more likely not less. Property markets, it argues, are subject to boom-bust cycles.
And the same view is found in the data from Australia’s recorded house price history.
Philip Soos of Deakin University has analysed data reaching back more than 130 years from 1880 to 2010. He has found that in that time there were nine major increases in prices – and then, in eight of the nine, there were significant declines. The only exception is a small three year window from 1961 to 1964 where prices stagnated.
|1||31.7 (1887 – 1891)||-31.5 (1891 – 1898)||Yes|
|2||20.5 (1920 – 1929)||-18.2 (1929 – 1931)||Yes|
|3||111.6 (1949-1950)||-25.5 (1950 – 1953)||Yes|
|4||21.4 (1953 – 1960)||-12.7 (1960 – 1961)||Yes|
|5||22.9 (1961 – 1964)||NA (1964 – 1967)||No|
|6||39.8 (1967 – 1974)||-16.0 (1974 – 1979)||Yes|
|7||9.7 (1979 – 1981)||-10.2 (1981 – 1983)||Yes|
|8||7.4 (1983 – 1985)||-5.4 (1985 – 1987)||Yes|
|9||39.0 (1987 – 1989)||-8.6 (1989 – 1992)||Yes|
|10||127.1 (1996 – 2010)||?||?|
It is hard to believe, argues Soos, as we face the largest increase in housing prices in Australian history – that we will not have a significant downturn.
But what about the impact of population growth?
Our dinner companion, like many bubble-dissenters, acknowledged the historic data. However, he argued that this time is different.
A downturn won’t happen this time around thanks to housing undersupply and increasing population growth.
The argument goes something like this. As Australia is facing a shortage of properties to meet the needs of a growing population, demand is greater than supply, and therefore housing prices must continue to rise.
If this argument is correct, argues Philip Soos, then we should be able to align historic annual population growth rates with housing price rises.
Yet in 1996, when house prices started to rise, and in 2001 when they began to skyrocket, annual population growth was a mere 1%. It was not until 2007 that it rose to around 2% – and this was also the first time since 1950 that the population increased faster than the number of dwellings.
If the housing shortage argument was correct, housing prices should have only started to rise around 2007 – not 11 years earlier. Soos concludes that “the historic data shows there is no correlation, let alone causation, between population growth, dwelling supply and housing prices”.
His view is supported by recent economic studies that found that in the long run, demographics have a relatively modest effect on house prices.
The Economist cites a widely noted study from the late 1980s that predicted that the ageing of America’s population would cause real house prices to fall by 47% over the following 20 years because older people tend to downsize to smaller, less expensive homes.
“In the end, demand for housing did not fall, and neither did prices. But even if the demand for housing were to decline, supply would eventually shrink too, because in the long run the nationwide supply of housing is almost perfectly elastic.”
The Economist concludes that this is why the popular claim that rapid population growth will result in ever-rising house prices is nonsense.