Why first home buyers are not buying, and ways to solve it.

The latest ABS data has indicated the percentage of first homebuyers active in the market has once again fallen, from 14.7% in July, to 13.7% in August.

Subsequently we’ve been bombarded with commentary asking why this should be so in a low interest rate atmosphere, where, there are ‘plenty’ of acquisitions available for sub $300,000?

Not withstanding, whilst 10 years ago $200,000-$300,000 would have secured a modest home in reasonably facilitated suburb, today – due to woeful supply side policy – you’d struggle to find family size accommodation on the fringes of our major cities for the same expense.

First home buyers will always wax and wane to some extent, based on their perception of value and ability to save over and above items of affordability alone.

And whilst a lower percentage entering the market can in part be attributed to lifestyle factors such as labour mobility, getting married later in life, numbers falling under the radar on loan applications, and the shadow effects of various grants and incentives being introduced and subsequently scaled back, thereby producing a demographic shift in the timing and age at which buyers enter the market, there are other factors at play which clearly point towards pressures of affordability.

For example just from the last census alone, we can see the percentage of 1 person households has decreased for the first time in over 100 years from 24.4%-24.3% - whilst at the same time group households have jumped from 3.9%-4.1% and crowded houses with 3 or more families have risen nationally by 64% to 48,499.

A closer look at exactly what it costs to rent a modest apartment within commutable proximity to our capital cities gives some indication why this should be so.

For example, in Melbourne - (which currently has one of the highest vacancy rates of any capital – 2.7% (SQM) for the month of September) - if you’re halfway fussy, requiring good proximity to transport, a modest balcony, or internal floor space over 40sqm, you’ll be hard pushed to get a 1 bedroom apartment in original condition under $320-$350 per week.

In Sydney, the equivalent will cost between $450 and $500 per week – therefore it makes sense to share expenses, and this is certainly the case with renters I’m in contact with.

An argument consistently put forward when discussing the first home buyer demographic, is the idea that many want to rent, rather than buy – and it’s certainly one I have sympathy with, whether that be for lifestyle, affordability, or work purposes.

However when two people meet, and plan a family, there is a natural desire to ‘settle.’ And in the absence of long-term lease and rent controls, most would preference purchasing over renting.

Therefore, a drop in ownership for this demographic, falling 79.5%-77.2%, coupled with increasing numbers becoming long-term renters, is concerning.

The Grattan report, released early last week, clearly demonstrated how tax policy is disproportionally weighted toward the owner/investor at the expense of the renter.

Indeed, so imbedded is it in the Australian culture that home ownership is the key to financial freedom, there is an un-witting air of sympathy when we refer to ‘generation rent.’

As for the first home buyer – assuming their initial property is not going to be their last, it would be more apt to term the demographic ‘first time investor’ with the need to purchase a ‘growth’ generating asset in an area with enough projected consistent buyer demand, to ensure equity to ‘tap’ into, when time comes to upgrade.

Notwithstanding, the investment potential of their purchase is always an initial question from homebuyers I assist.  And to get on what’s the commonly termed the ‘property ladder’ today, is markedly different from the post war environment baby boomers were born into.

Much of the newer accommodation being constructed is generally not attractive to consumers - being high-density, low-grade apartment blocks for which first homebuyers can have difficulty obtaining finance.

And whilst it’s not impossible for those who have saved a deposit to enter the established market - the stronger financial arm of the investment sector competing for a similar pool of dwellings around the suburban median price bracket, can present a significant challenge.

Urban boundaries and the propensity to towards land banking, hefty tax overlays and poor infrastructure development, has ensured land on the outskirts is already artificially inflated, rather than representing a cost that would assist purchasers to compensate for the expense of commuting greater distances to work related services.

The residents who purchased in Melbourne’s Point Cook for example, which was expanded in line with the 2030 plan and initially marketed as “A thriving neighbourhood … just 22km from Melbourne’s CBD” with “convenient access to established schools, shopping, recreational facilities and public transport” have seen their home values fall, battled with overcrowded roads, and a minimum 2 hour commute to the CBD in peak hour traffic.

So whilst it’s easy to accuse first home buyers of being picky, one could just as easily ask why they should they forgo a hard earned deposit to accept what’s currently on offer, or exceed the budget to outbid competition for a limited number of established dwellings?

First homebuyers are not a ‘buy anything as long as it’s cheap’ consumer – although some mistakenly assume they should be if they want to get into the housing market.  

And whilst commentators use low interest rates to support the argument that housing affordability has improved, it is important to understand that housing affordability and the cost of servicing a mortgage are two separate entities.

Mortgage rates are set up with different structures dependant on circumstance, and subject to interest rate changes influenced by the macro environment.

To take out a 25 year mortgage requires the expectation of secure employment in a terrain where frequent job changes or part time work are becoming a norm.

They may influence house prices through a cycle, but they do not take away the fact that home prices now – even with lower lending rates – require longer terms to pay down, with the interest over the duration of that period adding considerably to the capital cost.

So what can be done?

As recorded by APM, Sydney’s median house price has increased by +4.2% over the September quarter to $722,718 – ‘the first capital to reach this milestone,’ whilst, the unit median has pushed past the half million landmark to $510,000.

The current rental yield for a unit would be around 4%, therefore most new investors would be negatively geared and speculating on capital growth accrued during the period of ownership plus another like minded investor paying more at the end of that duration, to make the strategy productive.

Yet, despite this robust activity from the investment sector making up around 50% of the buying market, Sydney’s vacancy rate recorded the largest monthly decline in September of any capital - now at 1.8% (SQM).

This is because, the concentration of investment is focused overwhelmingly on the established sector through policies such as negative gearing coupled with 1999 decision to tax capital gains at half the rate applicable to other income. Since implementation, supply has not increased; rather investor activity around a limited pool of second-hand dwellings has multiplied. (see next graph)

Needless to say, common sense dictates that maximisation of policy initiatives to increase supply cannot occur if we don’t address this mindset.

As I touched on last week, prior to negative gearing being quarantined in 1986 – rents were already rapidly rising in Sydney and Perth, with vacancy rates below 1%.

Therefore, it is not clear whether subsequent rises were wholly due to the tax changes.  It is also not clear that a continual sharp increase in rents would have been worst had the policy backflip not occurred.

However, without effective supply side initiatives to offset the inflationary elements investment in established property has produced, the market is simply a game of musical chairs - replacing a property for sale with a property for let.

Solution

I’ve said on many occasions that the challenge of creating a balanced, affordable, attractive market for homebuyer, investor and renter alike cannot be tackled on one front.

There are many distortions that need to be slowly unpicked, whilst robust activity to lower land values and increase supply implemented.

As it stands, considering the number of investors who rely on negative gearing as a tax/investment strategy, we’ve arguably painted ourselves into a corner.

I am a full agreement that negative gearing is a failed policy however; I would hesitate in abolishing it in one foul swoop for the following reasons.

Whilst here is little evidence to suggest there’d be an investor exodus, there’s also scant evidence that first homebuyers would be in a position to immediately soak up any additional stock at current prices – bearing in mind negatively geared investments are most suited to this demographic (being smallish 1/2 bedroom apartments.)

The average first homebuyer borrows around $280,000-$300,000 – therefore we’d need to see more than a light correction in values to provide a competitive entry point – not to mention the difficulties most have saving a deposit

Furthermore, even if established supply were to increase with projected lower demand from investors, to see substantial drops in values assumes vendor’s being forced to sell at a loss.

As evidenced in some of our previous downward cycles (most recently during 2011 to 2012) markets can stagnate rather than truly ‘correct’ with many buyers taking a back seat expecting further falls.

However, a gradual deployment of speculation away from established dwellings, with incentives to investors to purchase new over old, coupled with assistance to potential home buyers to either save, or enter into shared equity schemes, would be a start to meeting any increased supply with new home buyer demand.

The policy could be gradually phased out by limiting it to a fixed number of investments  - 2 for example – or taking the suggestion made by the Henry Tax review of tightening current arrangements with a lesser 40% of interest allowed as a deduction, and capital gains taxed at the slightly higher rate of 60%

This at least would be a starting point toward a fairer market

Additionally, dramatically increasing supply of new ‘quality’ accommodation with some reserved for low-income workers must take priority, as well as a structured plan to increase infrastructure through the consideration of bond financing for example

Over the 17 years to 2012 negative gearing cost Australian tax payers around $33.5 billion (inflation adjusted for the period estimated.)  Considering we have an ageing population requiring increased spending on healthcare and other related services, coupled with a widely spruiked shortage of housing and, as Tim Toohey pointed out in a recent Goldman Sachs publication, forecast income growth of 3.5% in 2013-14 compared to an average of 15.5% over the last 15 years, it’s hard not to see better ways to manage the budget.

Indeed – any politician with more than a short-term mindset – would be blinkered to imagine we can continue with the current status quo for ever.

Additionally, an overhaul of policy surrounding tenancies is also necessary. However, that’s for another column.

Catherine Cashmore