The latest episode of Inside Business, screened Sunday on the ABC, contained an interesting interview with Rob Sindel, chief of publicly listed company, CSR (video extract above). In the interview, Mr Sindel questioned the commonly held view that Australia is suffering from a housing shortage. Below are the relevant extracts from the interview.
ALAN KOHLER: How does this situation that you’re seeing now compare with what you saw then?
ROB SINDEL: We seem to have dipped in construction whereas those, the dips then were much shorter. They were six or eight months then you could see your way through the other side.
This time I think we had the dip, we had the stimulus, and now we’ve dipped again on the basis- and I think people are very fearful about what’s happening in Europe and we’ve got got a lot more information through the media. So people are putting off those big decisions like buying a house and so you’re seeing a much, much more drawn-out recovery.
ALAN KOHLER: But clearly we’re not- Australia is not in recession?
ROB SINDEL: No, exactly!
ALAN KOHLER: Unemployment is low. The economy is okay. But housing is definitely weak.
ROB SINDEL: Yes.
ALAN KOHLER: Even though there’s supposed to be a housing shortage. So do you think that it’s possible that the housing shortage is a myth?
ROB SINDEL: I think that some of the forecasts that we’ve previously seen around 180 and 200,000 housing starts a year being underlying demand, I don’t believe those because they were predicated on the basis of household formations, the number of people living in a house shrinking. That hasn’t come to pass. We’ve actually seen that number start to turn the other way.
ALAN KOHLER: You mean the number of people in a house is going up?
ROB SINDEL: It’s started to go up after falling for a number of years.
What you’ve got is you’ve got shortages in certain places. You’ve got shortages in New South Wales, you’ve got shortages in south-east Queensland. You’ve got a shortage in Western Australia.
You don’t have a shortage in Victoria. And it’s often driven by land shortages, it’s driven by a number of factors. So I think it’s very hard to categorise the Australian market as just one market. There is a series of undermarkets.
Mr Sindel’s views are certainly refreshing, and fly in the face of most housing commentators who claim that Australia is suffering from an acute housing shortage that would place a floor under home prices.
Similar ‘shortage’ arguments were used in the United States in the lead-up to the bursting of their housing bubble. Here are a few examples from 2005/06 in the WSJ, James F. Smith, WSJ, and Mark Vitner, Senior Economist, Wachovia. Famously, the California Building Industry Association warned in 2006 that the chronic housing housing shortage in Southern California would cause home prices to escalate:
The California Building Industry Association (CBIA) continues to express alarm over what it calls an ongoing housing crisis in Southern California.
Alan Nevin, the association’s chief economist, projected in a 2006 CBIA Housing Forecast that only 185,000 to 205,000 building permits will be granted this year, far short of the 240,000 new homes needed each year.
Southern California has been experiencing a massive population boom in recent years and it’s believed that 6 million new residents will be living in the region by 2020. The population increase, coupled with the housing shortage, has the CBIA worried that it will be increasingly difficult for first-time homebuyers to find a moderately priced unit…
Officials are worried locally as well. “We are concerned that a lack of sufficient housing is causing prices to grow exponentially,” said Gary Wartik, economic development manager for the city of Thousand Oaks…
And finally, who can forget this testimony from Ben Bernanke in 2005 [my emphasis]:
“House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas.”
The problem with the mainstream views expressed above are that they are based on “underlying demand” which, as I explained last year in a post about the California housing market, is a questionable methodology:
‘Underlying demand’ (or ‘pent-up’ demand) is the common methodology used in calculating whether there is a housing shortage. Put simply, underlying demand estimates what the demand for newly-built housing might be given the growth in population, trends in household size, demand for second (or holiday) homes, and economic conditions (e.g. employment, interest rates, etc). Underlying demand differs from ‘effective (actual) demand’, which is the quantity that owner-occupiers, investors and renters are actually able and willing to buy or rent in the housing market.
General economic conditions can dramatically affect the level of housing demanded. For instance, as economic conditions deteriorate, and unemployment rises, the number of people per dwelling will rise as they group together to reduce their housing costs. This most likely explains the current situation in California where, despite experiencing a chronic housing shortage (as measured by underlying demand) prior to the onset of the financial crisis, there is now a large oversupply of housing brought about by a deep recession.
It’s interesting to note that in the lead-up to the global financial crisis (GFC), there were around 1.2 million households formed each year in the United States. However, as the below Bank of America chart shows, rates of household formation slowed to around 500,000 post-GFC as more households “doubled-up” – that is, moved in with family and friends.
The key lesson from the US experience is that the argument that housing shortages arising from high levels of underlying (or ‘pent-up’) demand would prevent home prices from falling is inherently flawed. The economic reality is that the demand for housing is highly changeable depending, largely, on the prevailing economic conditions. And when economic conditions deteriorate, causing unemployment to rise, the number of people per dwelling tends to increase as they group together to reduce their housing costs. Such actions, in turn, can also turn a perceived housing shortage into a surplus.
