Why Sydney and Melbourne housing is so expensive

The Reserve Bank of Australia (RBA) has released new research which attempts to explain why dwelling values respond much more to interest rate changes in some parts of the country (e.g. Sydney and Melbourne) than others:

We know that housing prices vary substantially across different parts of the country. The average price of housing is higher in Sydney, for example, than it is in Hobart. We also know that changes in interest rates have an effect on housing prices. When the RBA lowers the cash rate housing prices typically end up higher than they otherwise would have been. These two facts have been well documented, but what we don’t know is how these two facts fit together. For example, when the RBA lowers interest rates, is the change in housing
prices larger in Sydney than in Hobart? And what are the factors that explain any differences in the response of housing prices to interest rates across the country?

In this paper we examine how monetary policy affects housing prices across local areas. We explore three related questions:

1) How differently do housing prices respond to monetary policy across areas?
2) What can explain these differences across areas?
3) Does monetary policy cause changes in the housing wealth distribution?

We document considerable differences in the response of housing prices to changes in monetary policy across local areas. While housing prices in the median region fall by 2.3 per cent two years following a 100 basis point increase in the cash rate, at the 25th and 75th percentiles, housing prices fall by 0.9 per cent and 3.5 per cent respectively in response to the same cash rate increase.

What can explain these differences across areas? We find that a diverse set of forces are associated with the sensitivity of local housing prices to cash rate changes. We find some evidence that housing supply conditions matter. This is because a fall in interest rates leads to higher demand for housing. For areas in which it is difficult to build new housing – when housing supply is `tight’ – most of this increase in demand will be met by an increase in the price of housing, rather than in the quantity of housing. So changes in interest rates tend to affect prices more in areas in which housing supply is constrained, whether by geography or government regulation. But, on top of this, we find that areas with more mortgage debt, higher incomes and more housing investors also have larger housing price responses to changes in monetary policy.

Relatedly, we also find that changes in the cash rate alter housing wealth inequality. This occurs because expensive areas, which typically have tighter housing supply, are more sensitive to changes in interest rates. These differences, however, dissipate over time, suggesting any change in housing wealth inequality due to monetary policy is temporary.

Overall, this paper documents two findings on the effect of monetary policy on housing prices. First, the distribution of responses is substantial. And second, more expensive areas are more responsive to monetary policy. Housing supply conditions, and the availability of land, go some way to explaining these differences.

But there is clear evidence that other factors, such as incomes, mortgage debt and investor concentration, matter too. This supports the view that housing price dynamics are complex and that a wide range of factors need to be considered when trying to understand how changes in interest rates affect the Australian housing market.

Not a bad effort. Although it is curious that the RBA did not mention differences in population growth, driven by immigration.

As we know, Sydney and Melbourne are growing quickly driven by mass immigration:

This growth is obviously fueling demand and helps to explain why dwelling values in Sydney and Melbourne have grown so much faster than the rest of Australia:

Don’t just take my word for it. Many studies have also found that immigration helps fuel house prices.

For example, university academics last month released research showing that mass immigration is unambiguously lifting Australian house prices, thus making housing less affordable for the resident population:

In cities where the new migrant population grew by 1 per cent each year, house prices likewise rose by 0.9 per cent, according to the study titled The Impact of Immigration on Housing Prices in Australia by senior lecturer at Monash Business School Daniel Melser, and, RMIT University student Morteza Moallemi.

“House prices would have been around 1.4 per cent lower per annum, and units 0.8 per cent lower, if there had been no immigration [from 2006 to 2016],” they wrote, in the soon-to-be-published study…

“Interestingly, the effect of immigrants on different property types is different – there is a bigger impact on houses than units or apartments,” Mr Melser said.

Specific migrant groups also had a bigger impact on house prices than others, given they were more likely to buy a home, Mr Melser said

“Chinese and Indian immigrants have high rates of home ownership,” he said…

This study supports similar findings from the Productivity Commission:

High rates of immigration put upward pressure on land and housing prices in Australia’s largest cities. Upward pressures are exacerbated by the persistent failure of successive state, territory and local governments to implement sound urban planning and zoning policies…

The Grattan Institute’s housing reform blueprint also explicitly stated that “high rates of immigration” are a contributing factor to Australia’s rapid house price growth and reduced housing affordability:

Strong population growth, both from natural increase and overseas migration, has increased demand for housing and contributed to the increase in dwelling prices, particularly in our major cities…

Immigration has been the major driver of population growth since the mid-2000s… Immigrants are more likely to move to Australia’s major cities than existing residents…

Why did the RBA’s research paper fail to mention this?

Unconventional Economist
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