5: Australia's House Price Boom. Will It End In A Bust? Part 2

Podcast Transcript

Australia’s House price Boom. Will It End In A Bust?

Dec 2021

Brendan Coates - Economics Policy Director - Grattan Institute Housing

Welcome to Burgernomics, Brendan. Housing booms, do they always end in a bust, is what we're going to talk about today. And in demystifying the Australian housing market, you and I are going to cover a smorgasbord of topics in today's Burgernomics podcast. But, first of all, before we delve [00:04:00] into some of those economic topics of our current housing situation, you firmly believe that any discussion regarding housing needs to have a definition of housing to give meaning to any discussion. So, please, tell us the definition of housing from where you're coming from.

Brendan: Thanks, Ross. And thanks for having me on the podcast. You know, my, my experience of talking about this, is just the last few years, is people often talk about issues around housing without really defining [00:04:30] what they're talking about. And it makes it really hard to kind of understand the drivers, 'cause housing's unique in Australia amongst other sort of goods and services, for a couple of reasons. One, you know, housing is an asset. You know? So it's something that, um, we both live in and something that we own. And, therefore, it's not just about, you know, thinking about housing as, um, you know, the way that we think of our other goods and ser- services. You've also got think about it as an asset.

And people access housing in two different ways. There's the market for renting housing, which is really ... [00:05:00] you know, that's the pure market for, you know, if you wanna access a place to live, you know, what do you have to pay? Well, you have to pay rent. Um, and so, you know, the rent is what you pay in order to get access to that house, so that's the price of having a house that you can live in, the price of consuming housing. But we also have this other market in Australia, as we do in many countries, which is the price of owning housing. And that's, in a lot of cases, people are owning a house that they then choose to live in themselves. And the benefit they get from that is not having to pay rent.

Um, and it mean- ... but it means that there's, there's [00:05:30] two different markets. So the way to really think about it is, the price of like accessing a house is rent and that's kinda driven broadly by, you know, the durt- ... demand and supply of ... um, in the stock of housing, the relative demand and supply of the stock. So you have things like-

Brendan: ... immigration. You know, things like the rate of new building supply, construction. These things affect like those under- ... that underlying, you know, demand and supply of housing. Uh, but then you also have this extra level on top, which we talked about, which is the fact that [00:06:00] people buy a house. And it's kinda like, you know, the ... your show's called Burgernomics and we'll talk more about that later. Like, renting is kinda like going into Macca's and buying a burger. What's the cost of getting the burger that you then get to eat? Um, owning a house is kinda like, "Okay, I wanna go buy a McDonald's." You know?

And so that's affected by both the price that McDonald's sells the burgers at, versus the-

Ross: Yes.

Brendan: ... costs, but it's also affected by things like the fact that you normally, if you're yes buy one of those, like a McDonald's, you're probably gonna bo- borrow money in order to go and buy [00:06:30] it.

Ross: Mm-hmm (affirmative).

Brendan: And so access to credit, um, and the interest rate that you pay have big impacts on the price of the McDonald's, but they don't really affect the price of the burger very much, that you're actually buying when you walk into a Macca's today and, and, and eat one. And so it's the same with housing. Housing that you own is something where it's driven by the underlying ... the price of housing is driven by the underlying demand and supply for ... in the stock of housing.

Ross: Yeah.

Brendan: But it's also driven by borrowing costs and-

Ross: Yeah.

Brendan: ... driven by interest rates, particularly [00:07:00] in the short term.

Ross: So, if we were to look at the laws of supply and demand, applying them to the Australian housing market, and if I all of a sudden became the father of economics, Adam Smith, and took myself back to 1776, when he developed the laws of supply and demand, he would say that we've got a whole bunch of people out there that want houses to purchase. [00:07:30] And they're bidding up the price of those houses. And then Adam Smith would say, "The property developers would go, 'Wow, this is fantastic. We've got all these people who want these houses.'" His profit just sitting there and waiting to happen, "We will just build a whole lot of houses and we'll make lots of money."

And eventually all the people that wanna buy the houses, that are creating the demand, they will become smaller and smaller in number as they were purchasing [00:08:00] the houses being built for them by the property developers. And then eventually the market would reach equilibrium or would soften a lot because the demand has fallen. Prices wouldn't be going up as much, and so there would be a stabilization of price- prices in the housing market. Now, for 25 years, that doesn't (laughs) seem to be happening, because all we've [00:08:30] seen is prices going up, up, up, up, and we ... would appear that the supply side is not able to quench the thirst of the buyers.

Why isn't the laws of supply and demand functioning efficiently in the Austral- ... in the $1.9 trillion ... sorry, $9.1 trillion housing market? What's [00:09:00] going on?

Brendan: Thanks, Ross. I think 1.9 trillion's probably where it was at well in the 1990s. Um, yeah, it's gone-

Ross: It's, it's act- ... It's ... 1.9 trillion is actually the, the amount of mortgages that underwrite the $9.1 trillion market. Anyway ...

Brendan: We are talking about ... I remember giving these presentations a couple of years ago, it was a $7-trillion-housing market. So things can change quickly.

Ross: Yeah.

Brendan: Um, so it's worth stepping back and kinda going, "Okay. So can you explain what's happening in housing markets today using, you know, economics?" And I think the short answer is your broadly can. [00:09:30] And it comes back to what we talked about before, there's a market for owning a house and then there's, you know, the underlying demand and supply for physical housing, which is the rental market gives you a better ... a better linked, um, sign off. And so what's happened in the last 20 years, um, is that in ... we've deregulated the financial system, interest rates have fallen from, you know, 17%, 18%. We're back in Paul Keating's day, this, in the late 1980s, early 1990s.

Ross: Yes.

Brendan: So really low rates. And so rates have come down a lot. Now, that means demand for housing [00:10:00] goes up a lot. We only add a little bit to the stock of housing every year. So, you know, we only add 1.5%, maybe 2% to the dwelling stock a year. So you will inevitably see prices rise ahead of supply in a world where even if you supply was working well. Um, now what we've also had though is that we probably haven't ... Well, I think it's pretty clear we haven't built enough housing over the last 25 years to meet that i- ... uh, that increase in population. So our average household size, so the number [00:10:30] of people that live in each dwelling in Australia, you know, was steadily declining through the 80s, 90s, as we got wealthier.

People, you know, frankly don't wanna live with as many other people. They're happy, you know, as a wealthier society, you can afford for your kids to ... theoretically, could move out earlier. You know, you, you have more space per person. And that basically stopped. That's flatlined. And so Australia's one of the few countries in the world that's basically built very few ... our, our housing per adult is the same now as it was 20 years ago, whereas other countries, like Japan, [00:11:00] have 20% more housing per adult now than they had 20 years ago.

So, a lot of that's about the planning system. Because if you wanna build a house as a developer, or build a 10-story apartment building, what you have to do is you have to get planning permission. Planning permission is about making sure that, you know, land uses that are nextdoor to each other don't affect each other, don't cau- ... Uh, so you don't build like an abattoir, which has a horrible smell, next to a school or next to an apartment building.

Ross: Right.

Brendan: But where we've ended up, is those problems [00:11:30] around the plannings system, which is really about how local councils make decisions. And local councils reflect the interests of those that live there now. It means that it's very restrictive in order to build more housing, particularly in the inner or middle suburbs of major cities. Density has barely increased outside the CBD of Melbourne. And it's increased a bit in recent years around train stations in Sydney, but beyond that, you know, where there's profit ... opportunities for profit for developers that they can't take advantage of, because we make it hard to build the amount [00:12:00] of housing we probably need.

Ross: So you're saying there is an artificial limit to supply, directly linked to the planning departments of local council. Are you're saying that they are efficient, um, misguided? Wh- why ... W`hat's their motivation for not wanting to make Australia a, a f- ... a f- ... a far better place (laughs) to live and, and [00:12:30] assist people with housing? What's their motivation for wanting to create this limitation?

Brendan: It's a failure of political economy, Ross. So, the issue is, in most cases, local councils reflect the interests of who lives there now. That's who gets to vote in council elections. People who would move to an area, particularly this is a bigger problem in the leafier, nicer areas of our major cities that are already well served by infrastructure, southeast of Melbourne, you know, the, the northern eastern suburbs of Sydney. Um, [00:13:00] you know, the people who would move into an area if more housing was built, they don't get a vote. And you can see that in the, the ... some situations, where we've made greater progress, are in Sydney.

Now, um, they've moved away for medium-density development, so, you know, five-story apartment buildings. They're no longer running through the local councils, they're running through these independent planning panels that were set up to get development corruption out of the process, and you've seen a lot more housing. In Brisbane, you have one city council that represents the majority of the metropolitan area [00:13:30] of, of, of Brisbane. And, as a result, they are the, the one jurisdiction that built a lot of apartments on sort of around the river, and that actually saw rents fall. And rents have also fell in Sydney before COVID because they allowed more housing to be built.

So it's a problem of political economy and representation, and, essentially, power, uh, because the benefits of migration and population growth accrue to the community as a whole, but each council says, "No, I don't want them here. Put there somewhere else." And as a matter of fact, we don't build enough [00:14:00] housing, they end up living a lot more on the urban fringe and housing cost are higher than they probably should be.

Ross: Okay. So, we've got a whole bunch of people screaming unaffordability. We've got councils not wanting to issue permits to developers that are screaming, "I wanna build house and make a profit." That's altering our laws of supply and demand, not to create an [00:14:30] efficient market. Let me put this to you in regard to that law of supply and demand not working, we've got state governments, who are in charge of local councils, raking in the cash through stamp duty. So an increasing housing market, in terms of price, suits them.

We've got [00:15:00] a federal government. It's got record-low interest rates, low inflation. We've got homeowners with their houses endlessly climbing in value and that causes the wealth effect, which we're gonna talk about in a later podcast, but it basically says that they feel good and so they will spend money on other things, cars and hamburgers. The demand [00:15:30] for housing keeps a whole lot of tradies employed, together with the consumption, 'cause people are feeling wealthy, we've got near-full employment.

So, really, if, if I'm a federal government, I'm in Disneyland. This is Fantasyland. We've still got this group of people that are screaming blue murder, housing affordability, "I can't afford it," but if I was the federal government [00:16:00] I would see that as probably acceptable collateral damage, to have the economy in the state that it's currently in. So is there really an impetus anywhere in the system to correct this, the laws of supply and demand that seem to have been gotten out of kilter?

Brendan: So, you know, we've talked about supply being one of the problems. Uh, the other problem is obviously on the ta- ... on the [00:16:30] demand side, it's, it's the tax setting. So, you know, it takes both the demand ... prices and rent to set where demand meets supply. So you've gotta think about both. So there are problems on the supply side, which are a state responsibility. There are problems on the demand side, which are much more a commonwealth responsibility. They control the tax system, so the tax concessions available for investors, through negative gearing, but particularly the capital gains tax discount, the fact the, the house, the home, family home, is exempt from the age pension assets test.

You know, the fact [00:17:00] that own-occupied housing itself, if you live in your own home, you never pay tax on the capital gains. And that's a huge increase in wealth, the people have experienced in recent years. You know, and our numbers, if you did everything on the supply side and you built 50,000 more homes for a decade, then prices and rents would fall 10% to 20% from where they are, gradually. If you did everything on the tax side, we think prices would fall maybe 10%, at ... you know, that's kind of the, the, the value of those tax concessions, relative to the size of the housing market, like [00:17:30] actually what they're worth.

Ross: Okay.

Brendan: Um, now the ... all those policies are difficult. You know? Planning at the state level means taking on constituencies that are often marginal seats, or, or, in some cases, the heartland, particularly for the coalition, um, in Melbourne and Sydney. Um, taking on the tax side, you know, we had a whole election in 2019 about negative gearing and capital cains ... gains tax discount. We don't think it costs Labor government. The seats that swung towards the coalition were actually low-income areas. And the seats [00:18:00] that swung towards Labor were high-income areas that would've been most effected.

Um, whether ... But, it, you know ... it's certainly ... it's seen now as not having very effective ... or it's seen now as a bridge too far, at least on less Labor-formed government, then who know what happens? Um, so the challenge there is, as you put it, there are, you know, several million homeowners in Australia and 100,000 people buy a house for the first time each years. And so the economics and the pol- ... the politics are certainly such that, you know, it favors most people who own [00:18:30] their own home and therefore are happy with house prices to rise.

Ross: Mm-hmm (affirmative).

Brendan: The, the way in which this is gonna play out, I think, on the politics, is that, you know, people are seeing that their kids and their grandkids can't get into the market. And they can't get into the market near where they live. So families are being broken up, 'cause they can't ... the way that families are dealing with this is they're giving money to their kids, so they can afford a house, with the deposit, that's near them. And that's ultimately, if anything's gonna change, that's what's gonna change.

You sort of ... A premise of your question though, Ross, was that, like, this is good economics, almost. That, you know, [00:19:00] it's there in the economy's interest that housing's unaffordable. I don't think that's quite ... not sure it's quite what you meant, but, um, I would certainly think that that's not the case. Um, so there's really good research out of the U.S. that says that like if you boosted on the supply side, by fixing the planning system, U.S. GDP, um, would rise 5% to 10%, because basically people could live closer to their jobs. They could move to take on new opportunities.

I think the effects would be smaller in Australia, 'cause we have two, or three, or four big [00:19:30] cities, depending on your definition, whereas in the U.S. it's people would move from like the mid west, industrial mid west, into San Francisco. And that's what-

Ross: Yeah.

Brendan: ... they can't do now.

Ross: B- but, in the U.S., they've had, um, housing ... I mean, the last 12 months, they've had up to 34% increase in housing value. So they're suffering ... everyone's suffering the same sort of situation, worldwide. And, and like just-

Brendan: That's right.

Ross: ... the, the, the, the premise that I get back to is that currently everybody [00:20:00] wants to, um, allo- ... the, the people that can't afford wanna allocate blame, if you like, to the banks, or to quantitative easing, or they've got a whole range of things. But really what you're saying is, it's a political decision whether or not to increase the supply of housing, and maybe there's some political factors that say they don't want to, or it doesn't suit them, or they might lose some seats. And so [00:20:30] maybe it's not so much the housing question, it's another political question.

Brendan: Ultimately, this is about politics. So, if you look in the last two years kinda what's driven the boom we've seen, look, it's low interest rates. The Reserve Bank published a paper in 2019, um, a model of the housing market called A Model of the Australian Housing Market by Trent Saunders and Peter Stul- ... Tulip. You know, if you would use that paper as the basis for your understanding of what's happened since COVID, it makes perfect sense. So what they-

Ross: Right.

Brendan: ... say is that if you cut interest rates by [00:21:00] a percentage point from already low levels, then ... and that cut is seen as being fairly permanent, house prices rise by 25%. That is literally what we've seen since the onset of COVID, um, because prices, you know, when you're ... when rates are that low, you reduced your, your, um, your borrow interest payments. You know, if your interest rate goes from 3.5% to 2.5%, then you can borrow, you know, up to 30% ... 20%, 30% more. And that's what people do. Um, [00:21:30] and I think it's unlikely rates are gonna rise anytime soon. I think globally there's a whole conversation you could have about secular stagnation, the fact that interest rates are low around the world, and are likely to stay that way.

But that's the global thi- ... um, dimension that has rea- ... allowed prices to rise, or seen prices rise in Australia, New Zealand, Canada, the United States. The, the story is the same across all of these countries.

Ross: Yeah, recently.

Brendan: The difference was, over the long term in the 1950s and 60s we saw a similar effect. Acc- access to credit, you know, low rates, [00:22:00] so on and so forth, and it saw a building boom, rather than just bidding up the prices of assets. And that's what's different this time around, is that construction is strong, relative to history, but migration's also really strong, relative to history, late in the pre-COVID world. And so if you wanna see ... Interest rates should have the effect of boosting prices, and instead what they've ... Oh, sorry, boosting construction, but instead, what they've done, is they've boosted prices. And there's a great sign that you're gonna see a big construction boom coming down the path.

Ross: [00:22:30] Well, 300,000 migrants not being able to come into the country at the moment, which was our yearly intake. Those migrants, I would presume, would come into the country, if they were allowed, and they would rent, rather than they would buy. And so that gets into the investor market, to be able to satisfy the demand for, for their renting. A- again, you're saying these planning restrictions are capping the ability to supply [00:23:00] even the migrants coming into the country, which then flows through everywhere else.

Brendan: That's right. So you've kinda ... As I said, you've got these two markets, a market for renting, a market for owning. So, uh, what that means is, if someone comes into the market as a renter, they're adding to the physical demand for housing. Right? And so rents will, will rise, if there's no supply response. And that same RBA paper I just talked about said, basically, that since 2005 is when we saw a big lift up in re- ... in migration. If that lift up in migration hadn't have happened, [00:23:30] then by 2018 rents would've been 9% lower than they were in 2018, which by extension means prices would've been 9% lower.

So migration, look, has lots of benefits and we're a supporter of migration, generally, but it does have an effect on housing affordability, given that supply is constrained.

Ross: Right.

Brendan: Um, now, you take out 300,000 people, due to COVID, that probably means rents fall, or a thre- ... are, are lower than otherwise by 2%, 3%, 3% or 4%. Um, now, obviously there's other effects [00:24:00] happening in COVID, like I'm recording this with you from my office at home. We're looking to buy a new house-

Ross: Yeah.

Brendan: ... hugely because of COVID, and so Australians have also increased their demand for housing, 'cause they're after bigger houses. And so that's almost offset the effect on rents and prices from migration, 'cause you've you've got 10 million Australians increasing their demand for housing, versus 300,000 migrants who aren't here.

Ross: Right.

Brendan: You know, those effects, how that nets out is an interesting question.

Ross: So, okay, le- let's, let's talk about [00:24:30] COVID for a second. There seems to be pressures, both on price, both f- for and against increases in price due to COVID. I mean, after each lockdown, in Melbourne and Sydney there's pent-up demand. People go wild and start buying houses. Well, this, um, previous weekend we've seen the auction market go wild with huge clearance rates. So you would say that that pent-up demand [00:25:00] puts on pressure on prices, but then, as we've just said, you've got migration, you've got 300,000 people not appearing at the front ... knocking on the front door for housing. So I would imagine that takes pressure off, uh, the, the need for housing.

Then you've got another thing that might reduce the pressure in, in housing, the acceptance of remote working. All of a sudden, the people are supposedly, if we read the, [00:25:30] the newspaper reports, they're happy to leave the city and go and buy a rural property somewhere. I, I would've thought then, if you have people evacuating from, uh, CBD areas or inner-city areas to provincial areas, that takes the pressure off housing. But then, if people are at home and they're ... if, Melbourne, there's curfew, et cetera, there's no restaurants, household savings goes up because they can't spend their [00:26:00] money on anything.

And so if they're gonna save more money, they'll have more money for a home deposit and therefore they can borrow more money. And then when they come out of lockdown, that puts pressure on housing on an upward way, because they've got more money to spend. There seems to be so many conflicting pressures that COVID has created in the Australian housing market. Which pressures do you think ride out? I mean, a lot of people go, "Wow. We've seen [00:26:30] this demand. It's come out of the blocks. It's flying, but we don't expect it to continue. It'll peter out." Or, people are scared that, "Oh, my God, the demand may not be there in six months time. I've got a house to sell. I wanna do it now. Let's hurry up." And then that supply pressure push price pressures down.

What do you think wins out?

Brendan: Well, I think in the short term what we've seen is that you've kinda had things are moving, as you say, in opposite [00:27:00] directions. And, again, I'd recommend that RBA paper I mentioned, because I think it does the best job of setting up long-term relationships and the short-term ones. In the short term, if you think about what's gonna effect house prices, it's interest rates and access to credit. They are the two biggest factors that drive prices in the short term. And, as we talked about before, like a new ... a, a ... e- even a modest interest rate fall, 'cause rates are already so low, has an enormous effect on repayments and therefore your borrowing capacity.

So, you know, the best indicator of prices is typically, you know, growth [00:27:30] in your new lending commitments that are coming out, 'cause it's telling you how much peo- people are borrowing. And that tends to lead house prices by a cou- ... by a couple of months.

Ross: Mm-hmm (affirmative).

Brendan: So in the current market, you've ... yes, you've had a decline in rents, um, because of migration. You had a parti- ... a larger decline in rents in the inner city, because people have ... one, migrants go to the cities and, two, people have moved to the country, um, which is actually reduced rents more in, in the inner areas and re- ... seen increased rents in regional areas, particularly regional New South Wales. [00:28:00] Um, those effects exist, but they're just swamped by interest rates in the short term, so ... and access to credit. So in the short term, if you're thinking of like buying or selling a house, look at mortgage repayments and look at ... Oh, sorry, mortgage lending and look at interest rates, and what's gonna happen over the course of the next two years.

And that's your best guide. As a policy maker, I don't wanna see higher interest rates to reduce prices, 'cause that has a whole bunch of other very costly effects. Um, you know, it means higher unemployment. It has a whole bunch of effects that have a, [00:28:30] a very hurtful ... So a wages growth has hurtful effects on all Australians. Um, so in the long term, you know, you are talking about supply and demand, those policy levers, but if you're thinking about when the hell do I sell my house or buy one? You know, those, the credit story is probably the main thing for people.

Ross: Okay. Now, I wanna get to interest rates, the credit story, and some of those things just in a short time. But before we do that, I'd love to discuss with you [00:29:00] the famed smashed-avocado effect. Now, this is the ... this is the effect put forward by the famed Bernard Salt, who's a demographer and writes for the Weekend Australian. And he basically is saying that we have a group ... an age group that wanna buy houses, but they also [00:29:30] want to live a lifestyle as depicted by social media. And they're finding it difficult to save the right amount of money for the house that they wanna buy because they're paying $32.50 for a smashed-avocado at breakfast at their local café and that may be preventing them from getting what they want.

Now, I've got a slightly different [00:30:00] take on the smashed-avocado effect that I'd like to put to you for your comment. We've got all these different generations. We've got the silent generation. We've got the post-war baby boomers and the Millennials. Now, if I think about my father, he was from the silent generation, he came home from war. The government provided him with a war service loan and [00:30:30] like many Australians he went and built a house to have his three children, 2.8 children, whatever the average number of children everyone had in tho- ... in the 1950s.

And his criteria for buying a house, as were basically everybody's then, was, "I have this amount of money. I go to the bank and I say, 'I've got my war service loan, this is [00:31:00] my job, this is how much I earn.'" They lent him amount of money. He knows what he's got to spend on purchasing a home. He then goes and finds something he can afford. And for ... In those days, that would mean you just keep going out and out from the CBD, in terms of the suburbs, until you hit the suburb that you liked the most that you could afford.

You didn't say, "Well, I was brought up in," let's say, " [00:31:30] in Melbourne, in South Yarra, I'm ... I need to ... as my father was, um, I have to buy in South Yarra. The bank's not lending me enough money for me to buy where I grew up. Um, this is not right. Uh, that's where my social infrastructure is. It's also closer to where I work in the city, where he worked." And so he didn't have that attitude. He represented a common attitude at the time. He just kept [00:32:00] on moving out and out, and bought land in a market garden that was being turned into a housing estate. And he built a house. And everybody lived happily every after.

The smashed-avocado effect and the, the age group within that, they seem to be saying, "My buying criteria is completely inflexible. And if I can't buy where I want to buy, I'm not buying at all, [00:32:30] and I don't think this is fair." What do you feel about those, the silent generation and the mobility of housing purchasing, and the smashed-avocado effect?

Brendan: Yeah, Ross, there's a lot in that. So let's unpack it. So, first of all, okay, like what are the constraints to buying a house? There's normally three. Can I save the deposit? Can I afford to service the mortgage repayments? And then there's a third one, which is increasingly important, is am I comfortable with [00:33:00] the level of risk that I'm taking on, particularly with rates at low levels? Right? And the prospect that they may rise in the future. And they'll probably rise from where we are today. Uh, the question is kinda when.

So the constraint ... the service ability is pretty easy. Like, if I, uh, go to a bank, I can get a loan for a lot of money. The, the challenge is always, can I afford the deposit? And so what's happened is, as house prices used to be two or three annual incomes back in say the early 1980s or the 1990s, you know, now they're five, six, seven in Sydney and Melbourne, 10, 12 times annual incomes. So, you know, [00:33:30] that's one thing that has changed, is it takes a lot longer to, to accumulate that deposit.

Now, we did a study a while ago on different spending patterns of different generations. And what's really interesting is, younger generations actually spend less on discretionary items today than what older generations did 20 years ago. The difference is, and I think this is the source of sort of the Bernard Salt sort of, um, meme, or the idea is this is Austra- ... younger [00:34:00] Australians are spending money on going out, but they're actually not spending any more than, than previous generations did. They're just doing it a lot more because it's a lot cheaper.

So, restaurants are cheaper, clothes are cheaper. A lot of things that older generations saw as being expensive ... Like, I remember growing up and school uniforms cost an absolute bomb 'cause they weren't made in China, whereas now they are. They were made in a fac- ... So they previously were made in a factory in the northern suburbs of Melbourne, now they're made in China for one-fifth of the price. And so younger generations are actually saving more now [00:34:30] than what their parents did, you know, 20, 30 years ago.

So that's probably one where I'd sit on the side of the younger gen. It's not smashed avocados.

Ross: Mm-hmm (affirmative).

Brendan: You know? That the average ... The average person, uh, young person, is spending less on discretionary items than they did 20 years ago.

Ross: Okay.

Brendan: They're saving more. They're spending more on essentials, including housing. The other part of it is, the deposit takes a lot longer, so the deposit's the hurdle. So if you haven't got access to the bank of mom and dad, that's who's struggling. If you've got access to the bank of mom and dad, and they can chip in 50, 100 grand at [00:35:00] some point to help you, then people are accessing the market 'cause the repayments are quite low. Even if the mortgage is enormous, the repayments are relatively low. It's getting the deposit together.

And what we see is, you know, back in the 1980s, early 1980s, yeah, if you break Australian ... young Australians up into sort of five quadrants, so the wealthiest 20%, the second 20%, through to the poorest 20%, the wealthiest three quadrants are still buying houses [00:35:30] and they're often ... They're buying them a little bit later, 'cause the deposit takes longer, so they're often buying in their 30s, rather than in their 20s. Um, they're getting married later, you know, they're doing all that stuff. It's the poorest two quadrants that aren't buying.

So it's not ... I don't think this is a preference thing, where people are kinda going, "No, I don't wanna. I wanna be near where I ... my parents are," or whatever, I think it's like they literally just can't get the deposit together to buy, 'cause the deposit is now 10 times their annual income, when it used to be four or five. [00:36:00] Um, that said as well, Melbourne's a larger place. My father-in-law lives in the outer suburbs of Melbourne and he used to commute to the city, CBD, every day by car. And it used to take him half an hour. That same trip now would take him over an hour. So the city gets bigger, it's harder.

So, you know, I think it's very easy to fall into the trap of going ... of kinda saying, "Well, look, you know, older gens had 17% interest rates and that was hard," and I'm sure it was. If you bought a house where the interest rate was 9%, then it goes to 17%, that would've been a horrible [00:36:30] experience. If you got through it, then you, you had the run up where, as interest rates fell from 17% now, to 0.1%, then your house price has exploded in value. You've had a great run, because you thought you'd be paying a lot of money on your mortgage repayments and now you're paying less.

So that's kind of, I suppose, where we sit on the ... sort of the generation divide. It is actually harder. I think, objectively, it is more difficult. That doesn't mean that some people aren't setting their expectations high and possibly [00:37:00] unreasonably so. Uh, the ... You know, I think the solution there is ... Younger generations, in particular, you ask them, are they willing to be in a, you know, a f- ... do they want a free-standing house? Like, 'cause, look, if you want a free-standing house in South Yarra, good luck to you. You've gotta have a pretty good income or a pretty good life to do that.

The most likely way someone's gonna get a free-standing house in South Yarra is if they inherit it from their parents. But, you know, could you have a set of townhouses or a five-bedroo- ... five-story apartment building? What we find in our surveys is [00:37:30] most people don't want the suburban quarter-acre block. The majority actually want ... or close to the majority actually want a townhouse or an apartment close to ... close to transport, and therefore close to the city, but they don't get it, because the planning system doesn't allow those things to happen, because it's too hard to subdivide.

It's actually something that's now affecting downsizers. They can't find housing in the location they grew up in, because they, or perhaps, more generously, their neighbors, have been, you know, petitioning council to appose those developments [00:38:00] over the course of the last 40 years.

Ross: So you think that, again, getting back to the councils, the mobility of people's aspirations in owning a house could be solved by council planning permits going, "People wanna live in Melbourne, South Yarra, Vaucluse, Rose Bay, wherever, we should make it easier for them to live in those places by allowing the demolition of [00:38:30] the houses that currently exist there, maybe on the quarter- ... quarter-acre blocks, so that we can put four or five units on that block." That would solve a lot of the problem.

Brendan: It would certainly help a lot. Now, it's not to say that planning rules, you know, are not a good idea. It is absolutely important that you, you know ... where ... What you choose to do with your land, does have effects on your neighbors. So if you build a 10-story, you know, apartment building, surrounded by single-family dwellings, that'd be a big shock to the neighborhood. [00:39:00] Um, but at the moment we've got the balance wrong. You know, the, the, the, the balance is too far to the world of saying no. Part of it as well, um, it's ... to, to sort of give some credit to people who are skeptical about this, is ... abu- ... is development's often a one-shot game.

So like at the end of my street, you know, there's an industrial site. It's zoned to become an eight-story apartment building. I think that's a great idea. It's the site's big enough, it should be that. What I worry about is, [00:39:30] you know, what's the quality of the build gonna look like? What cladding are they gonna use on it? Is the thing gonna be an eyesore? And so the dif- ... I really hope almost that it dela- ... it gets delayed for a few years and then gets built when average house prices in the area are higher, because the ... that ... the quality of the development will be better.

Ross: Would increase.

Brendan: And so part of it's actually about the design. So you could have looser planner rules, but strengthen things like the building code to make sure things don't fall down, as they ... the concerns in Sydney apartments.

Ross: Sure.

Brendan: [00:40:00] And actually fix the design, so that you mandate certain forms of design in exchange for, for it to pass through planning.

Ross: Okay. Let's get into a little bit of the history of Australian housing booms. There's a lot of people out there that currently wanna buy a house and they're nervous. They don't know what's gonna happen to the housing market. They think, "Oh, what if I step in now and I totally commit myself [00:40:30] and then it falls over?" Or, "What if I don't step in now, I'll never own one?" So to put things into context for them, on average ... Well, first of all, what would you call a boom? What would you call a correction? What would you call a crash? What sort of percentages would you attribute to these fantastic media terms?

Brendan: [00:41:00] That's a really good question, Ross. So, you know, Australia hasn't had a big ... The last housing crash in Australia, in a sense, was actually probably sort of in the, uh, like 19- ... late ni- ... late 80s, was the real last really big one. Now, it's worth pointing out that you often see price swings of 5% to 10% as interest rates or credit moves, as it steadily moved up. In fact, if you look at a graph of house prices, say, since 1995 in Australia, like they've gone down a couple of times. They went down, you know, after the run-up in 2004. They went down [00:41:30] a bit. They go, go up again and they come down in the GFC.

They come down a bit, um, recently, and then ... but over that time, you know, house prices have kind of doubled or tripled. So, you know, to me, uh, the ... we often just use the terms, dramatic terms, like crash, to reflect sort of gyrations in prices that are ... They're ex- ... big experiences for the buyers and sellers, but they're just the noise in the upward trend that we've seen over the last 30, 40 [00:42:00] years. So, you know, you ... the last genuine crash in Australia was, I think, in the ... in the sort of late 80s, early 90s. The biggest one Australia's ever had was in the l- ... uh, the late 19th century, when there was a real land boom.

So if you're in Melbourne, you look around at all the, the train stations, the ... sort of the network that runs out of Melbourne, that was all built off sort of a boom in land prices through the 1870s and the 1880s, and it all come ... came crashing down. And prices took 40, 50 years to return to their pre-boom levels. [00:42:30] That's a crash. The late 1980s, early 1990s, that was a crash, a small one. Um, what we've seen recently, I would just see as gyrations as prices move around over time. They, they're assets. This is what happens in asset markets.

Ross: So like the share market, which is an asset market, you would say a correction is 10%. You'd say a crash is 20% or above. Um, f- ... I don't think anyone has come up [00:43:00] with a, a, um, definition of share-market boom because they never wanna think that they'll end, so that they're never ending in the press, a boom. What would you call ... At the moment, you'd say the Australian housing market is booming because we've got around 20%, depending upon what state you live in. 20% increase over the last 12 months, that's a booming market for you?

Brendan: Well, it's hard to describe it as anything else. As someone [00:43:30] trying to buy a larger house in this market, it feels like a boom. Um, and I think it'd be insensitive to say anything else. It's such a bi- ... It's a 20% increase in prices. That's huge in such a short period. It's just an effect that you can probably explain with the underlying economics pretty well.

Ross: Okay. So, o- on average, and I know average is a, a difficult thing to describe. On average, how long do the booms last?

Brendan: Look, you're talking about 20 ... often 20-year, [00:44:00] oh, cycles. But I, I think ... I don't like to look at it and sorta go, "Oh, there's like a natural cycle, every 20 years there's a crash." I think you've got to look at what's driven prices, like what's the mechanism.

Ross: Right.

Brendan: And the mechanism is that interest rates were at 17% in 1989 and now the cash rate's at 0.1%, you can borrow on mortgage for less than 2%. And that's ... The boom has been driven by that drive down in interest rates.

Ross: ... time, or would you say that each of the booms is really caused by interest rates, but [00:44:30] it's just dressed up a bit differently?

Brendan: In the ... Booms are typically caused by ... You know, the kind of booms we're talking about, like big increases in prices in a short period, the- they're caused by financial factors. Because, you know, you don't add 70% to the population, except for the 1850s. We don't add 7- 70% of the population in 2 years. So what's changing is three things. One, interest rates potentially. Two, access to credit. And, three, people's expectations. That can feed prices once they've taken off. They can take off. Like, [00:45:00] you can have irrational housing markets, um, or exuberances, as Ala- ... irrational exuberances, Alan Greenspan useyesd to talk about.

Ross: Yes.

Brendan: Um, but, you know, it's normally the financial factors that are driving these gyrations over, over the sort of short to medium term.

Ross: Okay. So, if we go from a boom to a bust, which has happened, we have a concept that comes into play called negative equity [00:45:30] with housing. And negative equity is when ... Well, please, you, you explain negative equity for us.

Brendan: No worries, Ross. So, you know, mo- ... people normally ... particularly first-time buyers, 'cause that's who ends up ... most likely ends up in negative equity. First-time buyers and investors. You buy a house normally, you know, with a ... in, in Australia you have to pay extra, add-on insurance, if you're lending ... if you're buying more than 80% of the purchase price. So the average Australian, average first-time buyer, [00:46:00] buys a house with a loan that's 83% of the purchase price, on average. And that's been pretty constant the last decade. That means you've got equity in the house, you know, of 17%.

Now, negative equity is where, over time, because of, uh, falling prices, the house is worth less than the loan you have outstanding on the property. This was a big problem in the U.S. during the global financial crisis, uh, where a lot of people were stuck in a world where they couldn't move because the house was worth less than they owed the bank. So the only thing they could really do is stay still, hold [00:46:30] on, until house prices recovered.

Ross: Okay. So, all of a sudden, I own a ... I buy a house for a million dollars. The bank, uh, owns $800,000 of my house. The market determines that my house is worth $750,000, so therefore all of my equity's been wiped out of it and $50,000 of the bank's equity has also been wiped out of [00:47:00] it. What does the bank wanna do when it's holding an asset that has devalued and it's in your hands?

Brendan: Uh, well, they get worried, because bank of s- ... residential mortgages account for 60% of the lending of the ma- ... lending books of the major banks. So it is the biggest sort of exposure that they have. You know, this is why, um, you know, the RBA and APRA run these stress at the banks. What they're basically doing ... So the worry is, if you see a big house price fall, the concerns are [00:47:30] twofold, like from an economic perspective. One is, as prices fall, then people's con- ... willingness to consume falls, so they, they cut back on spending because they don't feel as wealthy.

But, two, the big worry is always, as we saw in the U.S. in 2008, um, if the house ... if the bank lends that person $800,000 and the house is worth less, then they're not gonna get their money bank. And that worries the banks, because if that happens at scale, um, then w- ... if the bank has to foreclose, [00:48:00] you know, if it has to sort of, um, foreclose and it ge- ... it loses money, then the bank has to take in a hit to its ... to its equity. So every ba- ... Banks lend money and the lending has to be backed by capital, which is the shareholders' money.

Now, the standard, you know, bank has capital worth, you know, 10%, 12% of its risk-adjusted assets. Um, that means that if the bank loses money on a ... on a share of, um, of those loans, [00:48:30] uh, then it eats away at the capital, capital of the bank. And the risk, you know, as we saw in the 1930s, we saw in the 19- ... uh, the late 19th century in Australia, as we saw in the GFC in the U.S., is that the bank can go ... become insolvent. It can be ... It can go bust because its capital is, is eroded. Um, that's why the banks and APRA stress test ... the RBA, they APRA stress test the banks, um, uh, to make sure that they can withstand big hits to their ... to their ... to their loan books.

Um, and that's the ... [00:49:00] always the thing that worries regulators as soon as prices start falling. I think it's a really underappreciated reason. It's an unappreciated problem with a world with really high house prices and high debt, is that regulators get worried if prices fall quickly. Um, and that ... and treasury and the government gets worried if prices fall quickly. I don't think it's a conspiracy or they always want prices to rise, but it is an inherent bias that you get really worried when you've got these really high levels of household debt, about seeing prices fall, 'cause you start to worry about the financial [00:49:30] system pretty quickly.

Ross: So if I'm the CBA bank, I've currently, as of last week, got $1.01 trillion in assets, made up of $458 billion of mortgages and the property market turns down rapidly and largely. I've got lots of negative equity amongst my mo- mortgage [00:50:00] holders. Isn't it in my interest to go, "Let's just ... not forgive them their money, but let's just lengthen the terms of my ... of the mortgages that I've given them, so that it takes the pressure off us, as a bank, to have to take hard decisions. Because if we were to take hard decisions and foreclose, that's just gonna add more supply stock back into the market and create [00:50:30] an even bigger crash."

Brendan: That's right. And so one difference between Australia and the U.S. is, in a lot of U.S. states, you know, they had rules around bankruptcy, where they were no-fault mortgages. Basically, you could just put your keys in the mailbox and if you were in a situation of negative equity, it became the bank's problem. You're just like, "Thanks very much, I'm walking away from the loan." It doesn't work like that in Australia. If you ... If you ... If your house is now a 750 from a million and you've got an $800,000 loan, and you try to walk away, the bank will come after you for the remaining $ [00:51:00] 50,000, you know, if they sell it.

Banks don't like foreclosing mortgages because often a foreclosed sale gets less than the mar- ... often gets less than the market value. You're se- ... also selling into a ... that sort of falling market. And that's what ... You know, I think we saw that in the late 1980s, where banks tried to be really careful about not selling properties unless they really had to. You're certainly not gonna allow someone ... But the problem for the banks is that they ... uh, if a fo- ... if a loan becomes a non-performing loan, [00:51:30] um, then the, the, the amount of capital they have to hold against that loan increases.

APRA's rules are as ... You know, if a ... if a loan ... if a loan is, um, is, is solid, if a person's making their repayments, they only have to hold, I think it's, you know, the ... When I was talking about before, about risk-adjusted capital buffers, you know, a loan that ... with the, the bank, where the repayments are being made, the risk rate is 20%, which means they only have to hold one fifth of the capital, uh, against that loan. If it's a loan that's [00:52:00] got a non-preforming loan, they often have to hold 100% of the capital waiting. So they have to increase their capital.

They have to ... They have to get more equity in, which is what you'd expect banks would have to go in the event of a problem, is that the existing shareholders would lose a lot of money, uh, because the equity ... their equity's there to abs- ... to, to make ... get the dividends during the good times. But if banks run into trouble, equity holders lose out first. They'd probably have to recapitalize the bank. Um, that's where we saw this in the U.S., where ... [00:52:30] and the UK, where government in the UK actually just ca- ... took over banks, by basically providing capital and make sure they didn't fall over.

Um, the risk in Australia, 'cause you ... the premise, Ross, is kind of like, "How does this happen in the Australian context?" You know, I think I look at the Australian housing market right now and there's a little bit of risk that the, the li- ... quality of the lending is falling because people are taking out larger mortgages. Um, but on the whole, people are taking out these mortgages, um, becau- ... uh, [00:53:00] and the prices are kinda justified by low interest rates. The question is, what happens if interest rates rose? Now, the ... it's almost like a ratchet, when you've got very low rates and it's led to ... led to lots of debt, it means you probably don't need to increase rates as much to get the same effect on inflation, 'cause that's why you raise rates.

There's no natural level of rates that you're gonna try to ... We're no- ... We're not gonna get it back to a world of 7% mortgage rates.

Ross: 17% rates, but the ... but-

Brendan: Or 17.

Ross: But the, the-

Brendan: Yeah.

Ross: ... Reserve Bank do want rates to be higher than what they are [00:53:30] now because they want themselves a buffer, in crase ... in case there's another economic problem, either in the world or in Australia. They wanna have some flexibility.

Brendan: They do, but what their mandate is, their target is full employment-

Ross: Yeah.

Brendan: ... and low inflation. And so they're not gonna raise rates in a world where unemployment isn't back to sort of, um, the levels that ... what they think of as like a full-employment level, which is somewhere between probably 4%, 4.5%-

Ross: Yup.

Brendan: ... and where inflation's [00:54:00] rising. So Lowe has been very clear, the Reserve Bank governor, Phil Lowe, in saying they're not gonna raise rates until inflation is sustainably within the target ban of 2% to 3%. It hasn't been in that ban for seven, eight years now. So I think they'd like to be able to raise rates, but they're not gonna raise them prematurely to, to, to normalize just for the sake of normalizing. You know, monetary policy is a complex area, but the way they think about it is ... the way the Reserve Bank thinks about it is, there's some neutral risk-free interest rate, [00:54:30] which is determined by the global demand for supply ... global demand of supply for savings.

We've had a heap of savings 'cause populations of age, rise of China, growing inequality is a potential driver, which means that risk-free rate has ... neutral rate has fallen. And that's why interest rates are low. So they're not gonna raise rates now to sorta get us back there. I suspect they're more likely outcome is you raise a little bit, but I don't think we'll be going fa- ... very far up before, you know ... 'Cause if you did, if [00:55:00] you raised rates by a percentage point, you know, and my mortgage rate goes from 2.5% to 3.5%, you've just reduced my purchasing power by ... You know, you've increased my mortgage repayments by 15%, 20%.

Ross: But haven't, haven't the banks really got around that problem? Because, for example, when I went for my first mortgage many, many, many years ago, the ... it was pretty simple. You had to have 30% of the purchase price of the house. They would give you [00:55:30] 30 ... as a re- ... monthly repayment, 30% of your gross, not your net, of your gross wages. And that determined ... And that was calculated over the rest of your working life and your working life was defined 65 years of age. And that's how it went. That's how we built the post-war baby boom housing situation. Now, I notice that what the banks do is they'll give, uh, for example, someone that's 45 years of age a loan [00:56:00] with the term still of 25 or 30 years, out until, in some cases, they're 80 years of age.

Well, then they're gonna stop working at 67 apparently, according to the federal government. And so banks are lending, lending money against future equity in people's homes, so therefore people will have to sell their homes at 67, when they stop working and can no longer afford [00:56:30] the mortgage repayment, to return the equity of that house back to the bank. So aren't the banks really insuring themselves against any problems in the future, by having these incredibly long, uh, repayment periods?

Brendan: So, first of all, it makes sense to have longer payment periods when houses are a larger multiple of incomes, 'cause it means you're spreading out the payment for a larger share of your life. So, uh, that makers a lot of sense to me, to have 30-year mortgages, where it used to be more like 25-year mortgages. They're, they're gonna get [00:57:00] longer, I think. Um, I ... What I think the banks are doing, is they're probably expecting that if people need to sell, um, if people need to sort of pay out some of the mortgage at retirement, they'll use their super. Um, now, that, in a lot of sense, actually, actually makes sense. Um, you know, peo- ... there's a whole nother conversation we have about the adequacy of retirement incomes.

We don't think there are big problems there, um, uh, but ... So we think the, uh, current, you know, rates of super contributions are fine. You don't need to increase them from 9.5 to 12, [00:57:30] which is what we're doing now. Uh, but that's kinda what I think the banks are expecting. People have got this big other asset, which is their super, um, and all the research shows, the thing you wanna do when you hit retirement is to pay it off your mortgage. And then if you own your own home outright, you'll probably be okay in retirement.

So I suspect what people are doing is they're expecting they'll use of their superannuation-

Ross: To do that.

Brendan: ... to pay off the loan.

Ross: Okay. Before we get onto the hamburger effect, I just wanna to talk to you about the canary in the coal mine, because you have mentioned [00:58:00] throughout our podcast so far, really it's all about interest rates. We've got to keep interest rates low. That's the reason why the housing market continues to grow. If we were to stop the interest rate party, then there's a lot of problems for everybody. There's this f- ... particular measure called the 10-year Australian government bond yield. [00:58:30] So without getting into a great, long explanation about it, it basically forecasts the risk-free rate in 10 years of where interest rates are going.

It's used as a predictor of where interest rates are going in the future. You mentioned 1% or 2%. I recently sat with a, a very senior executive of, uh, one of the big-four [00:59:00] banks at lunch and he said to me, "If we were to increase interest rates by 2%, the cash rate ... well, and mortgage. If the cash rate was to go up by 2%, uh, we'd pass that through to mortgages and basically the whole system would collapse. You'd have all four banks going to the Reserve Bank going, 'Please, give us a whole lot of money. We can't survive.'"

The 10-year Australia government bond forecast in five years time is to increase [00:59:30] by 3.5% to a 5% level. That would mean that mortgages would be 7% from where they are today, which is, depending on who you're banking with, 3%. So, in other words, you had borrowed, for every million dollars you'd need an extra $2,000 per month to be able to just to keep up with that situation. [01:00:00] And the last week we've seen the Reserve Bank of New Zealand increase rates by a quarter of a percent. The world is talking about inflation and going in this direction.

The 10-year Australian government bond yield, is that the canary in the coal mine? Is that the thing that is going to bring the party to an end?

Brendan: Um, so, you know, the 10-year bond yield [01:00:30] right now, when I ... when I look at the numbers, is, is, um, 2.2%.

Ross: Mm-hmm (affirmative).

Brendan: So that means if you want ... if the Australian government wants to borrow for 10 years, it's got to pay an average into straight over that period of, of, of 2%.

Ross: Mm-hmm (affirmative).

Brendan: Um, so, you know, that to me suggests that in 10 years time market expectations are that interest rates will be at 2.2%.

Ross: Y- yeah. C- currently, [01:01:00] but they're saying ... Some of the, the, the economists, the financial people, people in the banks, based on what the overseas inflation trend is, and what's happening with the U.S. Fed that the increase in interest rates is going to happen at a quicker rate. And they're predicting that that could result in a 5% 10-year bond [01:01:30] yield.

Brendan: Yeah. Okay. So, so there's a pre- ... there's a series of forecasts out there for high rates. So the, the ... Here's the thought experiment I do. So ... 'Cause, you remember that you've, you've got to think about who's making this decision. The, the, the, the group making this decision is the Reserve Bank, right, of Australia. And so if you foreca- ... If you think about, "Okay, what happens if interest rates rise by 2% interest points in the next year in Australia?"

Ross: Mm-hmm (affirmative).

Brendan: "What does that do to the Austr- ... to the Australian economy?" I think it crashes you into recession. [01:02:00] Right? Um, if you're talking to your ... ta- talking to people who are in the banking sector, they think it would wipe out a whole bunch of, of, of potential home purchases. Or, sorry, um, home, home, home mortgages. That, to me, suggests the answer is it won't happen, because the Reserve Bank's job is twofo- ... is threefold. One, stable prices. Two, full employment. And, three, you know, the well- ... is supporting the wellbeing of the Australian population. Um, the ... They're not going to raise rates [01:02:30] by that amount of money.

The only world in which they'd raise rates by that amount of money is if nominal ... is if inflation has gone up. You know? So that's what's happening in the U.S., inflation's high. Um, the question is how long it stays at that level for. Um, that's potentially like a whole nother discussion, but it does mean the Reserve Bank is going to ... its objective is to get inflation back into that 2% to 3% range. Higher interest rates aren't gonna get it there. If intre- ... inflation rose into [01:03:00] above that 3% level, they would raise interest rates.

Um, you've got to remember that if inflation's higher, then your take-home pay also increases. So-

Ross: There's a lag effect though, isn't there, between, between inflation going up and people screaming and saying, "Increase my wages?"

Brendan: Yeah. It's a lag of ... Normally within a year. Right? So if you get higher inflation, then your bargaining will, will, will have that effect.

Ross: Yeah.

Brendan: One thing we haven't talked about is, um, the fact that house prices, [01:03:30] you know, w- ... A loan is set, uh, you know, in the prices that prevailed at the time. So, you know, I borrow a million bucks, um, or use the example, I borrow $100,000, then, you know, there's this concept called mortgage tilt, which is that my wage goes up. My wage partly goes up because of inflation-

Ross: Yes.

Brendan: ... but your loan doesn't. And so normally people might start off, you know, with your example, with 30% of their in- ... gross income on, on a [01:04:00] mortgage. 10 years in, it's 20% of their gross income on a mortgage even if interest ... assuming interest rates don't change. 20 years in it's 12%, 13% of their income on a mortgage. That's what tended to make housing affordable, is the first five years is the period where things are tough. And so even a world where interest rates were to rise, that would be a world where inflation has increased.

Now, if it's a sudden sharp increase in inflation and doesn't get priced through to wages, that's a problem, that real purchasing power falls. But I think in most worlds that's actually [01:04:30] one of the reasons why housing became quite ... in hindsight, quite cheap for older generations, is that they thought they were gonna be paying, uh, 17% interest rates. The inflation rate was high. It was 5% or 6%, 7%. And so four years down the track, the loans worth, relative to inflation, 30% less than it was when they took it out. And so I think that's the world I think you've got keep in mind.

Now, the, the objective here is not keep rates low to keep rates low. I'm, I'm ambivalent of where rates go. It's a ... You know, I'm a mortgage holder, I'd love them to stay low, [01:05:00] um, but the objective for the bank is to make sure that they hit their full employment and inflation-target benchmarks. And they will do whatever is required for that to happen.

Ross: To do that. Okay. Brendan, now we get to the really important part of the podcast. This is where you, as Australia's smartest housing expert, gets to apply our current housing market to the effects on a hamburger. [01:05:30] I want you to think about all the range of people we've discussed and the effects of our booming housing market, or if you wanna take it, you can even discuss a housing crash, what are the scenarios on, on hamburger sales and hamburger production in a true burgernomics term of Australia's current housing situation. Good luck.

Brendan: Thanks, Ross. And, yeah, [01:06:00] flatterial ... flattery will obviously get you everywhere. Um, um, I'd, I'd say we're probably one of the more independent housing, um, research outfits in Australia, 'cause we don't have a stake in either side. Um, so we sorta talked a little bit about this before, which is conceptually the way you should think about, you know, renting is like buying a burger from McDonald's and being a homeowner is like owning a McDonald's that almo- ... that only gi- ... sells burgers to you. Only, you know, you buy your own McDonald's so that you can have a burger whenever you want it. That's the rent that you get, [01:06:30] the benefit you get from living in your own house.

You're not paying rent to someone else for the privilege of living in your house. Okay, so how do we explain what's happened in the Australian housing market over the last few years? Well, as interest rates have fallen, then the value of shares in McDonald's have increased. It hasn't had much of an effect on rents, so hasn't had much of an effect on, on the price of burgers that you're actually getting out the door, that you're selling out of your Macca's, but it has had the effect of, of upping the value of those shares. 'Cause, we know that there's a clear link. As you reduce interest [01:07:00] rates and discount rates, then has the effect of increasing the value of the, the share.

Ross: Mm.

Brendan: So that's kind of what's happened in the last few years. What's that meant is, okay, it's become easier to borrow to buy Macca's. That means we build a few more McDonald's. That does has have a bit of an effect on rent, because ... or McDonald's, um, burgers, because there's more supply of Macca's. That's one of the ways that, that, um, interest rates affect the real economy.

Ross: Okay.

Brendan: Um, it's probably meant a few more people are employed and can go and ... can go and buy burgers at McDonald's. [01:07:30] Um, and that's why, to take your example before of like rising interest rates, what would that do? Well, the price of Macca's shares would fall. Um, fewer people would be employed. Fewer people would be able to go and shop at your Macca's. That would probably have some small downward effect on the price of burgers. Um, but the main reason Macca's, uh, prices would fall for buying a shop, is because the shares had fallen because the interest rates are low.

Now, think of a world where you can't buy ... build enough McDonald's, because there's planning rules that say that [01:08:00] you can't go and build one on a new shop corner. What does that do? Well, it means that the price ... there's, there's unmet demand for Macca's burgers. It means the prices of Macca's burgers you're selling through your store rise, so that's the rent that you're paying for your house. That's why rents rise. In a world where there's more demand, from migration, we all want bigger houses, and we don't allow enough new burgers to be made because we're not allowing the McDonald's stores, that make the burgers, to be built.

Um, then if you think of the tax concessions. [01:08:30] Well, I get a tax break from owning a McDonald's. I can ... If I own a McDonald's and it makes ... and I'm, I'm borrowing to pay to, to own that Macca's, and I make a loss on my Macca's, well, I can offset that loss against my other income.

Ross: On your tax, yes.

Brendan: Tax. So I pay less tax on my labor income. Okay, that's negative gearing. Um, you, you have a tax ... discounted tax rate on the capital gains I make on my Macca's. So if my Macca's goes from being worth a million dollars to two million dollars, I only pay tax on half [01:09:00] the gain. Great. Well, that's capital gains tax effecting housing. Um, and then, you know, if you have more like ... Sorry. And then, okay, from there, let's think about what happens if, if you have a crash. Well, lots of people get excited about Macca's. They can see the prices of McDonald's are going up, to buy. The rent ... The price of the burgers isn't going up very much.

You know, what happens? Well, maybe the bank's become a bit more ea- ... um, comfortable lending lots and lots of money to, to ... for people to buy McDonald's. [01:09:30] In fact, it's 60% of their lending book, like the Australian housing market. What happens then if, uh, some of those people are unable to ... you know, there's not enough demand or, or people have borrowed money and then they can't repay it, you know, interest rates rise? Well, then they have a fire sale of McDonald's. So there's McDonald's on all these street corners that are for sale.

That reduces the price of McDonald's. Does it change the pri- ... the value of the, the, the price of the burgers? Probably not so much. Again, it doesn't affect rents very much. Uh, what does that mean for the banks? Well, then you've got a world [01:10:00] where they own all these Macca's stores, they foreclosed on the owners, but they're worth less than the debt. Well, then we've got the scenario we talked about before. So I think that the, the, the, the analogy of burgernomics actually works incredibly well for housing because I think it actually explains kind of how to think about the two markets for housing, for owning a McDonald's store or walking into one and buying a burger.

Or, if you're in Melbourne at the moment, getting on Uber Eats and asking one to be delivered to your door.

Ross: (laughs). [01:10:30] Brendan, that is a fantastic explanation. You are getting the prize for the best, uh, correlation between your topic and, uh, explaining through burgernomics. So thank you very much. Thank you for joining us. I ... What you said is really fascinating. Let me ask you one thing in closing, with this incredible cumulative knowledge you have of the housing market, on the one hand, but on the other hand [01:11:00] you're currently looking to buy a house. Does that help you or, or (laughs) hinder you?

Brendan: That's a really good question, Ross. Um, I think ... I think where my thinking has evolved over the last few years, is thinking more about the financial aspects of the transaction. So ... You know? And I think that if you ... if you do that, you need ... you need to have almost two brains ... uh, you need two conversations inside your brain. You need to have the conversation about [01:11:30] what drives prices in the short term, which is interest rates and credit. And then what drives underlying demand and supply, which affects rents over the long term.

Um, so I think a lot of people get stuck sorta thinking, "Oh, well, you know, migration's gonna come back, so house prices are gonna boom." Or, "Migration fellows are clear and house prices are gonna fall." The way I describe COVID was to say, "Look ..." We've, we've got an experiment running. I did this on a podcast earlier on in COVID, I was ... 'cause we don't make forecasts, but, you know, I was skeptical of the big declines in price ... in prices [01:12:00] being forecast. It's like we've, we've got an experiment. We're about to find out what matters for, for prices in the short term, like underlying supply and demand fundamentals or interest rates and access to credit.

And it's pretty clear in the short term, we know the answer. How did we have 20% house price boom in the middle of a world where migration came to a standstill? Well, it's because interest rates affect prices-

Ross: Yes.

Brendan: ... much more than the what the falling in, in rents affect migration ... from migration effected rents and their fall prices. So, look, I find it helpful now, 'cause I think I, I know ... I've [01:12:30] got a good handle on the ... on the whole story. That said, you know, I'm looking in five sub-markets of Melbourne. You know, I'm looking in five suburbs around Melbourne. The person who knows more about what's driving demand and supply in that, that particular market at that particular time is probably a real estate agent.