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Big problem with Australia's housing crisis and why prices have to rise

How much property costs in Australia is influenced by Many factors influence house price movements in Australia and it's the same in many other countries.

As is often the case, the current economic and political discussion in Australia is dominated by house prices.

Despite many tens of thousands of homes being bought and sold each month across Australia with counterparties happy with the prices paid and received, the popular view is that dwelling prices are incredibly high and ‘unaffordable’ for many, including renters and especially the younger ones.

Nationwide, house prices have - according to Corelogic - risen by 10 per cent since the cyclical low point in the dwelling price cycle in early 2023. While the rate of increase has slowed in recent months, house prices will set a new record high in March when the data are released next week.

Suburban roof tops to signify house prices
House prices in Australia are up around 38 per cent since 2017. (Source: Getty) (mikulas1 via Getty Images)

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Just how high are Australian house prices?

One of the interesting charts included in the Reserve Bank’s recently released Financial Stability Review plotted the level of house prices in eight countries, including Australia. Reproduced below, the chart shows the rises and falls in house prices since March 2017.

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As one would expect, the changes in house prices differ widely.

Chart showing house price changes across several countries.
Chart showing house price changes across several countries. (RBA)

Broad economic cycles vary from country to country and there is a wide divergence in the various fundamentals that drive house prices from country to country, including population growth, new construction activity, the state of the labour market, and banking rules and regulations for mortgages.

Each of these variables have a significant impact on house prices, in particular the key drivers of supply, demand and the strength of the labour market.

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The chart, in broad terms, shows that since March 2017, house prices in Australia are up around 38 per cent. This is broadly similar to the cumulative gains in Canada, below that of New Zealand and a little stronger than in the UK. Prices in South Korea, Norway and Japan are around 25 per cent higher, while US house prices have risen almost 70 per cent, although more recent US data points to a turning point lower.

In the scheme of a big picture and international view, the change in Australian house prices is close to the average of the countries used in the chart.

In terms of specifics, the average annual increase in Australian house prices over the past seven years is 5 per cent, not much more than the 3.5 per cent average annual increase in inflation over the same time.

Cost of building materials matters

One factor that is important in the broad longer-run trend in dwelling prices is the cost of building materials. These have increased by more than 40 per cent over the past seven years. The price of timber and timber products, terracotta tiles, steel and other items essential for construction have increased by an even greater amount.

The inflation rate of building materials does not have a large impact in the short term on established dwelling prices. However, over the long run, if builders’ and property developers’ basic costs are rising, a builder’s asking price must also rise if their viability and reasonable profitability are to be maintained.

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If you own a house, you own the bricks, timber, wires, windows, tiles, cabinetry, nails, screws, glue and cement and all the other materials that were used when your house was built, however long ago that was. As the price of those items, plus the labour costs of tradies and other workers who build a house trend higher over time, the replacement cost and, therefore, the selling price of your dwelling must rise.

To be sure, housing is a big issue in Australia and more needs to be done to make a serious boost to supply, including social and affordable housing for purchase and rent.

In coming up with solutions to the problem, it is critical that the planned reforms take account of all of the issues that go into adding to new construction, which in turn adds to supply. At its most basic, be aware that building costs go up over time and this feeds into selling prices and rents.

The solution to the housing problem remains adding to supply at a faster rate than the growth in demand while acknowledging that the cost of building will trend higher over time. This is probably why prices are higher around much of the world as builders in Melbourne, Wellington, Miami and Seoul all pay up for materials in scarce supply.

This trend is certain to continue, making the problem of fixing affordability a difficult and long-lasting one.