CHAIR —Thank you very much, Professor Sorensen. We are grateful to you for assisting us by appearing slightly early. I understand it is not always easy to do these things by teleconference, but at least it means you have been able to stay in the beautiful New England area of New South Wales.

Prof. Sorensen —It is a wonderful day today, yes; it is good to be up here.

CHAIR —We have the benefit of your submission. Thank you very much for supplying that for the committee. I invite you to make some opening comments and then we will go to questions.

Prof. Sorensen —I have a few fairly simple remarks and I can make them quite quickly. I think that housing affordability issues like the ones we currently have are a major issue at the tail end of periodic house price booms. We have been here before, and I think we are going to be here again. Those booms in every case that I am aware of always reflect demand in excess of supply—that is, demand for housing against the available supply. What tends to happen in each boom event is that demand spikes rapidly whereas supply responses are much more long term. So, if you like, the home development sector of the economy is unable to respond to periodic sharp rises in demand.

As a result of this lag response, so to speak, booms tend to taper slowly, but always correct eventually. In other words, the condition we find ourselves in now will slowly deflate, but it usually takes around about five years. Demand events, of course, vary between booms and in the last few years we have experienced a rapidly rising demand because of an interconnected acceleration in population growth, interstate migration, economic globalisation, rapidly rising wealth and declining house size. Those, I think, are the principle factors involved.

We are not talking here just about owner-occupied housing but also rental accommodation, and both are very closely related. Obviously at the moment, with housing affordability for owner occupiers at a low level, a lot of pressure is being put on the rental sector. I would also note that housing is, to some extent, substitutable. During price booms alternative living arrangements come into being so that we get things like group households, children living at home longer, multigenerational households and so on.

I have to say that the recent very substantial boom may well unwind more slowly than most others in the last 20 or 30 years because of Australia’s strong economy, rising immigration and a large overhang of demand relative to supply. But I think, ultimately, it will unwind. Of course, the affordability problem is both spatially and socially variable. One of the major observations in the current boom is that stress is highly restricted in some of our cities, like Sydney, to what you might call the mortgage belt. In Sydney’s case that is a line of suburbs trending west and south-west from the inner, that being south of the harbour. It is notable that in the eastern suburbs and the north shore, where housing mortgages are actually often very high indeed, it appears the stress level is a good deal lower. Any boom creates winners and losers, and we have seen that Sydney’s house prices have held up very well in many of the higher income suburbs but are well off their peaks and are up to 30 per cent lower—I have heard even 50 per cent below peak values—in some of the western suburbs.

In the long run, Australia’s current house prices relative to income are what you might term ‘obscenely’ high by international standards. According to calculations of the ratio between median household income and median house prices by Wendell Cox, who is head of the Demographia agency in the United States, Australia’s levels—at around 7 to 8—are the highest globally. They are higher than just about anywhere apart from the west coast of the United States and Florida, for example. This, I suspect, comes about for a range of reasons: certainly the tax breaks afforded to housing—for example, the absence of capital gains tax for owner-occupied housing and negative gearing for rental property may, I think, just simply tend to feed in to higher prices for housing—and the pricing of infrastructure at the state level with its very heavy user-pays element, especially in New South Wales under section 94 of the EPA Act. Generally, pricing is attributed to the owners of housing at the urban fringe—incidentally, that is a move away from what used to exist about 20 years ago when the pricing of new infrastructure was community-rated in the sense that all residents of the city would pay towards water and sewerage connections and so on out of their recurrent charges, rather than doing head works, as is done now essentially, to new residents. So, that has also put up the price of housing.

It used to be that 20 years was a common period for a mortgage, but more recently this has been bid up to 30 years, so people are mortgaging away their lives. Also, I have to suspect that the absence of death duties has led to larger intergenerational transfers, and a lot of these, passing down from parents to children, have found their way into housing. So we have bid up the underlying rate of house prices through those kinds of mechanisms. As a result of all that, in parts of Sydney it is difficult to get a block anywhere for under about $250,000, whereas in some comparable United States cities, you are looking at prices for blocks of $30,000 to $40,000, and I cannot understand why we are paying six to seven times that amount in this country.

Policy, I think, has to focus on longer term issues; there is no short-term fix available. I have heard of suggestions that, for example, we raise subsidies to first home owners through something akin to the first home owners scheme. But the Reserve Bank has, I think, ably demonstrated that those kinds of subsidies are almost immediately capitalised in the price of housing, leading to higher levels of house prices at the very time, now, when we require house prices to come down to make them more affordable. I have also heard about households dipping into superannuation pools to help keep them afloat, but I suspect that, too, would be disastrous in the longer term, keeping house prices higher than they would have been otherwise, bringing forward consumption and reducing retirement money.

So policy, from my perspective, really has to focus on matching supply and demand much more effectively than we have done in the past. That is a planning and infrastructure supply and construction issue. We need to reduce the cost of infrastructure supply—I have talked about that in the case of New South Wales—and perhaps revert substantially or at least partially to more community rating of infrastructure expenditure.

Perhaps you need a design element here, encouraging new forms of entry-level housing, enabling the rapid and flexible redevelopment of existing urban areas. One of the problems with urban planning—and I happen to be a member of the Planning Institute of Australia—is that existing residents in urban areas tend to be over-represented in planning processes and have various opportunities to comment on planning schemes and particular planning projects, but would-be residents of particular localities are, of course, not represented at all, except by would-be developers.

I think that eliminating some of the tax breaks for housing could, in the longer term, bring prices down, reducing the iconic role of housing in Australian society. I note also, of course, that higher fuel costs will eventually eat into house prices, as what we pay for our housing is largely residual after we have expended income on other essentials.

In summary, I would simply say that the three most important means of making housing more affordable for both owners and renters in the long term are: to assist in the supply of new accommodation and become much more responsive to demand; to apportion the cost of infrastructure across the community as a whole, rather than billing residents moving to the urban fringe; and to remove the tax breaks—and I would also point out that the capital gains tax exemption for owner-occupied housing is vastly regressive in a social sense, with nearly all the gain from that exemption going to high-income households. But I also think, as a final remark, that in any boom there are casualties and, inevitably, those are people who get in last in the boom phase. They overpay for the properties that they are buying and when the downturn comes—often associated with rising unemployment—they are squeezed, and they are often squeezed quite savagely. I am sorry that I cannot offer any short-term fixes, but that is briefly a summary of where I am coming from.

CHAIR —We will go to questions from members of the committee and I will start with Senator Siewert.

Senator SIEWERT —We have been all around Australia, so we have had heaps and heaps of presentations. We had one this morning from Rismark International. As you are probably aware, Christopher Joye has been advocating Aussie Mac or some form of Aussie bank. I noticed that in your submission you say that you think that would be too late and would not work. Could you just explain that a little bit, because there has been quite a bit of talk around that issue.

Prof. Sorensen —These are developments of Freddy Mac and Fannie Mae, which exist in the United States. They are mortgage providers. I actually think that the financial side of the housing system that we have is pretty well catered for in Australia. One of the events of the last five years and one which has actually propelled housing prices higher is the advent of a variety of secondary mortgage lenders, who did a very efficient job in forcing down interest rates for home borrowers but, in so doing, enabled them to pay more for housing with the budgets that they had, and that underpinned at least part of the rise in house prices. I am not sure that we need similar agencies to those in the United States. I think we have the supply side of finance reasonably well sorted—and, incidentally, it is quite competitive.

Senator SIEWERT —Going on to the issue of tax breaks, we have had a range of submissions, with most people saying that we need to look at negative gearing. The Real Estate Institute this morning said that we should not be fiddling with negative gearing. If I understand your submission correctly, you advocate getting rid of it completely. Most people have been saying to fiddle with it, maybe aim it towards more affordable housing, whereas the Real Estate Institute said, if we do that, because middle income earners are the main people who use negative gearing, it will actually stymie supply. Can you expand a little bit on your thoughts around getting rid of it completely?

Prof. Sorensen —Yes. I am very much against having more complicated tax arrangements by exempting some people and not exempting other people, for example. I think either you have negative gearing or you get rid of negative gearing, and my preference would be to avoid it. One of the advantages of negative gearing is held to be that it will improve returns on rental housing and encourage people to move into the rental housing market by buying or constructing appropriate premises. One way of getting more rental housing, and probably a better way from my perspective, is to reduce the price of homes because that should in fact improve the returns to owners of rental housing. If you have relatively low house prices—like some of those that exist in the United States in cities like Dallas-Fort Worth or Atlanta or in Canadian cities like Montreal or Ottawa, where the price of housing is about half or even less of the price of comparable housing in Sydney—and you own one of those premises, you could get a very much higher return on your asset without any need to have recourse to negative gearing. From my perspective, negative gearing seems to be a contributor to high house prices. We would have lower rentals combined with better returns for owners of rental accommodation, were negative gearing to be abolished. In fact, it would work in favour of both parties. Have I made that point clearly?

Senator SIEWERT —Yes. I suppose my issue is: how do we work now to reduce the price of housing without using a whole lot of other mechanisms that we have also been hearing about? We have heard a lot about changing tenure, for example, and using different tenure models. We had the ACT government here this morning talking about the process they are going into now—renting land to people who are building houses so they do not pay for the cost of land. We have heard about housing co-ops et cetera. Are you not going to need a whole lot of those mechanisms to lower the price of housing?

Prof. Sorensen —I do not think so. I tend to regard the high cost of housing in Australia as partly related to the tax system, as we have just been talking about, and partly related to the gap between supply and demand. If we could see our way forward to redevelop to a higher level many parts of our existing cities or provide a lot more home construction at the urban fringes, we could go quite a long way towards keeping house prices a lot lower, more stable and under control.

This is a bit of an anecdote. A couple of years ago I was visiting a friend in Dallas-Fort Worth in northern Texas. He was out there on the fringes of the city. I went to this huge house—much bigger than a McMansion—and asked him how much it had cost him. It had cost him about A$250,000 for this humungously large residence. Basically this came about solely because in that part of the world it is easy to develop. Incidentally, Dallas-Fort Worth is actually growing faster than a city like Sydney or Melbourne. The construction industry and the land development industry were geared to providing a very rapid stream of housing. If we could get our housing blocks down from $250,000 to $50,000 or $60,000, for example, we would wipe $150,000 off the price of a house at a stroke. It seems to me that this is where the problem is.

A lot of the other schemes that are being suggested are palliatives. They are situated a long way from the main game, which is simply to develop land more efficiently and more effectively and allow our cities to adapt to changing circumstances more easily. This is partly a planning problem, and I know that various Australian governments are trying to streamline and make their planning processes more efficient. It is partly an infrastructure problem. I think part of the reason why we have an affordability problem now is simply that state governments have been underinvesting in urban infrastructure now for something like two decades.

Not only that, but what infrastructure is constructed is billed up-front to new home owners at the urban fringe rather than, as I explained earlier, community rated so that all the residents of, say, Sydney or Melbourne pay for new urban infrastructure. I think the UDIA, the Urban Development Institute of Australia, is pretty close to the mark here. We are finding that infrastructure costs are adding $150,000 to a block of land in Western Sydney. That is where we should be starting. Why are we billing new urban residents that extraordinary sum of money when apparently in comparable US cities you might only be paying a few tens of thousands of dollars for such infrastructure? I think the main game is this supply-demand nexus—not trying to invent a whole new series of mechanisms around the edge to try and deal with what the main problem is.

CHAIR —Thank you very much, Professor Sorensen, and thank you for the very comprehensive submission that you have provided to the committee. In fact it touches on almost all of the pertinent issues that we have been considering over the past 13 or 14 hearings, which is very helpful to us. Thank you for your time today. I am very grateful that you were able to appear earlier than scheduled.

Prof. Sorensen —Thank you very much. I appreciate the opportunity to participate.