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The high cost of housing and how to reduce it

12 July 2017
From our ‘Thinking outside the box’ series
In this article, Michael Bell investigates whether the current high cost of housing in Australian cities like Melbourne, and especially Sydney, is caused by excessive demand or insufficient supply.

There is a debate about whether the current high cost of housing in Australian cities like Melbourne, and especially Sydney, is caused by excessive demand or insufficient supply. The finger of blame is often pointed at investors, taking advantage of the negative equity tax concession, with the suggestion that the removal or watering down of this concession would ease prices. The counter argument is that if the tax concession were axed, investment in houses would indeed be discouraged, but the supply of rental property would be correspondingly reduced, driving up rents. There is evidence from past Australian experience that this is exactly what would happen. People need homes after all and will pay whatever it takes (and afford) to find one, whether bought or rented. The solution to the high cost of housing must therefore lie ultimately in increasing the supply of housing.

An important factor generally overlooked, however, is the accessibility of housing for the many whose work requires them to commute. Where accessibility is poor, workers who need to commute will find their house hunting more confined, reducing their price elasticity of demand for housing. Where demand is less price elastic, landlords can command higher house prices or rents. Economists are able to quantify this effect: The profit maximising markup for a developer selling new units increases as the price elasticity of demand is reduced toward one (the Markup Rule). It therefore follows that improving accessibility gives house hunters more choice, increasing the elasticity of demand for housing and reducing its cost.

The implication of this argument is that a more effective way to reduce the high cost of housing would be to invest in better accessibility, which in large conurbations like Sydney, implies building more public transport infrastructure to overcome road congestion. Supply-side housing policies aimed at densification can only have limited success in bringing down the cost of housing without matching investment in the transport infrastructure. Ironically, the veracity of this argument is demonstrated by the rapidly increasing cost of housing in those inner suburbs of Sydney, like Alexandria, which benefit from good and growing public transport access, because house hunters are willing to pay more for the better accessibility. Rather than constructing more units in these inner suburbs, the more effective antidote to the high cost of housing would be to improve access to outer suburban areas.

Lack of elasticity in the housing market resulting from poor accessibility is matched by lack of elasticity in the job market. By improving accessibility, firms in search of workers with specific skills are more likely to find what they need, because the search area will be larger. Conversely, workers with specific skills are more likely to be able to find employment, or indeed have a better choice of jobs. As argued in an earlier opinion piece on shrinking supply chains and the end of globalisation, the range of job opportunities has a direct bearing on social welfare. All of which adds further weight to the need to focus on accessibility in conurbations like Sydney.

Michael Bell is the Foundation Professor of Ports and Maritime Logistics in the Institute of Transport and Logistics. 

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