I was recently invited to speak at the Geelong Business Club. After the event, I was asked a question that was both thought-provoking and contentious: Are falling house prices actually a bad thing? At first glance, falling prices sound like good news. For someone trying to buy their first home, a $700,000 house becoming a $630,000 house surely improves affordability. Lower prices undoubtedly provide relief to people entering the market, but once that first-home buyer has purchased, they become a homeowner too. Imagine saving for years, buying your first home for $700,000 and then watching its value fall to $600,000. A substantial portion of your equity has disappeared. Your ability to refinance, move or use that equity elsewhere is also reduced. The homeowner who benefited from falling prices yesterday can quickly become the person hoping they don’t fall further tomorrow.
It is all about supply. Australia doesn’t simply need cheaper houses, Australia needs more houses. Developers build when projects are financially viable – land, labour, materials, finance, infrastructure, planning costs and taxes all have to be paid before a finished home reaches the buyer. If selling prices fall below the cost and required return of the development, those costs don’t magically disappear. The project simply doesn’t get done. So we can celebrate falling house prices today while potentially making tomorrow’s housing shortage worse.
Property also affects confidence. When property values fall, household wealth falls. People become cautious, renovations are postponed, cars aren’t replaced, spending at shops and restaurants declines. Businesses are then impacted by the reduction in spending.
There is another important issue: credit. Property has historically played an important role as security for Australian lending, particularly for small businesses. A business owner might use property equity to finance a truck, machinery, working capital, a new employee or the business expansion. When property values fall substantially, the collateral supporting that borrowing also falls. That doesn’t mean businesses suddenly can’t borrow, but it can make obtaining finance more difficult or expensive and less available capital means less investment. Less investment means fewer projects, fewer employees and ultimately lower productivity.
And productivity matters; Australia’s prosperity cannot come simply from property prices continually increasing, nor does deliberately making property owners poorer create prosperity. Long-term prosperity comes from productivity – producing more value from the labour, capital and resources available to us. Productive businesses need investment. Investment needs capital. And capital requires confidence and access to finance. At the same time, higher interest rates reduce borrowing capacity and increase household repayments. Combine that with high construction costs, taxation, weak confidence and falling property values, and the cumulative effect can become significant.
So, are falling house prices bad? It’s not quite as simple as yes or no. Modest price corrections can improve affordability and remove excessive speculation. But there is an enormous difference between housing becoming more affordable because we are building more homes and household incomes are increasing, and housing becoming cheaper because households are under financial stress, credit is contracting and economic confidence is deteriorating.
The objective shouldn’t simply be cheaper houses. It should be more affordable housing. And the sustainable way to achieve that is through greater housing supply, higher productivity, stronger real incomes and fewer unnecessary barriers to construction. Falling prices might make the entry ticket cheaper, but if the result is fewer homes being built, weaker investment, reduced access to capital and a slowing economy, have we really solved the housing affordability problem? Perhaps the question isn’t whether we want house prices to fall. It’s whether we can make housing more affordable without making Australians poorer in the process.
Gareth Kent