The University of New South Wales. Australian School of Business School of Economics

Transcription

1 The University of New South Wales Australian School of Business School of Economics Long Term Housing Prices in Australia and Some Economic Perspectives Nigel David Stapledon September 2007 This dissertation is submitted in partial fulfilment of the requirements for the degree of Doctorate of Philosophy at the University of New South Wales SUPERVISORS A/PROF GEOFFREY KINGSTON A/PROF GLENN OTTO

2 ACKNOWLEDGEMENTS I would like to thank my supervisors Geoffrey Kingston and Glenn Otto for their support in my endeavours to construct a dissertation. Geoffrey has been my principal supervisor and takes prime responsibility for keeping me on track to completion. Thanks also to the many members of the Department and fellow PhD students who have made my time at UNSW intellectually challenging and enjoyable. I would also like to acknowledge the work of previous economists in the field. It is only when one attempts to build a primary data base as I have that one can perhaps properly appreciate the endeavours of economists such as N G Butlin on whose work I draw in constructing the historical framework in which to put my data. Finally I would like to thank my family, wife Jennifer and children Alan, Rebecca and Peter for their support, understanding, forbearance to my constant distraction (they would argue what s new), and love during the past four years. To my parents, Roger and Ann Stapledon, also who have continued over the many years to take an interest in and support the wanderings of their son, many thanks. i

3 ABSTRACT This thesis constructs, principally from primary sources, a long term time series for house and land prices for Sydney and Melbourne, and house price and rental yield series for Australia. These new series span the period and give an historical perspective beyond the period from 1970 for which existing house price time series begin for Australia and for most of the world. The price series indicates that the modern experience (i.e. since the 1970s) of a significant upward trend in real prices differs markedly from the experience in the first half of the 20 th century when house prices moved very little. The thesis then takes several approaches to explaining the apparent shift in direction in the mid 20 th century. The first approach examines house prices in terms of demand and supply variables. Urban theory says that demographic and income factors are critical. However, assessed over this long time span, these demand factors do not offer a satisfactory explanation. Additionally, it is found that there is no cointegrating relationship between prices and income. Rather, it appears that supply factors have probably been the pivotal influence in explaining the shift in direction, consistent with a growing literature which focuses on the role of regulation and other constraints on supply. In Australia s case, government policies imposing capital contributions on the cost of land appear to be a major factor. The second approach taken is to view housing in terms of asset pricing as more typically applied to the equity market by Campbell and Shiller (1988) and others. A central debate is whether or not there has been a structural fall in the equity yield and given the parallel fall in the house yield, this question is posed for housing. The thesis finds that tax and other factors can explain a structural decline in the housing yield. The house rental yield appears to be a better predictor of future rental growth and a negative predictor of future returns. ii

4 CERTIFICATE OF ORIGINALITY I hereby declare that this submission is my own work and to the best of my knowledge it contains no materials previously published or written by another person, or substantial proportions of material which have been accepted for the award of any other degree or diploma at UNSW or any other educational institution, except where due acknowledgement is made in the thesis. Any contribution made to the research by others with whom I have worked at UNSW or elsewhere, is explicitly acknowledged in the thesis. I also declare that the intellectual content of this thesis is the product of my own work, except to the extent that assistance from others in the project s design and conception or in style, presentation and linguistic expression is acknowledged. Nigel Stapledon iii

5 TABLE OF CONTENTS ACKNOWLEDGEMENTS. i ABSTRACT ii CERTIFICATE OF ORIGINALITY. iii TABLE OF CONTENTS... iv LIST OF FIGURES.. vii LIST OF TABLES... viii TABLE OF CONTENTS: APPENDICES ix DEFINITIONS.xiii TABLE OF CONTENTS Chapter 1 Introduction... 1 Chapter 2 House and Land Prices Introduction Existing historical estimates: A review Existing estimates of Capital City House Prices pre Review of house price methodology New House and Land Price Series for Sydney and Melbourne Sydney Asking Price Series House prices Sydney Sale Price Series Comparison of New Sydney Series and the Abelson Series Melbourne House Asking Price Series Melbourne Prices Melbourne House Sale Price Series New series on Sydney and Melbourne land prices Some aggregate price series for Australia Constant quality house dwelling price series for Australia Increase in quality of structures Compositional Effects iv

6 2.5.3 Aggregate Quality and Compositional Effects Gross and Net Rental Income and Yields Estimates of private gross rental income Estimates of dwelling expenses and private net rental income Estimates of gross and net rental yield and real income Discussion Broad Trends Pre-WW2 Cycles in Land and House Prices The period of price controls and its aftermath Post-WW2 Cycles Chapter 3 Macro-economic Influences on Australian Houses Prices Introduction Theoretical Model The Price to Income Ratio The price to income ratio Price-to-income ratio as equilibrium Rent to income ratio Theory and the ratios Other measures of price to income ratios Linear regression model for change in house prices The model The data The results The Results and Demographic Trends The Results and Construction Costs Explaining the structural rise in prices Transport costs The rise in the cost of fringe urban land Discussion v

7 Chapter 4 Housing Yields : Steady State and User Cost Introduction Theoretical Framework User cost defining steady state housing yield Previous studies Issues with equilibrium user cost Some long term measures of user cost Housing earnings yield as steady state Candidates to explain the long term decline in the net housing yield Linear Regression Model of Structural Change Model The Data Econometric issues Empirical Results A closer look at the explanatory variables Discussion Conclusion: implications for the housing market in the early 2000s Chapter 5 Housing Returns : Predictors of Future Returns Introduction Past returns as predictor of future housing returns Housing yield plus rental growth as predictor of future returns Housing yield as predictor of real rental and price growth Econometric issues Regression results Conclusion vi

8 Chapter 6 Conclusion Reference List LIST OF FIGURES Figure 2.1 Sydney Median Detached House Prices Figure 2.2 Melbourne Median Detached House Prices Figure 2.3 All Capitals Median Detached House Prices Figure 2.4 Market Value of Private Dwelling Assets to Income Figure 2.5 Real Rental Income per Dwelling Figure 2.6 Gross Dwelling Rent to Income Figure 2.7 Gross and Net rental Yields Figure 2.8 Measures of Sydney Mean House Prices Figure 2.9 Gross Rental Yields: All Dwellings vs. Sydney Rental Figure 2.10 Real dwelling rental price index Figure 3.1 Mean house price to income ratio Figure 3.2 Gross rent to income ratio Figure 3.3 Capital cities median price to income ratio Figure 3.4 Constant quality house to income ratio Figure 3.5 Adult household growth rate and house prices Figure 3.6 Adult household growth rate and price to income ratio Figure 3.7 Real construction costs vs. house prices Figure 4.1 Net housing yield Figure 4.2 OECD user cost with 4% fixed costs Figure 4.3 OECD variable rate user cost with 4% fixed costs: Figure 4.4 OECD fixed rate user cost with 6% fixed costs: Figure 4.5 OECD fixed rate user cost Figure 4.6 Rental expenses as percent of housing market value Figure 4.7 Period average and actual net housing yields Figure 4.8 Period average and actual gross housing yields Figure year bond yields and expected inflation Figure 4.10 Marginal tax rate on male average earnings Figure 4.11 Housing sale transfer costs Figure 4.12 Inflation expectations Figure 4.13 Real 10- year house price growth Figure 4.14 Real rent and house price growth Figure 4.15 Regression model: net dwelling yield vii

9 Figure 5.1 Cumulative average returns from housing Figure 5.2 Cumulative average returns from housing Figure 5.3 Cumulative average net housing yield Figure 5.4 Contribution of change in valuation ratio to capital gains Figure 5.5 Contribution of change in valuation ratio to capital gains LIST OF TABLES Table2.1 Sydney median detached house price series Table2.2 New Long Term Melbourne House Price Series Table2.3 Sydney land prices vs. house prices 1880s Table2.4 Melbourne land prices vs. house prices Table2.5 New estimates of Australian median capital city house prices Table2.6 Private sector market value of dwellings Table2.7 Increase in value of structure, % market value Table2.8 Measuring compositional effect: Sydney Table2.9 Final estimates of gross rental income and yields Table2.10 Estimates of Gross Rental Income for Various Years Table3.1 Chow Tests for Structural Break in Mean Price to Income Ratio Table3.2 Stationarity test for price and rent to income ratios Table3.3 Correlation Matrix for Data Series Table3.4 Regression of determinants of change in real house prices Table3.5 Levels regression of real house price (Mankiw and Weil) Table3.6 Australian adult population growth : period averages Table3.7 Correlation coefficients: house prices and costs Table4.1 Stationarity test for gross and net rental yields Table4.2 Regression of Housing Yield and Fundamentals, Incl. House Price Growth Table4.3 Regression of Housing Yield and Fundamentals, Incl. Rent Growth Table4.4 Contributions to decline in net housing yield Table4.5 Unit Root Tests for Variables in Tables 4.2 and Table5.1 Testing the predictive powers of the net housing yield viii

10 TABLE OF CONTENTS - APPENDICES Appendix A : Historical House Price Data A.1 Existing house price series A.1.1 Existing historical estimates of land prices A.2 New House Price Series for Sydney : The data A.2.1 Asking Price Series A.2.2 Sale Price Data Sydney A.2.3 Modifications/stratification of median price data - Sydney A.2.4 Other data A.3 New House Price Series for Melbourne : The data A.3.1 Asking Price Data Melbourne A.3.2 Sale price series for Melbourne A.3.3 Modifications/stratification of median price data A.3.4 Other data A.4 Sydney and Melbourne: Mean price series A.4.1 Units A.5 Capital city median house price series A.5.1 Sydney-Melbourne composite median and mean price series A.5.2 Capital city house prices in the period A.5.3 Capital city house prices in the period A.5.4 Capital city house prices in periods and A.6 Constructing the Market Value of All Dwellings A.6.1 Non-metropolitan price series A.6.2 Constructing a series for non-house dwellings A.6.3 Constructing mean prices and market value of dwelling assets A.7 Estimates of Gross and Net Dwelling Rent A.7.1 Gross Rental Income A.7.2 ABS estimates of expenses and net rental 1948/ / A.7.3 Estimates of depreciation and expenses 1900/ / Appendix B: Historical non-house price data B.1 Stock of Housing B.2 Population B.3 Household numbers and size B.4 Nominal GDP B.5 Real GDP B.6 Inflation B.7 Real income per capita/household/adult B.8 Rent Indexes B.9 Construction Cost Index B.10 Marginal tax rates on average earnings B.11 Interest rates ix

11 B.12 History of Rent Controls Appendix C: Review of urban economic theory C.1 Summary C.2 Rural Land C.3 CBD Location Rent C.4 Transport costs and urban rental value: some additional points C.4.1 Transport costs common to urban and rural land C.4.2 Transport costs and potential size of urban areas C.5 Location rent and constraints on the urban area C.6 Ocean location rent C.7 Cost of conversion of rural land to urban land C.8 Cost of structures C.9 Aggregate urban rental value C.10 Aggregate price of housing Appendix D: Asset Pricing Theory and the Housing Market D.1 Overview D.2 Equilibrium and Rental Yields in the Housing Market D.2.1 Expected Returns for Housing D.3 User Cost: A special case D.4 Housing returns and rental yield: Decomposing land and structure LIST OF FIGURES - APPENDICES Figure A.1 Various Sydney median price series Figure A.2 Sydney Median Land Prices Figure A.3 Melbourne Median Land Prices Figure A.4 Capital cities median house price series Figure A.5 All capitals to Sydney-Melbourne house prices Figure A.6 All capitals to Sydney-Melbourne house rents Figure A.7 Adelaide median house price series Figure A.8 Perth median house price series Figure A.9 All capitals to Sydney-Melbourne house prices Figure A.10 Victorian non-metro to Melbourne house prices Figure A.11 Queensland non-metro to Brisbane house prices Figure A.12 SA non-metro to Adelaide house prices Figure A.13 Australian non-metro vs. capital city house prices, Figure A.14 Assumed & actual ratio of non-metro: capital city house prices Figure A.15 All capitals and non-metro house prices Figure A.16 Metropolitan unit vs. detached houses prices x

12 Figure C.1 Rental value of land in urban area Figure C.2 Rental value of urban land and transport costs Figure C.3 Impact of green belt on rental value Figure C.4 Ocean vs. inland cities east-west profile Figure C.5 Ocean vs. inland cities north-south profile Figure C.6 Topographical perspective of ocean and inland cities LIST OF TABLES - APPENDICES Table A.1 Sydney median house price series Table A.2 Melbourne Median House Price Series Table A.3 Neutze Index Series of House Prices Table A.4 Sydney and Melbourne Land Prices Table A.5 Cost of Urban Fringe Allotments Table A.6 New Sydney Asking Price Series Table A.7 New sale price data for Sydney Table A.8 Ratio of asking price to sale price estimates Table A.9 Sydney : Other Housing Data Table A.10 New sale price data: Sydney units various years Table A.11 New Melbourne asking price estimates Table A.12 New Melbourne Sale Price Series Table A.13 Melbourne unit sale price series Table A.14 Melbourne Allotment Prices Table A.15 Sydney : Modified price series for All Houses Table A.16 Sydney : Modified price series for All Houses* Table A.17 Sydney : Modified price series for Units Table A.18 Rents and Rent Ratios for the Capital Cities Table A.19 New estimates of gross rental income in census years Table A.20 ABS rent index vs. census rents 1900/ / Table A.21 ABS Estimates of Expenses Selected Years 1948/ / Table A.22 Butlin, ABS and New Estimates of Expenses Table B.1 Historical data Housing stock and population Table B.2 Share of dwellings by region Table B.3 Measures of GDP Table B.4 Inflation measures xi

13 Table B.5 Capital city rent indexes Table B.6 Interest rates, average earnings and marginal tax rates xii

14 DEFINITIONS Dwellings refers to all types of dwellings. Houses refers to detached houses. Also generic term which when the context is clear refers to dwellings in general. Medium density houses refers to semi-detached houses, attached houses, terrace houses and townhouses. This definition is from ABS Census (1971, 2001). All houses detached houses and medium density housing. Units refers to all dwellings other than houses and medium density houses, e.g. flats, units. Rents rent on dwelling, comprising structure and land. No separate measures of rent on structure and land. Gross rental income unless otherwise specified, refers to aggregate of actual rent on tenanted dwellings and imputed rent on owner-occupied dwellings. Net rental income gross rental income less all expenses, including depreciation but excluding interest payments. Real terms where a series is specified as being in real terms, it has been deflated by the private consumption price series in Appendix B, Table B.4. Growth rates where the text refers to growth between any two periods, the growth rate is estimated as the geometric annual growth between the two points. It is not the arithmetic average which is the average of the annual growth rates. Unless otherwise specified growth rates for house price series are in real terms. Yield refers to gross or net rent income return as percentage of nominal value of dwellings. Return unless otherwise specified refers to real return and comprises net yield plus real rate of growth of capital gain. ABS Australian Bureau of Statistics and its predecessor, Commonwealth Bureau of Census and Statistics. xiii

15 Chapter 1 Introduction Studies of house prices in OECD countries have been effectively restricted to the post 1970 period because of a lack of price data before then. By contrast, historical data on the US equity market goes back to 1802 and for the Australian equity market back to 1880 which has allowed empirical analysis of the equity market to examine trends over a much longer time span. The period since the early 1970s has been one in which house prices have risen quite significantly by any measure with the median capital city house prices in Australia having risen on average 3% per annum in real terms in the period While the rises in Australia have been above the average for developed countries, the picture is similar in most OECD economies and Australia is by no means unique. The question that can be asked is whether this period of history is unique for housing? Eichholtz (1997) has constructed a long term series for Amsterdam in Holland which spans the period The broad picture that his time series paints is one of prices essentially showing no trend for three centuries, with cycles related to the economic events. Against that long term perspective the post 1970 rise in house prices in Holland stands out. But one city is probably not convincing. To shed light on that, the first objective, and major contribution, of this thesis will be to construct a long-term series of house prices for Australia for the period To that end I gather a substantial amount of primary data on house and land prices for Sydney and Melbourne for the period , these new series over-lapping with existing series which start from The intent is a series which generates simple measures of the mean and median house and land prices in those cities in the June quarter each year. I then use those series as the base to construct median detached house price series for Sydney, Melbourne and the capital cities for Australia spanning the period. Samples for Sydney and Melbourne large enough to generate detailed annual assessments of quality and compositional effects was not considered feasible but long-term trend estimates of changing quality and compositional effects are derived and applied to the annual series to give a constant quality price series. To fill out the historical picture I also use the new series 1

16 as a base to construct a measure of the aggregate value of Australia s private sector dwelling assets which extends a Commonwealth Treasury series starting from 1960 back to As a separate exercise I construct series of gross and net rental income for the period to be used to measure real rental income per dwelling and in conjunction with the market value of dwelling assets, to give a measure of the gross and net rental yields on housing for that period and allow a measure of long-run returns on housing. The picture painted by these various new series give a broad picture of long-term trends and cycles in the housing market and do support the idea that the period from 1970 is different. More correctly, from about the mid -1950s there appears to have been a shift in direction in the housing market in Australia. For the preceding period, the price measures point to a flat trend in real house prices in constant quality terms; there is a similar flat trend in real rental income per dwelling and rental yields; while the aggregate value of housing was also broadly steady as a ratio to income. From circa the mid 1950s, each of these price measures shifted decisively to a clear upward trend. At the same time, while the historical picture is distorted by rent controls in the 1940s and 1950s, there also appears to have been a decline in housing rental yields. The second objective was to use these new long-term series to examine some of the potential economic explanations for this apparent shift in direction. I take two approaches to this question. The first is to look at in terms of macro-economic influences. Theory and the literature give a significant role to income as a prime determinant of housing/land value but a contentious point is the nature of the relationship between income and prices, with some arguing that there is a fixed or cointegrating relationship between the two variables. A long run series is ideal for testing such a relationship so I take the opportunity to test that and tests confirm the observation that there is no fixed relationship. To assess all the macro influences, I construct a long-term linear regression of the determinants of changes in house prices. The results indicate that income and demographic factors are important influences but also confirm that these demand variables do not provide an anywhere near adequate explanation for the shift in trajectory in house prices. Central to urban economic theory is the role of transport costs and in the mid 1950s, it is interesting to observe that economists were expecting transport costs to continue to drive down land prices subsequently traffic 2

17 congestion has come along and spoiled that prediction but it is not sufficient to explain the shift in direction. There is a growing focus in the US literature on the role of supply variables in determining house prices with, for example, the role of regulatory controls seen as a significant explanation for the upward trajectory in house prices in that market. The Sydney and Melbourne data on land prices give a measure of the price of fringe land which shows a sharp upward trajectory post In turn, given the role of supply variables in determining fringe land prices, that supports the proposition that supply side factors do play a central part in explaining house prices in Australia. The second approach to explaining the house story is to use the net housing yield and housing returns and to look at it in terms of asset pricing theory. In the equity literature, a key debate is over whether the long term average equity yield is a measure of long term equilibrium or alternatively whether there has been a structural decline in the equity yield. I argue that taking this same approach with housing offers insights into the behaviour of housing. A number of studies have taken a similar tack but the key to those studies has been the relationship between the user cost, effectively mortgage rates when expected capital gains are assumed constant, and the housing yield. While interest rates do matter, these models have not been very satisfactory in defining equilibrium. I take as a starting point that there is probably more insight to evaluating equilibrium in terms of the housing yield itself. As with the equity market I ask the question as to whether structural factors, such as changes in tax, can adequately explain the fall in the housing yield observed since about 1940? The linear regression model I construct supports a prima facie case for a structural decline but as about half that comes from housing price expectations that might be conjectured to be more cyclical than structural. Another interesting issue, which pertains to the efficiency of the housing market, is whether the housing rental yield is a predictor of prices or rents. Applying a version of the approach taken by Campbell and Shiller (2001) to the US equity market, I find some evidence that it predicts both prices and rents. My approach is to test the application of each of those two approaches to the housing market with the long term historical series I have constructed providing me with a broader perspective than has been available to others. 3

18 The thesis proceeds as follows. In Chapter 2, I use the primary data I have collated for Sydney and Melbourne houses prices for the period to construct several series of house and land prices for those cities for the period I then use those series as the base to construct a series for median detached prices for Australia s capital cities and a series for the market value of private dwellings for Australia for the period I also construct measures of gross and net rental income which I use to formulate a measure of gross and net housing rental yields for the period and, in conjunction with the estimates of real constant quality price changes, returns to housing over that period. In Chapter 3, I look at the macro-economic factors which might explain the shift in direction in house prices and rents since the mid-1950s: taking a close look at the relationship between prices and income; constructing a difference model to ascertain the contribution of demand and supply variables to changes in house prices; and, conjecture on the supply factors which might explain the rise in prices. In Chapter 4, I review the existing literature on applications of asset pricing theory to housing and then construct a long-term model to evaluate whether the long term observed decline in net housing rental yields can be explained in terms of fundamentals. Then in Chapter 5 I look at predictors of future returns and test whether the net housing yield is a predictor of growth in rents and prices. Finally, in Chapter 6 I conjecture as to what the long term history of housing and the analysis that follows might tell us about the future. There are four Appendices to support these Chapters. Appendix A outlines the original housing data and detailed workings to support the series used in Chapter 2, Appendix B sets out the long time span of non-housing data I have used to build the housing story. Appendix C supports the theoretical framework for urban economic theory set out in Chapter 3. Appendix D supports the theoretical asset pricing framework for housing set out in Chapter 4. 4

19 Chapter 2 House and Land Prices Introduction I have collected a large sample of primary data and constructed annual series for Sydney and Melbourne house prices spanning the period Those series tie in with existing series from 1970 for both those cities, and existing historical series from in the case of Melbourne, and allows construction of a continuing series from , which are highlighted in Figures 2.1 and 2.2 (see page 10). The data for these new time series are presented in Table 2.1 and Table 2.2. The primary data came from two sources: weekly newspaper reports of actual sales and advertised asking prices for houses. There is precedent for both types. BIS-Scrapnel constructed series for Sydney and Melbourne from 1965 based on the same newspaper reports of actual sales. In the case of advertised asking prices, there is precedent in a series constructed by Butlin (1964) for Melbourne spanning the years and by the US National Housing Agency for Washington, DC for the period (Fisher, 1951). Both data sources proved rich resources. As a by-product, I also collected data from both sources which present a picture of movements in fringe land prices in Sydney and Melbourne in the period The asking price data also allowed construction of estimates of the gross rental yield for rental housing for the period Using the Sydney and Melbourne price series as a base, I have constructed a capital cities series for median prices for and also an estimate of the market value of Australia s private sector dwelling assets for the same period. These have been spliced with existing price series estimates for capital city house prices which start in about 1970 (Abelson and Chung, 2004; ABS ) and the market value of private dwelling assets (Commonwealth Treasury, 2006; RBA) 1 which start in 1960, to create series spanning The series for median capital city house prices is shown in Figure 2.3 and the dwelling wealth series, expressed as a percentage of nominal GDP, is shown in Figure 2.4, 1 Commonwealth Treasury series published annually in Summer Edition of its Economic Roundup. RBA series published in RBA Statistical Bulletin B20. 5

20 and the data is shown in Table 2.3. These are substantial additions to the historical picture of housing in Australia. The Sydney and Melbourne price series represent estimates of the median prices in each year. That is, they do not account for the effects of the changing locational composition of the housing stock and the changing quality of housing structures, both from period to period and over the long term. These have been issues clouding most house price series and, in response, a number of techniques have been applied designed to refine housing price series, namely repeat sample, hedonic pricing and modifications to the traditional stratification methodology. However, the pre-requisites for these new methods are a large sample and good quality data on the characteristics of the housing sample. The database falls short in terms of the pre-requisites for a repeat sample or hedonic series, but does allow stratification of the data. While the level of stratification is limited by the size of the sample, it does indicate that the samples are a reasonable representation of the composition of the housing stock in most years. Larger samples could be collected but the collection cost would be very significant and for probably only a small incremental improvement in the quality of the house price series. The stratification exercise has been used to correct period to period volatility in the series. It has also been used, comparing points in time, to make estimates of the impact of the changing composition of Sydney and Melbourne in understating median price changes over time. I estimate that the compositional effects subtracted an average 0.35% per annum over the period To capture the improvement in the quality of the housing stock in the period, I have used ABS estimates of dwelling capital stock for the period to estimate the net contribution of new houses and alterations and additions less depreciation, to the market value of the dwelling stock the estimate was that it added 0.7% in that period. Over the longer period , I estimate quality improvements added an average 0.95% per annum to housing values while the compositional effects subtracted an average 0.35% per annum, giving a net constant quality factor of 0.6% per annum. I have used that net estimate to construct median constant quality price series for Sydney, Melbourne and the capital cities which are also shown in Figures 2.1, 2.2 &

21 Apart from prices, rental indexes and rental income are the other measures of the value and change in value of dwellings. In Australia s case the ABS has published an index of rents for houses for the capital cities starting in 1901, with quarterly data from There are also existing annual estimates of gross and net rental income for the period from which are from the ABS published national accounts series for the period from 1949 while earlier estimates owe much to the hard work of Butlin (1962). With the benefit of hindsight, i.e. observing the official ABS series from , I have chosen not to use the Butlin rental income series and to reconstruct estimates for the period for both gross and net rental income. I have then used the estimates of gross rental income for to construct a series for real gross rental income per dwelling which is shown in Figure 2.5. The series is deflated by the consumer price deflator, so that the long term rise in the series reflects the combined effect of a rise in the units (or volume) of rent per dwelling and a rise in the real price per unit. The estimates of gross and net rental income have been divided by estimates of nominal GDP to give a rent-to-income ratio which is shown in Figure 2.6 As a prime objective is to assess the housing market in an asset pricing framework, I have used the estimates of gross and net rental income, together with the estimates of the market value of the private dwelling stock, to construct gross and net rental yield series for the period , shown in Figure 2.7. Ambrose, Eichholtz and Lindenthal (2006) have created a rental yield series for Amsterdam/Holland which starts from but apart from that series, these new long term series of rental yields are one of the first such series created for any country for such a time span. For Australia, the RBA has constructed a gross rental series for the Australian capital cities starting in , and over that shorter period the RBA series shows similar movements. These various long time span series give a very different perspective on the history of prices than when viewed from the shorter time period They show that house prices, in real terms and allowing for quality adjustment, appear to show no real trend in the 2 I have collated these in Appendix B.8. 3 RBA Bulletin, July, 2002, pp 5. 7

22 period Consistent with that, the estimates of real prices of fringe land for Sydney and Melbourne also show no trend in real terms over this period. From the mid 1950s, house and land prices have moved up significantly. In the case of Sydney, the real constant quality median price of detached houses rose by 5 times in the period or about 3.3% per annum, while for Melbourne, the real constant quality price of houses rose by 3.2 times in the period or about 2.3% per annum. Over that same period, the price of fringe land has risen by a factor of 21 in Sydney and by a factor of 12 in Melbourne. The price of fringe land represented 16% and 13.5% respectively of the value of the median detached house in Sydney and Melbourne in 1955, and in 2005 it represented 58% and 41% respectively. It accounted for two thirds of the rise in the median house price in Sydney and for half of the rise in the median house price in Melbourne in this period. Consistent with the price movements, the market value of dwelling assets, expressed as a price to income ratio (percentage of GDP), shows no trend in the period from around a ratio close to about one. From the mid 1950s it then exhibits a clear rising trend, with the ratio to GDP doubling by the mid 1970s. There is then a marginal rise in the ratio to about 2.4 in the mid 1990s. The period from the mid 1990s to 2006 then stands out, with the ratio rising sharply to over four times GDP in this relatively short period. Expressed as real dwelling wealth per capita, it shows a steady rise in the period from , cumulatively rising by a factor of 2.6 times in that period. That rise chiefly reflects the increase in number of dwellings per capita (or decline in occupants per dwelling) rather than the modest 0.7% per annum average rise in the real value of the average dwelling 4. In the period , reflecting a further continuing rise in dwellings per capita but more the rise in real value per dwelling in this period, dwelling wealth per capita rises by a factor of nine times. The estimates of real gross rent per dwelling show no trend in the period to 1939 and consistent with that and the steady trend in prices, gross rental yields show no trend in the period. The estimates separately collated from the asking price data of gross rental yields for Sydney and Melbourne also show no real move in this period. Then from This 0.7% rise incorporates the improvement in the average quality of dwellings in this period. 8

23 government legislation fixing nominal rents, a policy which was only phased out gradually from 1952, had the effect in a period of high inflation of pushing rental yields well below market levels. The presence of controls on house prices in the years means that the impact on measured rental yields is not observed until, with the lifting of controls on house and land prices, house prices spiked sharply in Looking through that distortion there appears to be a clear decline in gross dwelling yields, or rise in the price-rent ratio, in the period from 1949 to That occurs notwithstanding that both real gross rent per dwelling and dwelling prices both show a clear upward trend over this period, the rise in prices has been more pronounced. In between, net yields were high in the 1980s, at levels comparable with those pertaining in the period This is not dissimilar to the experience of the equity market which also experienced high yields in the 1980s associated with high inflation and high interest rates. Subsequently, both equity and dwelling yields have fallen sharply, with the decline in dwelling yields lagging the decline in equity yields. This Chapter proceeds as follows. In Section 2.2, I review the existing historical estimates of houses prices for Australia and the debate about methodology used in constructing house price series. In Section 2.3 I present the new house and land price series I have constructed for Sydney and Melbourne. In Section 2.4 I have used the series for Sydney and Melbourne as the base to construct median house price series for Australia s capital cities and the market value of private dwelling assets for Australia. In Section 2.5 I estimate the effects of compositional and improvements in the quality of the housing stock on price changes over time and construct a constant quality series for the capital cities. In Section 2.6 I construct estimates of gross and net rental income for dwellings for the period to supplement the ABS estimates from 1949, then use those to create series for dwelling yields. Then in Section 2.7 I discuss the broad long term trends and major cycles illustrated by observation of the historical series. 9

24 Figure 2.1 Sydney Median Detached House Prices S e r i e 1000 s $'000 $'000, 2005 prices, log scale Median price (2005 prices) Index 1000 S p l i c e d 100 Constant quality index 1880= S e r i Figure 2.2 Melbourne Median Detached House Prices e S e r 1000 i e s $'000 Median price $'000, 2005 prices, log scale Constant quality index 1880=100 Index 1000 S p l i c e d S e

25 Figure 2.3 All Capitals Median Detached House Prices $'000, 2005 prices, log scale Capital city median price Capital city constant quality Figure 2.4 Market Value of Private Dwelling Assets to Income Commonwealth Treasury series New series Ratio to GDP

26 Figure 6.3: Ratio of gross rents to income Figure 2.5 Real Rental Income per Dwelling 12 $'000 $' Real gross rental income per dwelling Real net rental income per dwelling Figure 2.6 Gross Dwelling Rent to Income ratio Impact of recession on GDP ratio mean = Period of rent controls mean =

27 Figure 2.7 Gross and Net rental Yields % Gross rental yield Net rental yield % Impact of rent controls

28 2.2 Existing historical estimates: A review Existing estimates of Capital City House Prices pre-1970 For the period from about 1970, there is a substantial amount of data on house prices for Sydney and Melbourne and the other capital cities, and in the later years data on non-metropolitan house prices, which is set out in Appendix A.1. For the purpose of constructing spliced series spanning the period , I have used Abelson and Chung (2004) preferred series for the period from which is based on series from BIS- Scrapnel for Sydney and Melbourne and data from various State agencies (e.g. NSW Valuer-General). From June quarter 1986 I use the price series I have imputed from the ABS index of median house prices for the period and for the period , I use the actual ABS price estimates. For the years prior to 1970, the most comprehensive work on Sydney house prices has been done by Abelson (1985) in generating several series for all house prices spanning the period Neutze (1972) has also collated an index series for several representative areas of Sydney for the period Daly (1982) collected what appear to be a small number of irregular estimates of average selling prices for houses in Sydney for the period from Abelson (1985) constructed his series from NSW Valuer-General data on sale prices and improved and unimproved property valuations from a sample of (in the first years) about 2000 (detached and median density) houses, rising to about (in the final years) 4000 houses. In the early years, the number of sales from that sample population was small (<1-4% per annum) while all houses were revalued about every three years. The estimates from sales were typically well below the estimates from the valuation data which, particularly as valuations have a downward bias, points to sample bias. For those reasons Abelson preferred the series generated using valuations for the period covering the 1920s and 1930s. The valuation-based estimates were also volatile but that was partly solved by creating a repeat sample series. In the 1950s and 1960s the frequency of valuation dropped to about every six years and given the movement in the market in this period, the valuation series started to lag. At the same time the sample size of sales had increased which improved the 14

29 representation of the sale series although it still remained disconcertingly volatile and does not match well with the BIS-Schrapnel series in the 1960s or the new series I have constructed for the 1950s and 1960s. Nonetheless, the broad picture painted by the Abelson series for this period is similar to that of the new series I have constructed (see Figure 2.8 below ). That is, it indicates flat prices in the 1930s and 1940s, followed by an upward trend in the 1950s and 1960s. Neutze (1972) collated an index series for Sydney for the period He selected four municipalities of Sydney which he took as reasonably representative areas of the city in that period and collected sales data from the Local Government valuation rolls. As can be observed in Figure 2.8, the movement in the Neutze series closely corresponds with the movement in the new series I have constructed which covers this period. Figure 2.8 Measures of Sydney Mean House Prices $'000, log scale Abelson repeat IV series Neutze Series New mean series Daly (1982) presents a picture of mean house and land prices for the period Closer inspection reveals that Daly appears to have constructed estimates at 5-yearly intervals and interpolated movements in prices between those years, presenting this in his. 15

30 His prime sources are stated to be newspaper reports of sales and advertised asking prices from the Sydney Morning Herald 5. Daly indicates a sample of per year which is consistent with the numbers I have collected for this period 6. However, his data is not published and is only presented in figure form, specifically his Figure Close inspection of his Figure 5.5 strongly suggests that Daly has constructed estimates at 5-yearly intervals and interpolated movements in prices between those years. Thus his series misses much of the story of houses prices and as discussed below (see Section 2.7: Discussion) I find it difficult to reconcile his Figure 5.5 with the new annual series I have constructed. In the case of Melbourne, there are two series which give a picture of broad guide to house price movements in the second half of the 19 th century. Butlin (1964) constructed a series of average asking prices per room for the period This was based on the classified advertisements of houses for sale in the Melbourne Age and Argus newspapers. In measuring the series in per room rather than per house terms, Butlin was making a partial adjustment for quality. In the period from , the Victorian Census data shows a rise in the average rooms per dwelling from 2.8 in 1861 to 5.1 in The rise in room per dwelling in the period was probably a reasonable proxy for quality improvement. By itself, incremental rooms will probably overstate the rise in quantity/quality of housing but Butlin observed that there were many other factors which had improved the quality of housing in the period For the overlapping period Simon (2002) used Victorian Valuer-General data to generate a series of improved capital value per ratable property for all Victorian urban municipalities. While ratable properties include non-residential properties, it will be 5 Daly (1982), page 149. He also cites the business records of Richardson and Wrench, real estate company, held in the archives of the Mitchell Library, NSW State Library. I inspected these and found them to be of limited value. Richardson and Wrench is heavily reported in the Sydney Morning Herald in these early years but as a single agent (not a chain as is case in 2000s) it may not have representative of the whole Sydney housing market. A telephone request to Daly to view his data sources did not prove fruitful. 6 I interpret his reference to the sample sizes of as comprising land, and established and new houses. This represents a significant amount of work in collecting for each year and explains why he collected data at only five yearly intervals. 7 Daly (1982), page Victorian Census as cited in Butlin (1964), pp Butlin (1964) pp

31 dominated by dwellings: if we compare estimates of numbers of dwellings with the total numbers of ratable properties, residential properties appear to account for at least 90% of ratable properties. Moreover both residential and non-residential property markets will be moving in the same direction. Both the Butlin and Simon series move fairly closely together over the overlapping period With the severe depression of the 1890s causing havoc to government finances, one casualty was the frequency of property valuations. This is observable in the extended periods of unchanged levels in the later years of the Simon series. The data is also there to extend the Simon series beyond 1909 and, while in theory that would have potentially been a good property price measure, valuations continued to be infrequent and with that the quality of the data declined, particularly in periods when prices moved significantly Review of house price methodology There has always been an interest in house prices. However, the heterogeneous nature of houses and the cost of collecting data have discouraged efforts at measuring house prices. The advent of computer technology has changed that somewhat and this has seen increased investment in house price measurement. The ABS has published a quarterly index series of median house prices for each of Australia s capital cities since 1986 based on data of actual sales of houses provided by the various State offices registering property transfers 10. Its primary objective has not been with levels but has been to assess the rate of change in houses prices over time but it has since 2005 also published levels. In assessing price changes over time, the ABS creates a mix adjusted series using methodology which makes some adjustment for compositional changes by stratifying the data by regions within each city. In the case of Sydney the ABS stratified the city into seven regions in the period What the ABS series does not do is adjust for improvement in the quality of houses from capital spending on improvements. 10 ABS House Price Indexes: Eight Capital Cities 17