What’s Wrong with Housing in Melbourne?

This is the first article in a series, in which I share some thoughts on the housing market in Melbourne – a recurring topic in my conversations with friends who recently relocated to Australia.   

Melbourne is experiencing its most vigorous era of change.  Population growth, urbanisation, and the transformation towards service-based economy are causing profound changes in the city’s landscape.  However, the city’s housing market is not doing very well.  

Over the past century, Melbourne has evolved as low-rise suburbs spreading out from a high-rise Central Business District (CBD) where jobs are located. As the city has reached a population of five million people, its urban sprawl and the century old low-rise mode of housing have become a big economic mistake.  Melbourne’s housing in-affordability has become legendary, it is the 4thleast affordable housing market on the Demographia international list of 2019.   

As this series of articles will explain, much of the blame lies with the government’s approach to housing which is entangled with an obsession with home ownership. This combination has caused one of the city’s most serious and longest-running economic controversies. A fresh plan/architecture is urgently needed.

In this article, I attempt to give a quick background on some of the challenges that are affecting the dynamics of the city’s housing market.  

Population Growth 

The State of Victoria is currently experiencing its third population boom, rivalling the gold-rush and post-War booms.  However, over 90% of its growth is taking place in Melbourne, and in areas within 2 hours’ drive of central Melbourne (SGS Economics and Planning). 

Melbourne is home to aprox 5 million people, today.  Based on current immigration, fertility and life expectancy trends;  it is projected to become the largest city in Australia with an estimated population of 8 million by 2051, and 12 million by 2066, surpassing Sydney during the 2030s (ABS, 2018).  This is an unprecedented population growth, and it is more significant growth rate than most other cities in rich nations.  The city must meet its housing demand without jeopardizing its quality of life for which it is renowned.   

Melbourne’s population growth has both benefits and challenges. It has the potential to provide the city with the critical mass needed to better build infrastructure; deliver services; transition to a low-carbon economy.   However, it is adding a lot of pressure on the city’s infrastructure and housing market. 

Urban Sprawl 

Melbourne is Australia’s largest urban area geographically.  It is also among both the very largest by size and the least densely settled cities in the world.  The city occupies the 32nd largest urban area in the world at 2,453 square kilometres, making it larger than London, which is home to 10.4 million people, and Mexico City, with 20.4 million residents. Melbourne ranks as the 955th most densely populated city out of the 1,040 on the Demographia list, with approximately 1,500 people per square kilometre.

Since its founding in 1835, Melbourne developed following a low-rise, low-density urban sprawl model.  It continues to use this model up till today.  However, this model has well established negative social, economic and environmental externalities; such as: costly infrastructure (development and maintenance), car dependency, long commutes, social isolation, loss of walkability, loss of agricultural land, higher carbon footprint … etc.  Continuing to use the sprawl model – beyond the 4-5 million inhabitant limit - will come at significant cost to economic productivity, environmental degradation, and social isolation.  

A high portion of Melbourne’s fast population growth is taking place in its outer suburbs.  However, the population is growing much faster than the rate of economic growth (and outstripping jobs growth).  This is resulting in a worsening jobs deficit, and the consequent “nightmare commutes”.   Moreover, these outer suburbs are housing a disproportionately large share of new - and increasingly isolated - immigrants.  

Shortage of housing supply in inner city suburbs

People continuously refer to the shortage in suburban housing supply as a direct cause for the sharp increase in house prices in Melbourne.  However, at the heart of the city’s housing problem is a lack of “livable” residential apartments, especially in the inner suburbs near the CBD in which jobs are plentiful.  Anywhere within a 15 minutes train commute to the CBD.  

Awkward regulations protect an elite of existing homeowners who live in the significantly under-utilized inner suburbs, which in turn prevent developers from building medium to high density housing that the city’s modern economy demands. The resulting high rents and exorbitant house prices make it very hard for people to move to close to where the most productive jobs are.  

Surge in housing prices

As well as being inefficient, the city’s housing market is totally unfair. Over a period of the past decades, falling interest rates in Australia have compounded inadequate supply and led to a surge in prices in Melbourne (and other big cities). 

Median house price in Melbourne has risen from AUD40,000 in 1980, to AUD191,000 in 2000, to AUD900,000 in December 2019.  

Sadly, punting on property has become a sort of a sport. The 2008 financial crisis did not kill off the trend, despite recent falls, prices in Melbourne remain much higher today than in 2008 and they are continuing to rise. 

Melbourne expensive housing is damaging the economy, creating dangerous resentment, and poisoning politics. And it is becoming ever more so.  

Affordability Crisis 

The flip side of Melbourne’s much celebrated property boom has been a housing affordability crisis. While the market has cooled in the past couple of years, affordability is still at a staggering low, with the average house in Melbourne still costing some 10 times the average household income.  Borrowers – in Melbourne - need to dedicate over 160 per cent of their annual gross income to raise just 20 per cent deposit.  The city has become the 4th least affordable housing market on the Demographia international list of 2019.    

High prices, political games, and the damage to economy 

Traditionally politicians like it when house prices rise. People feel richer and therefore borrow and spend more money, giving the economy a nice boost, they think. When everyone is feeling good about their financial status, politicians have a higher chance of re-election.  Sounds nice?  Not really.  An economic policy which relies on homebuyers taking on large debts is not sustainable. On the short term, rising household debt boosts economic growth. But households then need to rein in spending to repay their loans, so in three to five years, those effects are reversed: growth becomes slower than it would have been otherwise, and the odds of a financial crisis increase.

Malfunctioning housing markets also hit the supply side of the economy. Melbourne does not build enough new livable residential units at the right locations, constraining its growth and making it more expensive than it would otherwise be. People who would like to move closer to Melbourne’s CBD cannot afford to do so. Since productivity and wages are much higher in the city center than outside, that reduces overall GDP of the city.

High prices and inequality 

The rising cost of housing has created wide inequalities and aggravated both generational and geographical divides.  Young people's view that well located and livable housing is out of reach, unless you have rich parents.  They feel that the economy does not work for them. Whereas baby-boomers tend to own big, expensive houses, youngsters must increasingly rent somewhere cramped (or accept living on the urban fringes), fomenting millennials’ resentment of their elders. 

Soaring household debt

The global financial crisis of 2008 taught us the dangers of a mismanaged housing market. However, these lessons came in a bit too late.  Australia appeared to be following on the footsteps of the USA.  During the past 2 decades, housing debt has more than doubled in real terms.  Mainly fueled by irresponsible mortgage lending entrapping households to accumulate more debt than they could sustain.  Today Australians have the world's second-largest household debts, hovering around 120% of GDP.  

Cost of new infrastructure 

With Melbourne’s continued urban sprawl, the costs of infrastructure are going to be an issue.  

A higher population growth rate means a greater proportion of total economic activity has to be dedicated to expanding infrastructure.  Nationwide analyses show that acquiring the durable assets to support population growth has historically cost around 6.5-7% of GDP per one percent population growth rate. Thus, if Australia’s growth is 1.5% p.a., around 11-12% of GDP is diverted to the task of acquiring infrastructure and other durable assets, merely to extend to the additional people the level of service already available to the existing population (J. N. O’Sullivan, ‘The burden of durable asset acquisition in growing populations’, Economic Affairs 32).

Moreover, the long-term average cost has been compounded in the last decade by the much higher cost of retrofitting already built-up areas. For example, the East-West link tunnel was costed at $1billion per kilometre, around twenty times higher than above-ground roads and rail.  Don’t forget the environmental cost of such infrastructure.  

Is it possible to escape Melbourne’s housing crisis? It is hard to ignore the anger over housing prices, shortages and unfairness.  In the coming articles we will explore how did the city’s housing market evolve, and what could be done to build a new housing market that works.