Almost a decade and a half ago Malcolm Turnbull led a task force commissioned by then Prime Minister John Howard to examine why the cost of our housing was appreciating so quickly and furnish solutions to the ensuing "affordability crisis". This was in the midst of the great 2003 boom when the house price-to-income multiple leapt to an unprecedented 5.3 times and the household debt-to-income ratio likewise hit an unchartered 150 per cent.
To that point all popular explanations for surging prices had focussed exclusively on "demand-side" variables including interest rates, incomes, credit growth, and the expansion in the availability of finance through innovations in competition, including the sale of portfolios of home loans to investors that hold them to maturity via a process called "securitisation".
Turnbull's task force showed for the first time that there was another casual contributor to housing costs: artificially imposed constraints on the production of new supply, including zoning restrictions, sluggish building approval processes, and quarantined greenfield and brownfield sites, which were materially inflating the implied cost of land in major metropolises.
The recommended remedy was to liberate supply by allowing builders to more rapidly respond to variations in demand attributable to population growth, incomes and interest rates. If new housing supply promptly sated demand, there need not be a big increase in the price of putting a roof over your head.
This could be augmented by the development of high-velocity and volume transport infrastructure that enhances the substitutability of homes located across Australia's otherwise vast land mass.
The emphasis on "elastifying" supply eventually became conventional wisdom, embraced even by the Reserve Bank of Australia's boffins who in 2003 rejected our argument that supply-side rigidities were fuelling housing costs in favour of the notion it was all demand driven. (I was the principal author of the report in question.)
Shared equity an option
On the demand-side of the housing equation Turnbull's task force highlighted that the inability of property investors—be they owner-occupiers or landlords—to share their asset's returns and risks with outsiders had created a tremendous reliance on the sole use of leverage, or interest rate dependent debt finance, when purchasing a home.
Most public companies and commercial properties are made up of a safer mix of equity and debt. Rather than one investor owning 100 per cent of the asset, equity is distributed amongmany parties. While there might be a large founding shareholder, like a Packer, Lowy or Murdoch, they have drawn on other shareholders to fund Crown, Westfield and News Corp.
Although equity is more expensive than debt, it carries much lower risk. There are no interest repayments, debt covenants, default risks or repossession hazards. In the good times, equity participates in the upside of capital gains. But during the bad times when the value of your asset falls, equity costs you nothing (indeed it reduces the losses you bear because you are sharing the downside with others).
Experts agree the single biggest financial system risk Australia faces today is the massive build-up of housing debt because it is not normally possible for families to source external equity in the same way companies and commercial property owners do. The household debt-to-income ratio has thus soared to a new record of 187 per cent while the house price-to-income multiple is now a staggering 6.1 times.
First time buyers leverage their 5 per cent equity 20 times via bank debt---leverage that is way above what most corporates would deem prudent---in the name of acquiring an asset that is actually much more volatile (or risky) than the one-way bet many presume.
In research I published here in 2014 we demonstrated that a single family home with no debt has similar levels of return variability to the Australian sharemarket. Add in leverage and the individual dwelling is, in fact, much riskier than an equities index.
The only reason we can be assured of always accessing a home loan from banks that are, ironically, themselves leveraged 15 to 20 times is because the government guarantees their deposits and liquidity (and hence solvency). Wittingly or unwittingly, the financial system is geared towards forcing borrowers to rely on debt.
Glimmer of hope
There is, however, a glimmer of hope. With no government support at all Bendigo & Adelaide Bank have made hundreds of millions of dollars worth of equity-like finance available to retirees that want to unlock wealth stored in their homes and buyers that are prepared to rationally trade away a minority of their capital gains (and losses) in exchange for reducing their interest burden.
This latter objective will become especially germane when mortgage rates inevitably lift off their historic lows to more normal through-the-cycle levels that are at least a couple percentage points above current marks.
Launched before the global financial crisis, these "shared equity" products have been a positive-sum game in which customers and the investor (Bendigo) have benefited. Whereas the home owner has one highly idiosyncratic asset that they are de-risking, the investor gets low-cost access to a portfolio of thousands of properties that collectively have low volatility.
The problem is that housing equity is not an asset that belongs on bank balance-sheets. The natural owners of nationally diversified portfolios of residential property equity are super funds, which have virtually no exposure to the sector having loaded up on listed corporate equity risk.
In 2009 professor Joshua Gans and I developed an idea that ultimately became the first modern case of quantitative easing in Australia. We convinced the government to use its balance-sheet to buy billions of AAA rated home loans, which back-stopped the liquidity of a market that had become a crucial source of finance for smaller lenders.
Given the government's much lower cost of capital, taxpayers have made huge carried interest profits while the residential mortgage-backed securities (RMBS) market is thriving again today providing billions of dollars of finance to all banks (including the majors) without public support.
If the government wanted to kick-start housing equity finance it could roll some of the RMBS maturities into co-investments with super funds that are trying to work out how to capitalise on these innovations through the likes of ME Bank.
Because the finance is delivered through a mortgage contract, the investor avoids the traditional transaction and holding costs that have historically plagued direct property interests.
In theory it's a win-win for borrowers and investors.
The author is a portfolio manager/director of Coolabah Capital Investments and Smarter Money Investments, which invest in fixed-income securities.
