Fluctuations in prices and ‘affordability’ are inherent features of housing markets.

The upswing in housing prices since the mid-1990s has been bigger and more widespread than in previous cycles.

• Notwithstanding lower interest rates, ‘affordability’ measures have fallen to relatively low levels in the past year or so.

Rising house prices indicate that demand has been outstripping supply.

• Much of this increase in housing demand is due to cheaper, more accessible finance and buoyant economic growth through the 1990s.
• This led to price escalation because of inherent limitations on housing supply in response to general demand pressure, particularly as much of the demand has come from existing home owners seeking to ‘upgrade’ to higher quality houses or better locations.

Only in the last couple of years have house prices surpassed levels that seem explicable on this basis, as additional investment has been encouraged simply by the prospect of further capital gains.

To the extent that currently low housing affordability reflects cyclical price pressures, this will eventually be reversed. (Evidence of market cooling is already emerging.) However, there is a role for policy to address any forces that cause prices to be excessive over time.

On the demand side, interactions within the taxation system between negative gearing, capital gains provisions and marginal income tax rates lend impetus to investment demand when prices are rising.

• However, these influences are not confined to housing and need to be assessed in a broader context.

On the supply side, there is scope to moderate price and affordability pressures by:

• Improving land release and planning approval processes;
• Ensuring that developer charges for infrastructure relate appropriately to the benefits accruing to a development; and
• Replacing stamp duties with less distorting taxes.

The First Home Owner Scheme, although conceived to compensate for the GST, would have more impact on home ownership if targeted at lower income households.