Expert Advice with Jeremy Sheppard. 15/09/2015

Increasing housing supply won’t improve affordability, a recent report suggests. In fact, some data in the report suggests prices might even rise during periods of increased supply.

Bunkum!

This rumour is based on an address at Sydney University Sept 9th advertised as: “Why building more houses won’t fix Sydney house prices." The keynote address was advertised as “Myth: Increasing housing supply leads to more affordable homes.”

The speaker is University of Auckland’s Professor Laurence Murphy. He is a professor of Human Geography in the School of Environment. Murphy was formerly Professor of Property in the University of Auckland Business School.

I’m yet to read any negative sentiment in the media about these notions so I thought I’d be first.

One eye'd focus

The 400+ year old law of supply and demand says that if demand exceeds supply, prices rise. If supply exceeds demand, then prices fall. This doesn’t mean that increasing supply will cause prices to fall or even prevent growth. There’s another side to the equation that hasn’t been considered – demand.

Let’s say supply increases and at the same time we notice prices increase. This does not mean the law of supply and demand has failed. It’s possible that at the same time, demand increased too.

In other words, supply can be increasing, but demand can still outweigh supply, so prices continue to rise. In fact, supply can be increasing, but demand could be increasing by an even larger degree causing price growth to actually accelerate even when supply is increasing.

If you focus on one side of the equation, you miss the whole point. It is the demand to supply ratio (DSR) that determines price growth. Looking at supply or demand in isolation will lead you astray.

New properties always sell for more than a comparable property of older age. Houses sold 60 years ago were typically 2 bedroom fibro shacks compared to the monster 4 bedda, 2 bath, double storey brick houses of today.

Let’s say you have old properties selling in a town for \$300,000 each. If three of them sell for the same price of \$300k, then the median is \$300k – that’s the middle figure.

\$300,000

\$300,000 the median

\$300,000

A developer then comes along and builds new houses nearby in a new estate. These sell the next year for \$450,000 each. Let’s say there were now 5 properties sold instead of only 3...

\$300,000

\$300,000

\$450,000 the median

\$450,000

\$450,000

The old houses still sold for \$300k and the new ones all sold for \$450k. So median has gone from \$300k to \$450k. This is not capital growth. This is median growth.

Old properties are still selling for \$300k, no capital growth for an investor holding an old property. New properties are still selling for \$450k, no capital growth for an investor holding a new property either.

If you use medians to calculate price growth, you’ll find that new supply seems to suggest price growth. But it’s a statistical anomaly caused by increased sales of new properties.

Conclusion

Relax. The universal law of supply and demand is still operating as it always has. From time to time however, you might find a peculiar interpretation of the data. Perhaps this isn’t what professor Murphy is saying. Perhaps it’s just a media stunt by Sydney Uni to get us in the door.

The point is to focus on the demand to supply ratio (DSR) rather than look at supply or demand in isolation. You can also ignore change in medians as an indicator of capital growth, especially in markets experiencing heavy developer activity.

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Jeremy Sheppard is head of research at DSRdata.com.au.

DSR data can be found on the YIP Top suburbs page.