Australia is among the world’s wealthiest countries. Our total wealth is about $15tn, or nearly $575,000 per person, well above the OECD average. But much of this wealth is not really accessible – around $9tn is tied up in residential property, primarily in the family home.
Calculating the “real” value of a home is far from simple. Say, for example, you are lucky enough to buy a house for $1m with a mortgage of $800,000. The property’s value may increase to $5m over 30 years (a presumed rate of 5.5% growth per annum), during which you pay off the mortgage. You may believe you have a $4.8m gain ($5m minus your deposit of $200,000), available to fund consumption, retirement and anything else you like.
But the reality is quite different.
First, this gain doesn’t account for interest. Assuming an average annual interest rate of 5%, the interest payments on a mortgage this size would equate to about $750,000 over 30 years, reducing your perceived gain to $4m. Then, factor in inflation – let’s assume, optimistically, that it’s back at 2.5%, the middle of the Reserve Bank’s target band. That reduces the purchasing power of each dollar until the gain is down to $1.9m – still a sizeable amount, but much less than the $4.8m initially imagined.
There are an array of other factors as well. One is exposure to volatile real estate markets. If housing prices rise by slightly less than hoped, say 4.5% instead of 5.5%, after 30 years your house is worth $3.8m, not $5m – a quarter less than you imagined.
Houses cannot buy things
Even if you’re lucky enough for the value of your house to rise considerably, this wealth embedded in your residence does not generate actual income to pay for goods and services. In fact, the opposite is often true. Houses can be money pits – there are maintenance costs, rates and taxes (frequently based on rising land values), insurance and utilities. In the absence of other income, households are asset rich but cash poor.
Unlocking this wealth requires selling the home or borrowing against it. But a house is not just an asset – it’s usually a home. Because it serves as a shelter, selling your home could mean downsizing. And if the property has appreciated in value, then the potential replacement will also have risen in price. Any gain will be decreased by transaction costs such as stamp duty, legal and agent fees, which can reach 5% of the total selling price. In addition, where a large cohort of homeowners, such as the baby boomers, simultaneously seek to trade down to free up cash, the difference in values between what is sold and bought may narrow, reducing the cash released. This could mean needing to relocate to remote locations away from family, friends and essential services.
Selling requires purchasers with cash or income to support the increasing levels of borrowings that have underpinned prices. Stagnant real incomes and changes in labour markets – especially reduction in regular long-term employment, rising contracting and self-employment – may limit the borrowing capacity.
Demand for housing may be affected by an ageing population, immigration levels and restrictions on non-resident property purchases. Fewer new households, falling affordability, job insecurity, aversion to debt and anxiety about an uncertain future reduces the appeal of home ownership.
The other option to release wealth is borrowing against your equity (the market value of your house minus any mortgage outstanding). But this requires proof of serviceability – difficult for those in or approaching retirement. Borrowers face exposure to fluctuating house values, interest rates and refinancing conditions.
The problem of borrowing to monetise the value of your house is evident in the increase in older Australians carrying mortgage debt at retirement. It results from high mortgage levels due to increasing houses prices, which cannot be repaid during working lives. Households have also borrowed to supplement incomes that have not kept pace with rising costs of goods and services. Superannuation balances are increasingly used to pay back outstanding debt, reducing retirement savings.
Australia’s overstated housing wealth
One way that the value of a home can be gauged is by a proxy measure – the amount that can be raised using a reverse mortgage, which allows borrowing against the home as a lump sum or as a regular income stream without the need for interest or principal payments. The amount that can be borrowed is around 15-40% of the value of the house, reflecting uncertainties around the borrower(s) uncertain life expectancy and compounding unpaid interest adding to the loan balance.
This all suggests that Australia’s so-called “housing wealth” may be greatly overstated – perhaps by 50% or more. It raises the question of whether savings might be better employed in more productive income-producing investments, such as real businesses and income-producing shares, although that too has its risks.
Sadly, favourable tax policies and incentives for mortgage lending have converted the basic need for shelter into a financial asset, encouraging Australia’s housing obsession. This has created economic distortions and over-investment in houses, making Australians reliant on an illusory paper wealth which cannot be readily accessed.
In the words of poet Alexander Pope, those on the country’s housing treadmill may “have dreamed out their dream, and awaking have found nothing in their hands”.
The great Australian dream may well be just that – a figment of our imagination.
Satyajit Das is author of Fortune’s Fool: Australia’s Choices (March 2022) and A Banquet of Consequences – Reloaded (March 2021)
