Wages - affordability - where does this factor in a bubble

Sorry I am not an economist but a humble homeowner - can someone explain to me please 'where and when the affordability to continue to support a rising house market' fits into the equation.
Surely there is a 'saturation' point where the 'wages in a community' cannot continue above a certain level (on average) to service the increasing levels of debt required to enable house prices to increase.
Suburbs in the Canberra housing market appear to reach a top level - and then the domino effect to neighbouring suburbs spreads.
What I cant understand - is what are the limits - ie there are only so many wage earners and so many layers of a market for real estate.
Is there a mathematical formula that can be applied...??
Surely the limits of wages has to have a 'cap' somewhere on the housing market. (this is not to mention the possible' import of overseas buyers who may also be a factor in the escalation of housing in capital cities).

You would think so. That's how it's always worked historically. Except in bubbles like the 1880 bubble and bank crashes which resulted in Melbourne house prices dropping by 50%.

Looking at the current climate, this could definitely happen again.

It's all got to do with supply vs demand -- demand is too high and supply is too low. In this environment that means prices must rise! Build more supply -- that's your answer to the problem!!

Affordability factors into the equation is the demand side. This can cause bubbles in products which the supply side is slow to respond. In a perfect market a bubble should not form due to the supply kicking in satisfying excess demand so prices will always reflect costs of production plus a fair margin. Of course the housing market as we have seen in the USA, Spain and Ireland is not a perfect market.

Easy credit and higher after tax wages have both enabled us to spend more on housing. This will increase prices which will bring more marginal producers on line building capacity in the industry. Housing is known to have a relatively elastic Supply curve when land is available.

In most goods this rise in affordability would lead to a rise in price which leads to a spurt in supply so a price rise followed by a supply glut followed by a correction in prices.

What is disgracefull in Australia, while we have no shortage of land, taxes on new builds only has allowed the price of existing homes to increase without a corresponding increase in the level of supply. Papers done on the issue call this taxing of windfall profits, i.e. if the tax was not there the development would go ahead with abnormal profits to developers. Of course this is how markets respond!

Without the abnormal profits you get only a steady rate of supply getting us to our present situation where even while prices in no way represent true costs of production once the government and regulation costs are added the margins for developers are not encouraging USA like supply response.

In Sydney from what I gather there is a regulatory premium of about 130k* on a block of land, that is comparing land zoned as residential to that 15km away not, 170k v 20k per lot. On top of this there are three levels of taxes to turn this 170k lot into a saleable block of land, 45k state levy, 20k council levy and around 20k GST on the improved value, so 85k. All up I reckon our government is the single biggest cost in a new block of land. Not the physical development costs, not the raw land procurement costs but government costs.

Some places have had a natural supply response. I reckon Perth has almost certainly got more subdivided land then it needs especially around Mandurah. The new road might help but I know I would not buy with lots of blocks of land on the market for in excess of 18 months.

Sydney and Canberra on the other hand are basket cases. The problem with policy like this is it puts a massive policy premium on top of house prices. This means with a policy change, which will come given time, potentially to get us out of a future recession, house prices have so far to fall. For an example of this look at NSW govs response to the last little scare halving stamp duty on new homes. This is the sort of policy which will start the rot! I noticed that it was never planned to be in place for long though ensuring not much supply could come thorugh more to clear existing supply!

Better to have a short sharp bubble collapse in my opinion, USA style, then a government aided bubble, caused by a lacklustre supply response. Our bubble has been inflated so much further so has so much further to fall.

* Taking 20k out for differences in amenity.

And you think with the current system that investors just won't go and buy up the new stock as it's being released anyway?

'Demand' is an interesting term there mate. You can manipulate 'Demand' quite easily by other measures than simply building more houses.

Australia has been over building for 20 years and suddenly, because construction is low there's a supply shortage?

C'mon mate, that arguement is dead and buried. Just the last census alone shows that 10% of ALL property in Australia is uninhabited.

The 'demand' is artificially created for profit, pure and simple. Attack the means for demand in the first place and you solve the problem without even one extra house being built.

The government are cowards however and won't halt the gravy train for the speculators, even though it's costing the tax payer billions every year.

I don't believe for one moment that building more stock will solve a damn thing.

The problem with supply and demand is that it can not explain a property crash.

Property crashes or bubbles bursting are a reality.

The only way a crash could occur based on simple supply and demand is that a massive over supply of property was to occur. (I'll get to that in a bit)

Or everybody decided at the one time not to invest in property.

Neither of those things happened.

So why did property crash in America for example?

What changed?

Well there was an over supply of property but not as result of excess property being built. It was forced sales.

But should not the magical excess demand come in with its invisible hand and quickly snapped up the excess property?

The argument was that it was demand causing the price increases but over night there was no demand. Why did people now not want property?

Simple really the value of property was decreasing, people didn't want property to live in they wanted to invest. If its value drops there goes your investment demand.

Its INVESTMENT demand that drives up prices not roofs over peoples heads.

So in another way if supply and demand of housing stock was the answer they should have bull dozed all the excess housing and that would drive prices up again.

Sub-prime crisis solved!!

Bring in the Cat D11 dozers and we can fix a property crash.

Here is a picture of the property crash recovery machine:

http://www.mischa2000.de/Technik/Rau...zer-D11-02.jpg

Cheers

Justin

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Economics in a Nutshell: Sure, it works in practice, but does it work in theory?

I wouldn't knock down the houses mate... people still need a place to live in after all.

Give the excess property to the homeless and destitute. Put all that property to a good use for a change maybe?

Mate I agree with you!

Or better yet don't force people out of their houses.

Any cash flow is from a house is better than no cash flow. (From the lenders perspective)

I was just suggesting a supply/demand solution Ever so slightly tounge in cheek.

Cheers

Justin

__________________
Economics in a Nutshell: Sure, it works in practice, but does it work in theory?

I think that it does.

It explains the investment cycle in minerals, so why is housing different. Their will be parts of the cycle where price is lower than costs, this is the part where you have overcapacity.

during a time of overcapacity no new capacity is built, and often some is removed. In minerals the lag time for capacity building is long so the minerals cycle is slow and can have bubbles lasting for close to a decade. But even the minerals cycle will turn whether Chinese continue demanding at their current rate or not. Ourselves and Brazil will build for it.

During a glut untill the next time demand reaches costs of production plus fair margin then capacity does not build.

At present in the US prices are below costs in many places due to an oversupply hence no new properties are being built. As long as you have increasing population eventually prices will return to costs of production.

I think as good a definition as any for a bubble is when prices no longer reflect costs of production. this is why the USA had an oversupply of housing, same for spain and Ireland. We tax away windfall profits so dont get the same supply response.

No doubt in the tulip bulb bubble fools were paying far more than it cost to create more tulips. This was always going to divert resources into tulip production to a point where their was a supply glut destroying the bubble prices. Tulips like houses are not built overnight so it gives the market plenty of time for irrational expectations of price increases till the supply builds up.