NIGEL STAPLEDON: When people talk about wanting to control what the banks do, and you have APRA coming in and people say, that's great. People, I think, forget what the regulated market was like. And there's a reason we got rid of it. Just as there are strict limits on what the Reserve Bank can do, there are strict limits on what interest rates can do for housing prices on the upside.

So I'm expecting the story over the next 20 years to be very different to the last 20 years. And when the market understands that and takes out a bit of the growth premium, that will certainly cap what prices can do.

JOE WALKER: Hi, I'm Joe Walker, the host of The Jolly Swagman Podcast, and I'm here with Dr. Nigel Stapledon of the University of New South Wales. Nigel, thank you for joining me.

NIGEL STAPLEDON: Pleasure.

JOE WALKER: I'm very glad to be able to share you and your views with our audience, because of all the people I've met and conversed with about the Australian housing market, you're possibly the most sober, calm, and reasonable. So I'm hoping you can add a certain degree of levity to the very emotionally charged debate that we often see in Australia.

NIGEL STAPLEDON: Well, I have to. I have to Inform the listeners.

JOE WALKER: So let's get started. I first want to begin by having you tell us the story of the index you built and providing us with some historic perspective. Your paramount contribution, which I regard as an incredibly important contribution to the Australian economic literature, was a long run house prices index for Australia back to the 1880s. Give us a sense of the long view of Australian house prices.

NIGEL STAPLEDON: Well, I suppose I collected prices for that Sydney and Melbourne markets. Those are the two main markets in Australia. And starting in the 1880s, collecting them from newspapers, since that's the only major source at the time. They published sales and asking prices and also sale prices. And then I spliced that into existing series collected in Australia in the '60s and '70s and constructed a series from 1880 to 2012 and I've make it up to date.

I suppose the story-- and I should say there's now been a global series. So while I was collecting that data, there have been people in other countries also collecting long run series. And when you look at the global picture, it's broadly that, from around 1880 to, you go forward to about 1960 or a bit before, you don't see much movement in real prices, either in Australia, Sydney, Melbourne, or globally. So you're not seeing much movement.

And then from the '60s, you've seen a steady rise in prices. So it's a period in which there wasn't much movement. And then from the '60s through the last 50 years, there's been a very significant move up in prices. So that's the basic story.

JOE WALKER: So a couple of things changed in the post-war era. I'm speculating here, but you can correct me if I'm wrong. One is, we're now living in the age of credit. Mortgage lending started to expand. The other is, most national house price indices weren't really created and published until the 1970s onwards. In Australia, for example, the Australian Bureau of Statistics only began to publish a national price index for Australian residential housing from 1986.

NIGEL STAPLEDON: Correct.

JOE WALKER: So the publication of the indices might have provided something for the media to report on, attracting more speculative attention to housing markets, possibly. This is an argument that Bob Shiller makes. What do you make of those two thematic explanations?

NIGEL STAPLEDON: Well, I don't quite buy the latter. I think credit became a factor from the '80s. I mean, up until then, interest rate markets were fairly heavily regulated. There was a lot of quantitative controls up till then, and then we had the deregulation in the '80s, so it changed the market.

So you can say from the '80s on, that was a factor. So it wasn't a factor explaining what happened between the end of the '50s through to the '80s. Essentially, from 1880 to around about 1960, the value of land-- and the land market wasn't particularly regulated. It was pretty much a free market. Cities grew. And land wasn't a significant component. I mean, today in Sydney, a block of land on the fringe cost $450,000. Back in the '50s, it was less than 1/10 of that in today's dollars. You're looking well less than $50,000.

Land was relatively cheap. You could buy it and put a house on it, and the land wasn't a significant component of the cost. And that was pretty much the situation around the world. And then in the '50s and '60s, markets began to be constrained. So you had controls on the-- urban sprawl was, the planners sought to control it, so you had restrictions on supply at the edge, and then later you've had restrictions on cities going up in the center.

So the market's become much more constrained in supply. We had huge periods of growth in terms of demographic. But with a free market and the cities just growing, it didn't translate into too much. And then we-- so then we had that happening. And of course, also, you also had a dichotomy between what you might call successful cities and less successful cities. And you can see that more in the US than you can here, where you've got the inland cities, where even today, there's no particular location premium for living in the center. Land is still really cheap. Housing is really cheap, and then you contrast it with San Francisco, which is like a Sydney, or a Melbourne, or a Vancouver in Canada, or a London, where there's huge migration to San Francisco, which is a hugely successful city.

People want to live there. It's on the coast. It's got restricted supply, and it's become more and more restrictive. So you'll find, in San Francisco, that a block of land on the edge is very expensive, and living in the middle of San Francisco is hideously expensive, on a quantum above Sydney. So San Francisco makes Sydney look a bit more modest by comparison.

So there's those dynamics happening, and then the '80s came along and you freed up. So I think people forget-- when people talk about wanting to control what the banks do, when you have APRA coming in and people say that's great, people, I think, forget what the regulated market was like. And there's a reason we got rid of it.

Sure, there was cheap bank interest rates back then, but really only high income wealthy people were able to access it, the cheap money. If you're a modest person and you went to the bank, they'd give you a little bit of that, and then you'd have to take out a personal loan. Your effective interest rate was significantly higher than if you look at the series. So the series was saying 4% or 5%. People were paying double that, really.

And then the building societies came along and, of course, they charged higher rates than the banks, but they made it more accessible. But nonetheless, it was more expensive money than you could get from the banks. And so that was an inequitable situation, really. And that was-- and we got rid of it.

So that has then made money cheaper. Of course, the other thing about the '80s is, of course, that that was the '70s and the '80s, a period of very high inflation, which then saw with the interest rates go to very high levels. So in the mid '80s, you had very high nominal rates, very high real interest rates. And that was actually depressing prices. The interesting thing about going from the '70s to the mid '80s is, the part of the markets which grew fastest weren't the bits in the center. They were the bits on the edge. The outer parts of Sydney had faster appreciation, because the restrictions on supply were driving up the price of land out there, but the high interest rates were keeping the value of the location premium in the center down.

So the big capital gains were actually, ironically, happening more in the outer than the inner. Because expensive money was-- you couldn't afford to pay that location premium, but the actual cost of buying a block of land and putting on the replacement cost was going up significantly on the outer parts of most Australian cities. So that was an ironic situation when you look at it. But it was telling us how the restrictions on supply were driving up the cost, even though interest rates would have been constraining prices. So you had those pressures all building.

And then, of course, then from the mid '80s, well, then you had a recession that killed the inflation in Australia. We came out of the recession and unemployment was still high. When unemployment's 11%, house prices are going to be pretty flat. What was surprising in the early '90s is that house prices didn't actually fall that much.

JOE WALKER: Yeah, about 8% in real times.

NIGEL STAPLEDON: Yeah. So you had the dynamic of 11% unemployment and a significant drop in interest rates. So you had the two working. You could see interest rates should be driving up house prices, they didn't. But there was also-- and you could actually see it more in the bond market than in the housing market-- it's the interest rate markets didn't quite believe, then, that that decline in inflation in Australia brought about by the recession was permanent.

Everyone was somehow expecting that, as soon as the economy recovered, Australia was inflation prone. Inflation would go back, and so would interest rates. And so we had, in about '93, '94, we had the Reserve Bank hiking rates, and they went up. And then everyone was expecting them to go up significantly more, and they didn't. So they peaked. They peaked at around 10%.

Higher now, but they've gone up from about 7 1/2% up to 10%, and that was the peak. And inflation kept dying down, and so the mid 90s, there was a belief started to develop that inflation was actually going to stay down in Australia. And that meant interest rates were going to stay down.

I mean, people were expecting the rates to go back to 14%. Sure, they'd been at 17%, but people were expecting it to go to 14%. So that didn't happen, and then it started to percolate out. So the bond market started to believe it. The share market started to believe it, so the second half of the 90s was very strong in the share market, so all asset prices were lifted.

That, of course, favored the inner parts of cities. So the location premium went up significantly. So the big price movements were happening more in the inner than the outer. And then it developed momentum. The Sydney market went first, typically does. It developed significant momentum and it overshot a bit in about 2004, and then had a fall, which probably would have translated into a bigger fall, but for the fact that the resources boom came along, and that injected significant demand via pick up and integrations.

The, yeah. Credit-- is the interest rate story effect factor post '80s, post mid '80s, but the housing story is always more complex than just interest rates.

JOE WALKER: Many people use price to rent ratios, or rent price ratios, if you want to frame it that way, as a measure of overall undervaluation in the Australian housing market. Sort of the equivalent of a PE ratio for housing. Perhaps, most famously, The Economist, who likes to point to price to rent ratios.

You've implicitly touched on the answer, but why do you think we should be cautious about using a price to rent ratio to gauge the existence of a bubble in Australia?

NIGEL STAPLEDON: The price to rent ratio is the best metric, okay? But you really need to compare what the price to rent ratio has done and with what interest rates have done. So what The Economist, looks at the rent to price ratio or price to rent ratio, and takes an average, and then says, well, the price to rent ratio is significantly above its average for the last 30 years. Therefore, it's overvalued.

Well, by the same token, you would look at the mid '80s and say, well, they're dramatically undervalued back then. So they've gone from dramatically undervalued to overvalued. But what is so precious about that period? And of course, the other thing about that period is, if you looked at the interest rates and you looked at the averages, well, the average interest rate has dropped. The average interest rate is below its average for the period. The current interest rate is significantly below its average for that period.

So if interest rates impact on asset markets, they should be impacting on the house market with low interest rates, lower than the average for that same period, then you should expect the rent to price ratio to be below its average or, conversely, the price to rent ratio to be above its average. So it doesn't necessarily tell you that it's under or overvalued, taking that simple approach.

JOE WALKER: Because the discount rate by which we're capitalizing rents into prices is lowered?

NIGEL STAPLEDON: Correct. At the same time The Economist was saying that, a few years back, some guys at the Reserve Bank looked at the relationship between the rent to price ratio at interest rates, and were saying they thought housing was undervalued. Now, they got it right. The Economist got it wrong. Okay, I think there was a bit of a tendency post the global financial crisis to say, well, what happened in the US must happen in Australia.

So a lot of people will say, they felt that in the US, must happen here, without looking and understanding the dynamics-- and I'm not saying the housing market here can't fall. I mean, the Sydney market had an appreciable fall post 2004, which would have been sharper, but for the resources boom coming along and boosting immigration. And so that-- there was oversupply in Sydney market, and that oversupply was absorbed. So the market recovered sooner than you might have expected.

JOE WALKER: I remember when we caught up back in June, it might have been, you told me that you thought the worst was over for the residential housing market. And I guess you were right.

NIGEL STAPLEDON: You get some right, you get some wrong. I don't want to-- I don't want to but, I mean, you had the Reserve Bank talking about cutting rates back in June. But you also, the other factor in prices weakening-- I mean, prices weaken without rates doing anything, essentially. I mean, rates didn't go up. In fact, they'd been cut around 2017.

So it was a tightening in credit. I mean, everyone thinks there's interest rates and credit. But, in fact, if you look at it in terms of demand and supply, and you look at the amount of stock being built, the growth in stock has been running above the growth in population for a number of years. So the market's been going from being tight, which it was three years ago, to being moving into a situation where there's more supply, and you can see that in the rent market.

So rent growth has decelerated substantially. So it's around in nominal terms or slightly negative in real terms in most markets in Australia. So if you think of two determinants, if I'm an investor, one is, what's my rent and what's my expectation about rent growth. And the other is, what's my expectation about interest rates.

So, you had a market where the expectation on rents was from growth to no growth and, with the rising vacancy, so the vacancy rate in Sydney has gone from being tight to being a surplus. So, your property might be vacant. So we can focus-- and interest rates matter significantly, but this is of significant importance to the market.

And I think we'll-- that's in the background a bit, and it's why I wouldn't be wildly optimistic about the prospects for what prices might do over the next few years.

JOE WALKER: Allow me to push back on your argument that low interest rates-- low real interest rates-- mean that there's not a huge degree of overvaluation in the market. The first question is, interest rates started falling from the-- real interest rates started falling from the mid 1980s. But we didn't begin to see a large run up in house prices until the mid 1990s. So there was somewhat of a lag.

Now, earlier you mentioned it was because people weren't entirely certain as to whether this was a temporary phenomenon or a secular shift. And once they were certain that low interest rates were here to stay, they began to-- house prices began to expand accordingly. What's the actual evidence that that's what people were thinking?

NIGEL STAPLEDON: Well, I mean, in the second half of the 1980s, interest rates were between 17% and 20%. So in nominal terms, are very high.

JOE WALKER: Yeah.

NIGEL STAPLEDON: I mean, just in terms of servicing that. There was a limit on how much people could borrow.

JOE WALKER: But why was there such a lag-- five years or so-- between that large fall in real rates at the end of the '80s and then house prices?

NIGEL STAPLEDON: Well, the fall--

JOE WALKER: If you know.

NIGEL STAPLEDON: The sustained fall in interest rates really happened in the '90s. You had really high inflation in the '70s, and interest rates lag that. So in fact, you had incredibly negative interest rates. I mean, people did wonderfully well out of housing in the '70s. Simply because their debt got devalued. You started with a big mortgage in 1970 and by 1980, it was just a credit card debt, really.

And then, you had a big hike. Investors stopped putting any money in. They wanted really high rates. So you had a big spike in house prices. So the peak in rent price ratios was around '86, '87. And then you actually had a sharp fall. I mean, prices went up even though interest rates were actually quite high. Because that pressure was building in the market.

So you actually had quite an appreciable drop in the rent price ratios, in the second half of the 1980s. But then, in the 1990s, you then had a much more sustained and significant fall. So it's been an ongoing story. Which I suppose is your point. It wasn't just a '90s phenomenon. Some of it actually happened then, which was a very volatile period.

And then, of course, we had a huge recession. So then, like nothing happened in the housing market for a sustained period of time. I mean, rents were flat to negative in real terms. House prices didn't do anything for five or six years. So it was quite a stable period. And then, the second leg, in a sense, happened.

When people believed that rates were going to stay below 10%-- Back then, it was below 10. And now we're talking about something like below 5.

JOE WALKER: The second question is to say that low real interest rates-- meaning the discount rate by which rents are capitalized into prices-- is lower, therefore, we should see higher prices. To say that is to rely on an assumption of rational expectations, where we collapse models economists use and models of the economy in the public's