Unintended consequences?


A lot of complaints from the “guardian” class of people seems to centre on the terrible exploitation of others by property owners who rent out houses. Theres also the same level of wailing about how expensive property has become due to investors buying up/renting out most of the cheaper housing stock.

I have a theory on this, and would invite anyone to pick it apart.

Most property investors are the “mum&dad” type, not educated enough or comfortable with either stocks, money managers or “exotic” schemes.

At the same time inflation, over 10 years,  of around 2.5% per year sees them loosing around 35% of that “saved” money if they were to stick it under a mattress, or slightly (very slightly) less if they banked the money.

Heres the Wiki figures, tell me why (in the absence of a crash) you wouldnt invest in real estate in Australia?

Between 1998 and 2008 inflation was about 36%[30] yet property prices inflated by more than 300% in all capital cities except Melbourne (up 280%) and Sydney (up 180%)

So given cash goes backwards, most investments have an element of risk, lack of control or both where is an average person to invest their money? Housing in Australia is a rather large bubble waiting to burst, but the government isnt willing to risk deflating it anytime soon. A reflection of how much is tied up in housing can be seen by the devastation in America, where it was largely residential homes that triggered the financial crisis.

 

Australia treats property investment much different to nearly any other type. Live for a few years in a house and when you sell it, the profit is taxed at a massively lower rate than any similar item sold.

I blame the taxation system for the massive overinvestment and price bubble in Australia. The desire was good, more properties available for renters, more small investors, but it has become a monster.

Im not calling for a swathe of new taxes on housing though, but a realisation that the investment market is massively distorted  by the taxes levied on every other type of “ordinary” investment. If, for example the government was to cease taxing bank deposits the “average” investor might begin to see that as an attractive and less risky proposition to investment housing. Again this might begin to distort the flow of money, but I think its time the housing bubble was deflated softly in Oz, rather than allowing the upwards spiral to continue.

The problem isnt “greedy investors” its the inevitable result of the government taxing most other “unsophisticated” investment options. If they were to lessen taxes on other investment options it might take a lot of the heat (and the huge risk building) out of the housing market.

5 Responses to “Unintended consequences?”

  1. Kaboom Says:

    Frollick, the whole problem can be summarised very neatly as follows:-

    1. The purpose of housing is a roof over one’s head. It should never be considered an “investment”.
    2. Historically (in fact ever since caves were bought and sold on the open market) housing should not cost you more than 3x your gross family income.
    3. In most capital cities of Australia, the median price of a housing unit (a family residence) is roughly 8x, 9x or 10x the median income of that neighbourhood.
    4. The median income per census details in YOUR neighbourhood is surprisingly low – try maybe $70,000 per annum. Gross.
    5. On this historical perspective, a median house should fetch $210,000, being 3x median gross income. Nah – the median is about $650,000, isn’t it?

    This all poses several dangers. Firstly, it is a significant deviation from the historical value, which means that there is potential for someone to lose an enormous amount of money. Hint: It will not be the clever people.

    Secondly, it is unsustainable in the absence of wage increases (sometimes mistakenly called “wage inflation”), as the mortgage debt is almost impossible to repay within a working life-time with slight interest rate increases.

    What have average wage increases been for the first decade of the 20th century? Pretty close to 3/4 of 1/6 of 5/8 of SFA.

    For hypothetical example: I am newly married, and earn $50,000 p.a., and my wife earns $35,000 p.a. We buy a median value house at $650,000, even though our gross family income is slightly in excess of the median of $70k, sitting at $85,000 gross, or approx $67,200 per annum net, or $5,600 per month. Our net income looks like this:

    Me: $50,000 gross = $3,200 per month net
    Her: $35,000 gross = $2,400 per month net
    Total net income: $5,600 per month.

    Suppose we had saved up a 10% deposit of $65,000 (try doing that in real life!) and borrowed 90% ($585,000) over 25 years, at an initial 5.2%.

    Our monthly nut would look like this:
    Principal and interest: $3,500
    Left to live on: $2,100 per month, or $484 per week.

    Best of luck with that. This covers food, fuel, council rates, insurance etc etc.

    Now, if the markets react in the traditional fashion to profligate government spending schemes, interest rates will increase. Those of us with grey hair will no doubt remember 17% interest rates on mortgages. But, let’s be gentle, and say interest rates only go up to 9%, which is the actual historical mortgage rate average, ever since man started lending money for someone to purchase a cave.

    Let’s have another look at our monthly nut, at 9%, for the same $585,000 borrow:

    Unchanged family net: $5,600 per month
    Principal and interest: $4,900
    Left to live on: $700 per month, or $161 per week.

    That’s Pal dog food, and strapping into the neighbour’s electricity.

    Don’t forget – we are earning slightly over the median.

    Honey! Guess what!!!

    Oooops.

    The issue is an interest rate rise. Would you bet against it? Kevin Rudd certainly does………

    The whole property market is the greatest fucking shell-game in history! Don’t even get me started on “negative gearing”. Big secret: “negative gearing ” is code for “making a fucking HUUUGE loss this year”.

    I will do a comprehensive guest post on this if you like. Without the “F” word. Maybe.

  2. thefrollickingmole Says:

    Go for it, the whole mess is, as you say a shell or bubble, last ones to buy being the biggest losers.
    There is no way housing should be as rediculously priced as it is.

  3. ozzieaussie Says:

    It is ok to “rail” against the negative gearing, but it sure helps to keep taxes a little bit lower when the income tax rate is still way too high.

    When you are receiving even a modest salary of around $100k-$250k per year having a negatively geared property certainly helps to reduce the income tax bite at the end of the year.

    As to being grey-haired and remembering the 17% mortgage interest rate. Not quite. That happened in 1987 and there were thousands like us who were in the process of purchasing a property when Keating froze the interest for some but the rest of us got slugged. We were in our 30s when that happened. The house we purchased was worth under $100k at the time.

    Personally, I object to the whole notion of capital gains tax because yes it does distort the markets.

    This is a very good article.

  4. ozzieaussie Says:

    One reason for the property distortion and this is from observation back in the 1970s, is that when you have DINKS purchasing property they are more willing to pay the higher prices.

    A DINK has more spare case than a family with children, therefore they can afford to push the price of a property higher than its real value.

    At the same time, the push by real estate agents to have property auctions also pushes up the price, and helps with the distortion.

    Take for example the property where I am living right now. The house was passed in at auction but the people wanted a sale. We viewed the property well after the auction. The price demanded was too high anyway. We did negotiate an acceptable price for the house.

    Also, some DINKS are purchasing property that requires repairs and renovation and then on selling, and this again tends to help with the distortion in the market.

    The USA situation is different to Australia because over there they have a bill where the banks must lend to people who cannot afford to pay off a mortgage (and some even lie to get the loan in the first place). The distortion over there is made worse when the WH keeps changing the rules so that people do not have to pay their mortgages – talk about toxic assets!! We do not have that problem here and have more sensible lending policies. Even so there are people who enter the market thinking they can afford the mortgage, the Reserve Bank steps in and raises interest rates, next thing you know they lose everything.

  5. Kaboom Says:

    Oz, good points all, but you’ve got to watch that “It’s different here!” or “It’s different this time!” argument.

    There are also different legal ramifications to default in Australia, as opposed to many so-called “non-recourse” states of the USA.

    I am working on my Tizona Thesis, but have been delayed by family type things!


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