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Are we paying too much for the Australian dream?
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In one of the more remarkable occurrences, residential property, despite macroeconomic indicators to the contrary, has been an incredibly resilient asset class this year. In fact, the “affordable” sector of the property market is trading at record high levels, while auction clearance rates in major cities remain above 70 percent (in Melbourne, the clearance rate is above 80 percent). The use of inverted commas around the word “affordable” is intentional — for many, the “affordable” sector of the housing is perhaps ironically, relatively unaffordable. To purchase a property within 15 kilometres of a major city, first home owners are required to spend often upwards of six times average incomes, double the amount previous generations would spend on a home. That means one of two things is happening; people really like buying homes these days, or punters are vastly overpaying for residential property, or perhaps a little of both. Property bulls will no doubt argue that the housing sector in Australia is not really over-priced, but due to the shortage of satisfactory property, the price is at an equilibrium level. While supply issues no doubt have a short-term effect (Australia still has significant net population growth), in the longer term, the free market requires capacity to increase to match the higher demand. (Australia isn’t Monaco, urban centres take up a mere fraction of total land). No, the major impetus for the prevailing boom is the continued, boosted first home owner’s grant and the ongoing lax lending standards exhibited by major banks. The FHOG is a dreadful piece of policy which has the unfortunate effect of inflating the cost of homes for young people. Various potential buyers, all with the grant in their back pocket, simply bid up the price of a property to what they could afford, plus the value of the grant, plus the leverage they are able to obtain. (Figures released last week indicated the “first home buyer” sector continues to dominate property prices with data indicating that 29.5 percent of owner-occupied mortgages were to first home buyers. Before the grant was boosted, the figure was around 12 percent). But even the boosted FHOG (and various stamp duty concessions in certain states) isn’t enough to cause the dead-cat boom in residential property. For that, we can thank the highly concentrated banking sector, especially the major banks, for continuing to lend on loan-to-valuation ratios of upwards of 90 percent. The apparent generosity of the banks could be stem from their desire to increase market share and earnings. That of course, does not inspire a great deal of confidence given that these are the very same banks which funded Opes Prime, ABC Learning, Centro, MFS, Babcock & Brown and Allco (among others), presumably, also to increase market share and earnings. When it comes to assessing risk, notwithstanding their penalty fee-funded profits, the performance of Australian banks leaves a lot to be desired. It is also interesting to compare the buoyant Australian banking sector to the flailing US financial institutions. For it seems that Australian banks are following a similar path to that of US lenders earlier this decade. In that regard, we note Bill Bonner, in the Daily Reckoning, who claimed:
There is one other possible explanation for Australian banks’ continued generosity. That is, they are desperately trying to put their collective fingers in many collective holes in a very large dyke. If all the Australian banks tightened their lending standards, for example, by requiring LVRs of 50 percent (which is the level which they could fund from deposits, without the need to seek overseas finance or issue bonds) there would be an almighty crash in the property market. Instead of using a $40,000 deposit to purchase a $350,000, the young couple would only be able to spend $100,000. Forget a supply-driven boom, the recent spike has been caused by banks unwilling to reign in borrowers to any large degree (banks have only marginally cut back on LVRs and slightly tightened deposit requirements). Banks are in a Catch-22 of sorts — if they tighten lending not only will their income drop (from writing less loans), but more importantly, the value of collateral underpinning their existing loans will slump; dramatically. This will lead to a surge in bad-debts, much like what happened in the United States, when borrowers had the equity in their homes dwarfed by their mortgage. When homes start getting foreclosed, the value of property falls even more as buyers adjust their expectations (Why buy now when the guy next door will have their house sold in a month’s time for $50,000 less?). Of course, if the banks continue their generous lending policies, that would add to the boom and cause an even greater problem when eventually unemployment spikes, borrowers start missing payments and banks are forced to foreclose on even higher-priced properties. The banks are currently choosing the second option — delaying the pain for a few more years (and possibly allowing executives to continue to receive handsome performance bonuses along the way). The victims of this policy will be bank shareholders and home buyers paying far too much for their Australian dream. |
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14 Comments
Very interesting article Adam. I would be interested to know what percentage of first time home buyers have received the odd 50K from the asset rich parents; when my wife and I bought our house, all the other prospective buyers were youngsters with Boomer parents in tow
And what about negative gearing? Asset rich investors buying up expensive inner city property safe in the knowledge they can rent it out at outrageous prices and be subsidised by the tax payer. This middle class welfare/tax rort is also keeping house prices too high and its removal would not only save the government money but make housing more affordable.
Good article Adam. However as covered in the recent series “Ascent of Money” on the ABC, which suggested lending gets really hairy when there is no relationship to income to repay. Ie. LVR is just one component in lending - equally capacity to repay is just as important. And at 6 times earnings the capacity to repay doesnt leave much of a life.
The problem with looking at just LVR is as you point out its a bit circular as the inflated values support a greater debt. The feedback loop creates wobbly valuations. But income vs loan is absolute - do you have data on the trend in that?
I’m not predicting this, but if some major unforseen external shock hits and we get unemployment and falling real incomes then that will be the double whammy. The Ascent of Money series pointed to various wars, oil shocks etc that have triggered this. “Nobody expected Spanish Inquisition….”
It would help if the FHOG only applied to new houses, not existing ones.
Then the subsidy would be increasing supply, instead of demand.
The FHOG is not “bad policy”, it’s just disguised as bad policy. In fact there are no votes to gain and lots of them to lose by making homes affordable. There are just so many more property holders than ready buyers at any one time. Add in Australia’s banks, for reasons I think Adam has got exactly right, and there really isn’t an affordability lobby worth ten seconds of the PM’s time.
Notice how Kevin Rudd quietly dropped barriers to overseas investment in Australian residential property over Christmas? How about the fury of Wentworth voters/homeowners in 2007, holding John Howard responsible for the drop in their local values? (See the Australian, 16/07/2007 http://www.theaustralian.news.com.au/story/0,25197,22080703-2702,00.html).
Think of high prices as another form of borrowing from the future for economic stimulus now. Retirees live it up today, newlyweds work off the debt in years to come, before passing it on to tomorrow’s children, and so on. Almost all the losers are children or still unborn - not a lot of voters in that lot!
That’d be fewer loans, not less.
M
I agree with your view of the slow subprime our banks are visiting on Australia. The argument that we haven’t had a collapse yet, so lets just keep doing what produced a collapse everywhere else has always struck me as a bit thick.
I think James has a good point, and your article, while pointing out the problem with Ozzie bank lending fails to really bring attention to the 800lb gorilla in the room. The Rudd government since coming to power has totally bent over backwards to maintain property prices at their current level. The headlines about cash splashes and minor falls in employment hide the fact that the real game for Rudd and Co is preventing a crash in the housing market, such a crash would almost certainly hand the opposition a large slab of disaffected voters regardless of whether or not this government is to blame.
No government wants to be in power when the sh*t hits the fan and Rudd knows this only too well.
I would have thought the Crikey readership would be a bit above dragging out the old anti-negative gearing argument. Why can’t I claim as a tax deduction the expenses incurred (bank interest) in earning an income (rent)?
Why shouldn’t AFOX be allowed to claim those additional expenses as a tax deduction?
1) Ummm… Maybe a good starting point would be to ask the other 190-odd countries that don’t permit negative gearing?
2) Even without negative gearing, you could still claim those expenses as tax deductions, AFOX… To the extent that the investment has earned income.
3) Before we ask anyone why you shouldn’t be able to claim those additional expenses as tax deductions, perhaps it would be better to ask the majority of taxpayers who don’t negatively-gear WHY they should continue to subsidise property speculators’ cost of capital to the tune of $6b per annum?
But back to FHOGs… Two queries:
1) What was the average house price when Howard introduced the FHOG? What is it now? And how does that annual growth rate compare to increases in wages / GDP / etc over the same period?
2) Does it not seem strange that the size of an average FHO mortgage is now HIGHER than an average non-FHO mortgage? Why would the demographic that has negligible equity, lower-paid jobs and greater risk of unemployment be gearing themselves up to a higher level than the rest of the population? It wouldn’t have anything to do with the free carrots being dangled in front of them, would it?
YES! qed.
We might not be Monaco but we might as well be in our Cities. It’s not the cost of housing that’s the problem, it’s the cost of LAND. We have a generation of baby boomers with a vested interested in ensuring Nothing At All Changes. (Trust me, I’m from Perth and we’re full of them). We have suburbs full of the 1960s quarter acre block with empty nesters or a single old lady living on them. Of course, there’s no political will to promote density.
Additionally, any land suitable for development is obliterated by the green movement. This is driven, once again, by the baby boomers sitting in their comfy homes tut-tutting about saving the lovely cockatoos that visit in the evening. The extensive UWA bushland just 5 km from the CBD that has been earmarked for development for 100 years (and now won’t be) is case in point. Our “green enlightenment” comes at great cost to today’s families.
So while the baby boomers sit fat, dumb and happy, their Gen X children are in families where both parents are working to desperately pay a mortgage double the relative value of the baby boomer generation.
A huge cache of baby boomers turn 60 this year. In the next ten years, their inevitable downsizing, I predict, will put incredible downward pressure on housing values.
If anyone but me is still reading this, an answer for AFOXRUSSELL might be that negative gearing was originally intended to help farmers get through bad years and new businesses get through the start-up period on the way to profitability. Using negative gearing as a structural component of an going concern with no intention of ever making a profit was once considered a loophole that needed closing, until the number of investors using that loophole made it politically untouchable.
But negative gearing isn’t the only tax distortion to consider. What about the Capital Gains Tax? This tax took ten years from its inception to start having an effect on home prices (the opposite effect of that intended) because other factors needed to fall into place like the minerals boom. But it provided property-speculator spruikers a great reason to convince fellow speculators to buy and hold in certain markets, rather than selling after a few years as they used to. New (and in my opinion incredibly risky) investment models evolved in response to the CGT in which you can make money by leveraging off increased equity without ever selling a single property. It works best if many other speculators are doing the same thing, because together they reduce the available pool of properties for sale and thus the supply-demand imbalance. That’s why the proportion of investor-owned to owner-occupied houses (not just apartments) has risen in the last ten years. So of course, not very much CGT is actually collected on properties.
A fair policy option to consider would be excluding all residential property from Capital Gains Tax. This would allow speculators hit by hard times to exit cleanly and realize most of their capital gains. It would also increase the available pool of homes and thus help home buyers. Of course there is no free lunch; owners who choose not to sell would see a temporary drop in their beloved home prices. But owner-occupiers would also be able to move paying tenants into their homes without crossing over into CGT territory. There’s no absolute win-win available in the cutthroat property market, but excluding homes from Capital Gains Tax may be the next best thing.
We had a sub prime mortgage crisis before the yanks, during the recession we had to have. Or have you all forgotten that in 1990/1991 all australian real estate markets dropped, almost as far as the stock market. They just took longer to get there. The australian economy usually lags behind the rest of the world both on the way up and down.
Have you not seen the ads urging first home owners to buy on zero deposit, legals or stamp duty, because the FHOG covers all that. Together with ads from home wares retailers on zero deposit, no payments for 5 years. Have it all now? pay later?
Economic Stimulus has only delayed the crash until after an early election can be called.