It appears that the awful truth of the much celebrated First Home Owners boost is becoming more apparent, as feverish bidding continues to increase the price of “affordable” property. The panic set in last week when Prime Minister Kevin Rudd intimated that the Boost would not be extended past 30 June 2009, noting, “…the first home owner’s boost, as you know, we have indicated that will conclude within a very fixed and finite time frame … it’s had strong, useful results so far, but I have got to say all good things must come to an end.”
It has taken a while, but property commentators have finally realised that the FHOG doesn’t actually benefit first home buyers, but rather, lines the pockets of (often wealthy) property vendors, including investors who have already benefited from negative gearing and who can then collect concessional capital gains upon the sale of their investment asset. The Australian reported today that Kevin Lee, head of Smartline Mortgages, noted “the first-home buyers grant has been counter-productive” while, property analyst Michael Matusik claimed:
It should be called the vendor’s grant…in the outer suburbs of major capital cities the prices went up between $7000 and $14,000 in a 24-hour period immediately after the announcement. There’s anecdotal evidence that it has boosted housing construction, but over the longer term all it has done is bring forward construction.
Matsuik’s comments resemble what this column noted back in October 2008, shortly after Rudd unveiled his vote wining FHOG boost:
The most obvious problem with the grant is that it doesn’t actually benefit home buyers. Most recipients of the grant will be purchasing lower-end properties, probably in competition with each other. Giving them extra money will have the effect of “bidding up” the property up by the value of the grant. It is inflation in its purest form.
Not only does the FHOG cause the price of sub-$500,000 properties to be bid-up, but through the use of leverage, first home owners are required to spend far more than the value of the grant on their new property. Consider a young couple who have managed to save $50,000 to purchase an established property. Without the FHOG and using a loan-to-valuation ratio of 80 percent (the lowest level before mortgage insurance is required), the young couple could afford a property which costs approximately $250,000 (for the purposes of this example, we will ignore associated costs such as stamp duty, legal fees and mortgage establishment charges). However, with the “benefit” of a $14,000 grant, using the same LVR, the couple would be able to spend $320,000 on a property.
The $14,000 grant has effectively inflated the purchase price of a property by $70,000 through the multiplying effect of leverage. More worryingly, even using a relatively conservative LVR of 80 percent, the grant would also allow the young couple to borrow $270,000, rather than $200,000. Using an LVR of 90 percent, the same couple could have acquired a property which cost more than $600,000 and increased their purchasing power by $140,000. That debt needs to be serviced — even using today’s relatively low rates, at the higher LVR, the value of the boost would be almost completely absorbed by higher interest payments in the very first year of home ownership.
Anecdotal evidence appears to be indicating a market quickly reaching tipping point. Melissa Singer in The Financial Review reported this morning that Sydney agent, Sebastian Bonaccorso, claimed “there’s fierce competition and a lot of buyers are going past their limit. We’ve had a lot of properties priced between $350,000 and $550,000 that are selling for more than their asking price and if you wanted to, you could sell some of them within 48 hours.”
Like a dry forest at the end of a long summer, the lower-mid end of the property market faces a perfect storm — the end of the FHOG boost, interest rates approaching the bottom of their cycle, near record low unemployment and low inflation — a disturbing mix of ingredients.
How will it end? Probably not well for taxpayers. Dan Denning of the Daily Reckoning suggested “RuddBank will end up buying these [first home buyer] mortgages from the banks over the next few years. The government will directly negotiate mortgage payment moratoriums and ‘foreclosure prevent programs’ to keep people in houses they simply can’t afford at these levels.”
The first home owner’s grant, especially in its boosted form, is not a policy which benefit first home buyers, but one which will lock them into a lifetime of possibly unserviceable debt forcing them to pay more for a property than would otherwise be the case. But that’s what happens when politicians make decisions which are popular, but make no economic sense.