On housing in Sydney

[Gandalf]

Last night, ABC news program Four Corners broadcast a story on Australia's housing affordability crisis. This article is more like a promo for the video available at the link. It's three quarters of an hour, but an amazing watch. If that's not your cup of tea, a transcript is there too.

On the eve of the Federal Budget, Four Corners reports on the white hot issues of housing affordability and negative gearing and the generation left wondering if they will ever own their own home.

"We will start it at 1.1 million dollars ladies and gentlemen." Auctioneer

A house with a million dollar price tag used to be confined to the super wealthy suburbs in Australia's biggest cities. Today, properties with that sort of asking price are commonplace, even in the urban fringes, with little infrastructure and lengthy commute times.

In Melbourne, the median house price is $700 thousand dollars, around 10 times the average wage. In Sydney, there are suburbs more expensive than Manhattan. It's why the IMF declared Australia one of the most expensive cities in the world to buy property in.

This week reporter Ben Knight explores the housing crisis locking younger people out of home ownership and the negatively geared world of investors building their nest eggs.

"It's only money!" Auctioneer

He meets investors like Wayne and Karen who've created a multi-million dollar property portfolio from their dining room table.

"We saw them on the internet, we actually borrowed 105% using the equity we had in our house to fund that." Wayne & Karen

And the agents spruiking the investor-led property gold rush.

"Why are people looking at negative gearing? Because it's generous. It's a wonderful opportunity for people to become involved in property investment. It's a gift." Real Estate Adviser

With negative gearing and affordable housing shaping up as key issues in the forthcoming election, we look at the politics at work behind the major parties' policies.

"Labor's reckless changes will reduce property values. They'll devalue every home, every property in Australia." Prime Minister Malcolm Turnbull

The Coalition is banking on leaving negative gearing policy exactly the way it is. While the Labor Party is hoping its plan to wind it back will attract those first home buyers who feel locked out by the high price of property.

"We're not looking to buy an investment property. We want a house we can live in." Jules, House Hunter

But some economists are warning that there are property bubbles in our major cities which could wreak havoc on our economy.

"According to pretty much any housing market indicator you want to look at, house prices in Australia are significantly over valued." Investment Fund Manager

And there is worrying evidence of fraudulent loan applications which could leave banks and consumers dangerously exposed.

"They're lending to homebuyers that have no ability to be able to pay off their loan and they're basically depending on the property market to continue to rise at a consistent rate." Economist

While for some first home buyers, a housing crash is just what they are hoping for.

"Are we all done...?" Auctioneer

Now imagine being a renter in this market, at the whim of investor landlords who know you can't afford to go elsewhere. This is the face of class struggle in Australia, as the country has somehow managed to create a landed gentry out of the baby boomers. Fuck it all.

[Patroklos]

Whats stopping a construction boom? If allowed investors would be tripping over themselves to create supply to undercut competitors. Whats enforcing the status quo?

[General Zod]

So what you're saying is you guys didn't learn anything from our subprime mortgage crisis.

[The Jester]

Whats stopping a construction boom? If allowed investors would be tripping over themselves to create supply to undercut competitors. Whats enforcing the status quo?

It's not the building, it's the land that's at the heart of it.*

Australia is completely warped in how tax incentives work. It's the only country that I know of that gives tax imputation on dividends, and it's the only country that I know of that allows interest from investment loans to be deducted against personal income: the Negative Gearing that's frequently mentioned in relation to the topic. On top of this, if a property is held for at least a year, the owner is only subject to half the capital gains tax. This makes real estate a very attractive asset class for investment because it's incredibly tax effective.

But it gets worse. You see, while Australia does have a public pension system, back in 1992 a compulsory contribution to private pension accounts was introduced in order to keep retirement income solvent with a change in population demographics. While this has lead to what I would consider a hideous monster within the financial industry that Australians call Superannuation Funds, there is also a growing industry of Self-Managed Superannuation Funds (or SMSFs) under which the individual has full control over what assets the fund holds (though subject to regulation). One common reason to run your Superannuation account as an SMSF is so you can invest in residential property.

But it gets worse. Foreign investors are also allowed to buy real estate in Australia. Now normally the rules stipulate that they can only invest in new property, there certainly appears to be minimal oversight on behalf of the board that should be regulating those purchases (due to massive under-staffing from what I've heard). While the board produces no reports about the amount of real estate being purchased by foreign buyers and so there is very little available in terms of stats, it is rather noticeable the amount of existing property being marketed in Chinese and the presence of buyers at auctions working on behalf of non-English speakers. It's honestly difficult to come up with concrete evidence, but there is a lot of suspicion (myself included) that a lot of questionable money is moving offshore from mainland China and entering Australian real estate via complicated investment vehicles that the regulators frequently aren't able to investigate thoroughly.

To put it shortly, incentives behind real estate investment are very warped. But unlike a lot of the world there really hasn't been a whole lot to bring it back in line with something that looks remotely reasonable to anybody looking to enter the market. There are a lot of sources of new money entering the market, but not a lot to cause financial distress for investors as Australia has fairly strong safety nets. With very little exogenous to precipitate a large selloff or change the current dynamics of the market, it's entirely possible that this problem could only get worse for years.



*Though it is noteworthy that a fresh coat of paint adds considerably to a property value given time spent which suggests that there is somehow a shortage of painters in Australia. Or people are irrational with real estate.

[Col. Crackpot]

So what you're saying is you guys didn't learn anything from our subprime mortgage crisis.

Sure sounds like it. Christ... 105% financing, what could possibly go wrong with that. Oh wait I saw this movie before.

[Alkaloid]

Whats stopping a construction boom? If allowed investors would be tripping over themselves to create supply to undercut competitors. Whats enforcing the status quo?

It's not the building, it's the land that's at the heart of it.*

There effectively has been a construction boom already. The article focuses on Sydney, but Melbourne has the same problem (to a marginally lesser extent) despite having 82,720 residential houses standing unoccupied as of 2014. (If you're wondering, this is measured as the number of properties using less than 50L of water a day, otherwise known as less than a dripping taps worth of water a day). I can't find data with the same measurements for Sydney with a quick google, but estimates put Sydney at more than 90,000 unoccupied residential properties. If I could snap my fingers and make 10,000 new houses appear out of thin air tomorrow it would make effectively no difference.

The negative gearing + capital gains exemption means it is potentially profitable to own an unoccupied house and for investors this is quite often an advantage as an unoccupied house means you don't need to provide any notice to tenants before selling so if you need to move the house quickly it's much easier. It's certainly possible to argue that people that can't afford top buy into the housing market could invest in other industries but that ignores two rather salient facts. 1, investing in property is considerably more profitable, so excluding property from your portfolio puts you at a considerable disadvantage on a dollar to dollar basis than more established investors who can clear the higher barrier for entry and 2. You still need somewhere to live, so even if you do invest elsewhere you have no choice but to spend hundreds of dollars a month repaying someone else's investment rather than your own.

So what you're saying is you guys didn't learn anything from our subprime mortgage crisis.

Not exactly. People getting loans typically have the money and/or assets to service them, even if in a lot of cases they have effectively no diversity in what they've invested in, it's all housing. There is arguably a housing bubble (certainly a housing bubble really, but the only studies you'll find on the subject are typically funded by vested interests one way or the other with predictable results) which almost everyone with a SMSF or multiple investment properties is horrendously exposed to, and yes, if it bursts the country will likely end up experiencing the results of the GFC 10-15 years after the rest of the world, but even if it doesn't there are issues around housing affordability and the working/middle class essentially losing the ability to ever own a home without inheriting it.

[mr friendly guy]

So what you're saying is you guys didn't learn anything from our subprime mortgage crisis.

Sure sounds like it. Christ... 105% financing, what could possibly go wrong with that. Oh wait I saw this movie before.

Funny thing is, we didn't have NINJA loans like the US preceding the subprime crisis. It seems that we are starting to pick up their bad habits if we now have 105% financing.

[mr friendly guy]

Just like to add as well as negative gearing, we have quite a few other methods of minimising tax via property. For example, I could claim a deduction on
a) plant costs
b) depreciation of the house - so if the house cost 200 k to build, you can claim a depreciation of x% of 200k per year as a tax deduction (until you used up all of the 200 k).

The idea is that even if you are in negative cash flow, ie you're negative gearing, you can turn it into positive cash flow via these other "on paper" tax deductions.

Now I was damn frustrated when I tried to get into the property market. It was ridiculous. However I eventually did so and now have a second property which is a newly built and has a tenant. Its currently in positive cash flow because with low interest rates it was easier to put the money against the mortgage and get a better return.

[The Jester]

There effectively has been a construction boom already. The article focuses on Sydney, but Melbourne has the same problem (to a marginally lesser extent) despite having 82,720 residential houses standing unoccupied as of 2014. (If you're wondering, this is measured as the number of properties using less than 50L of water a day, otherwise known as less than a dripping taps worth of water a day). I can't find data with the same measurements for Sydney with a quick google, but estimates put Sydney at more than 90,000 unoccupied residential properties. If I could snap my fingers and make 10,000 new houses appear out of thin air tomorrow it would make effectively no difference.

I've seen those numbers for Melbourne but have never seen anything like that published for Sydney. Do you recall where you got those numbers from? Unscientifically looking to see if the lights are on in the new high-rises around my former district doesn't indicate anything was amiss there, but that's a very narrow perspective compared to the whole of Sydney and a terrible method of measurement, so real stats would be interesting.

2. You still need somewhere to live, so even if you do invest elsewhere you have no choice but to spend hundreds of dollars a month repaying someone else's investment rather than your own.

What gets more perverse is that the incentives can put individuals in a position where it's better for them to rent and own an investment property at the same time. But I'm sure real estate agents are quite happy with such an arrangement and the additional rental management fees they're able to collect.

Not exactly. People getting loans typically have the money and/or assets to service them, even if in a lot of cases they have effectively no diversity in what they've invested in, it's all housing. There is arguably a housing bubble (certainly a housing bubble really, but the only studies you'll find on the subject are typically funded by vested interests one way or the other with predictable results) which almost everyone with a SMSF or multiple investment properties is horrendously exposed to, and yes, if it bursts the country will likely end up experiencing the results of the GFC 10-15 years after the rest of the world, but even if it doesn't there are issues around housing affordability and the working/middle class essentially losing the ability to ever own a home without inheriting it.

The thing is in order to realise a profit from an investment property, you're going to have to sell it at some point. With a shrinking pool of first home buyers available that can afford to buy in, your best option is to sell the property to another investor. I have difficulty believing that a market composed mostly of existing investors exchanging properties amongst themselves is sustainable in the long term.

Funny thing is, we didn't have NINJA loans like the US preceding the subprime crisis. It seems that we are starting to pick up their bad habits if we now have 105% financing.

Australia has NINJA loans, they just call them low doc loans instead. There are very little stats about the extent of them though it would be reasonable to believe that they're not as pervasive as NINJA loans were in the US. Nonetheless, you can see from the 4 Corners episode that the banks are definitely altering documents to make their clients seem more credit worthy than what they really are. Unfortunately, it won't be until things start exploding spectacularly in the finance industry before the forensic accountants are brought in and the real extent of doctoring is brought to light.

Now I was damn frustrated when I tried to get into the property market. It was ridiculous. However I eventually did so and now have a second property which is a newly built and has a tenant. Its currently in positive cash flow because with low interest rates it was easier to put the money against the mortgage and get a better return.

And you're a doctor, if I recall and you're in Perth, which is cheaper than both Melbourne and Sydney. For an individual on an average income, home-ownership just becomes are bigger and bigger pipe dream with there being literally nothing they can do to improve their circumstances or even keep pace with the rate of price growth short of winning the lottery.

Recent developments in yesterday's budget and interest rate cut could also continue to exacerbate the problem of housing affordability going into the near future.

A crackdown on superannuation tax concessions for the rich, coupled with a budget day cut to interest rates, could increase the flow of funds into negatively geared investment property.

Ahead of the 2016-2017 federal budget announcement, two of the country's leading actuaries, Rice Warner chief executive Michael Rice and Mercer senior actuarial partner David Knox, warned that any crackdown on super tax concessions for the rich without any changes to the negative gearing rules could have the unintended consequence of pushing more money into property.

Finance Minister Mathias Cormann brushed off fears that a crackdown on super concessions might push more money into negatively geared property.
That is exactly the policy combination that we got on Tuesday night. And to add fuel to the fire, earlier in the day, the Reserve Bank of Australia dropped the benchmark interest rate by 0.25 per cent to a record low 1.75 per cent.

A centrepiece of the budget was a package of changes to super taxes, forecast to save the budget $2.9 billion over the coming four years, that was squarely targeted at the very rich.

This included the introduction of a $1.6 million cap on the amount retirees could transfer from their super accumulation account into the even more generous tax settings of a retirement account, where earnings are tax free. Other measures included higher super contributions taxes for those earning between $250,000 to $300,000, a new $500,000 lifetime cap on non-concessional contributions, and a lowering of the concessional contributions cap to $25,000.

As previously flagged, there were no changes to negative gearing rules and Treasurer Scott Morrison emphasised the government had no plans to touch it in the future.

"We have no wish to undermine the value of Australian's homes," Mr Morrison told Fairfax Media.

Speaking to Fairfax Media last week, Mr Rice and Mr Knox said that, if super was made significantly less attractive to wealthy savers, they might find other investments, such as negatively geared property or share portfolios, more attractive.

"There'll be a bit of that but it's not a big deal, most of the money will stay in super," Grattan Institute chief executive John Daley said from inside the budget lockup.

"Anyone with more than $1.6 million in their super fund at retirement is likely to be in the top marginal tax rate. That means paying 15 per cent tax on the earnings in their super accumulation account is a big discount to their income tax rate of 47 per cent."

"Even with a 15 per cent earnings tax applied to the excess of balances over $1.6 million, super will remain a wildly attractive savings vehicle," Mr Daley said.

Finance Minister Mathias Cormann said the government was confident there would be no spike in negative gearing in response to the budget.

"Negative gearing is mostly used by middle-income earners, people with more than $1.6 million in super have other ways of managing their wealth," Mr Cormann said.

It was the first time in living memory that the RBA moved the official cash rate on the same day that a federal government handed down a budget.

RBA governor Glenn Stevens, who had previously flagged his concerns about the property market becoming overheated, said on Tuesday that macroprudential measures seemed to be working and there was less reason to be worried about the potential risk of lower rates overheating the property market than there had been a year ago.

[bilateralrope]

The thing is in order to realise a profit from an investment property, you're going to have to sell it at some point. With a shrinking pool of first home buyers available that can afford to buy in, your best option is to sell the property to another investor. I have difficulty believing that a market composed mostly of existing investors exchanging properties amongst themselves is sustainable in the long term.

It's not sustainable. It will lead to a crash at some point.

Worse still, any attempt to lessen the size of the crash is likely to trigger the crash early. Giving politicians an incentive to leave it alone so that they don't get blamed for the crash.