Property taxes are about to fall! (and why this is bad news)

Auction clearance rates are falling, sales volumes slowing, and prices are coming off the boil in the formerly red hot markets of Sydney and Melbourne. This is bad news for State Governments who have increasingly relied on property taxes to fund a growing list of infrastructure promises from transport to schools to hospitals. It could also be bad news for the Australian economy because one of two things could happen: falling forward property revenues will see infrastructure spending curtailed (even though we continue to have an infrastructure deficit) or we will go into more debt to keep the tap on even when the tank’s running dry. Neither is a great outlook and let’s hope it doesn’t happen.

The remarkable thing is just how dependent State Governments have become on property taxes – chiefly stamp duty on transfers. (Remember, this was the tax they promised to abolish in exchange for GST revenues. Paul Keating once said: “Never stand between a State Treasurer and a bucket of money.” He was so right).

Nationally, total State Government taxes on property (according to the ABS data) have soared from around $30 billion per annum in 2009 to over $50 billion in 2016-17. That figure will probably climb for 2017-18 and could even approach the $60 billion mark, given how white hot Sydney and Melbourne were in 2017 and into the first quarter of 2018. Imagine if a slowdown in markets (mostly a fall in volumes) brings that revenue back to even 2013 levels… that would be a $20 billion per annum hit to state budgets. Ouch.

NSW is going to feel the pain. Its last State Budget announced a raft of infrastructure projects which had the country weeping in envy. Their stamp duty revenues alone grew from $4billion per annum in 2011-12 to $9billion in 2016-17. Property tax dependency also grew – from around a third to nearly 45% in the same period. A sustained fall in sales volumes combined with a fall in prices could see $3billion per annum wiped from future state revenues.

Victoria doesn’t fare much better. With both stamp duties and land taxes steadily climbing, their annual revenues have swelled by over $3billion per annum. Their property tax dependency has grown from around a third to over 45% of all income. Nearly one in two state tax dollars comes from property. That’s going to take some delicate fiscal balancing if revenues fall on the back of a slowing property market.

Queensland has less to lose. Its market (mostly the Brisbane region) never reached the fever pitch of Sydney or Melbourne. Stamp duties rose by just over $1billion per annum (but I bet State Treasurers had hoped for more). Property tax dependency in Queensland actually fell as other income sources (payroll tax, gaming taxes and motor vehicle taxes) rose faster. Plus, having never overheated, the prospects of a substantial cooling are less, meaning the likelihood of falling forward state revenues tied to a slumping property market are less. So in this case, it’s perversely not a bad thing if property taxes don’t fall in the years ahead?

Is housing affordability the egg we can’t unscramble?

The new NSW Premier Gladys Berejiklian has made housing affordability a commitment of her government and our Federal Treasurer Scott Morrison has been to London investigating alternative means to providing low cost and social housing, while Opposition Leader Bill Shorten claims only Labor has the solution to housing affordability. Politicians are starting to get the message, but is it all too late? Has the affordability horse bolted, permanently?

It was ten years that a research paper I wrote for the Residential Development Council first started doing the rounds of various Parliaments in the country. “Boulevard of Broken Dreams” as it was titled, warned – ten years ago mind – of the impending problem with housing affordability. It got plenty of political attention at the time and the debate over housing affordability was a key issue in the 2007 Federal Election. No one can say there weren’t warnings back then. Here’s what it predicted at the time:

“While much media and political attention is focused on the role of housing interest rates, these do not explain the very high costs of housing in Australia. [Indeed not – we now have record low interest rates and record high housing prices] The root cause of worsening housing affordability lies squarely at the feet of various public policy settings, identified in this discussion paper. If these policy settings continue on their present path, there is no question that housing costs will continue to spiral beyond reach of many Australians. As this happens, dependency on rental housing will increase. Future generations of Australians will not be able to afford a home of their own, and will increasingly be consigned to rental housing - and rising rental costs.

Home ownership will be in the hands of an increasingly elite group of Australians: those wealthy enough to afford a home and those who bought into the housing market before the affordability crisis reached a tipping point.

Housing standards will fall - due to price constraints - and new homes will be built on smaller and smaller lots, with cheaper and cheaper materials to stem the tide of ever increasing government and regulatory costs.

The signs of a deepening crisis are now evident, and industry groups are united in voicing their concerns that present policy settings will only lead to a worsening problem. Failure to act now will leave future generations of young Australians a dismal legacy of housing stress - in a country which by any other assessment should boast the highest standards of home ownership and affordability.”

It’s worth a read if you want a reminder of how ineffectual governments can be in dealing with the bleeding obvious, or of ignoring good advice when there’s plenty of bad advice to be had. There is a copy of “Boulevard of Broken Dreams” you can download here.

Ten years have since passed and – as predicted – the problem is now much worse. Which also means that remedies are now more complicated since the problems are more deeply rooted. If we really wanted to do something meaningful about housing affordability today, there are quite a few more issues for politicians and policy makers to deal with. Here’s a sample:

Are we even measuring the right thing? The city wide median house price is primarily a reflection of second hand (established) housing in established urban areas. It’s the half way price point and can be distorted by heightened activity at either end of the price scale. What this doesn’t measure is the typical cost of new housing supply, being either house+land, or apartments. Nor does it measure within established markets what proportion of houses fall into the lower quartile, and whether these are accessible to new entrants or lower income households. As a market wide measure, the median has some use but in the affordability debate, it can tend to disguise as much as it reveals.

Land supply. It’s no longer a simple case of adding to supply, given that new supply is more heavily taxed than second hand (established) supply. Adding to land and housing supply with highly taxed and over regulated new stock is hardly likely to make things instantly better – it just adds more needlessly expensive stock to the market. So for improving supply to work the distortionate tax system as it applies to new land and housing needs to be addressed first.

Economic concentration. There has been an increasing concentration of economic opportunity in the inner urban regions of (mainly) Sydney and Melbourne – which is also where the worst housing affordability is. A report earlier this year noted that half the country’s new jobs were within a couple of kilometres of the Sydney and Melbourne CBDs.  Decentralising some of the jobs - both government and private - into suburban business centres and into the regions would remove some of this pressure cooker effect, but few seem willing to do so. I’m with Barnaby Joyce on this one – if you want affordable housing and views of Sydney Harbour, you’re being unrealistic. But without higher order jobs and more of them, Barnaby is unlikely to be welcoming hordes of housing refugees into Tamworth, where the housing is - like many regional towns and cities - quite affordable if you have a job.

Regulatory reform. Urban Growth Boundaries, introduced in the late 1990s and early 2000s, sought to contain outward growth. “Sprawl” as it was pejoratively called, was an evil that would lead to social decay, dislocation, congestion, obesity, pollution, environmental degradation, loss of farmland – pretty much a full catalogue of sins, most of them unverified. But these growth boundaries immediately limited supply and saw land prices escalate. To address housing affordability, especially of new housing, we’d have to have a grown up discussion about the effect of urban growth boundaries, which itself will be a challenge.

Planning regulations. More regulatory reform, this time on a host of planning regulations and prescriptive policies which can mean that even a car port application can become a topic of council debate in some places. There is too much planning and not enough doing but we are so attached to “having our say” that the community now seems entitled to advise other property owners what they should and shouldn’t do with their properties. There are regional plans, state planning policies, council town plans, neighborhood plans, plans for everything and the red tape and delays (and costs) that go with it. In the history of this country, I struggle to think of one government at any level which has actually left office with fewer rules and regulations than when it entered, so hope on this front seems remote.

Industrial relations. The militancy of building industry unions is a matter of public record. This particularly affects multi-level or large scale housing projects and adds significantly to the costs of new housing supply. But our appetite for taming the excesses of building industry unions doesn’t seem sufficient to achieve meaningful reform. Without it, new housing will continue to cost more than it needs to.

The GST. The GST adds directly to the cost of all new housing and the cost is borne by the buyers while the tax revenue flows to the federal government and is redistributed to the states. The GST does not apply to established housing. This distortion remains little discussed but it does mean that new housing is taxed at a higher rate than established housing. Talk of reform to the GST seems to end in political apoplexy so we tend to avoid it if we can. Fixing or countering this tax anomaly would be another component needed in any moves to improve housing affordability. 

Stamp duty. As house prices rise, so does the money made by State governments via stamp duty, to the extent that some governments become addicted to it. The NSW Government is one that enjoys a very healthy stamp duty revenue, much of it paid for by the very people it says it is concerned about in terms of the high cost of housing. Paul Keating once warned you should never stand between a State Treasurer and a bucket of money. He was right and Stamp Duty is a good example. In NSW it is now a $9 billion per annum bucket. In 2011, it was $3.8 billion.

Land tax. Argued by many economists to offer a more equitable property tax base than stamp duty and other levies, the extension of a broadly based land tax seems off the agenda for discussion, full stop. But any meaningful discussion of housing affordability can’t be had without a grown up discussion about property taxes, of which land tax is one.

Infrastructure levies. Introduced mostly in the early 2000s as a “user pays” approach to funding infrastructure associated with new development, these quickly became usury and applied without a transparent connection to the purpose for which they were raised. Councils and State Governments got away with calling them a “developer tax” knowing full well that it was home buyers of new housing that were paying. And pay they did – levies at one point exceeded $100k per dwelling in some parts of NSW. The HIA and other groups still say they can account for a quarter to a third of the cost of a new home. Any serious moves to improve housing affordability must look at the equity of these levies as part of the mix.

Negative gearing. What a hot potato! If this was to be reformed, how would you do so for just housing and exclude other investments? Could you confine reform to limitations in just parts of the Sydney or Melbourne markets, because if you limited this nationally, many struggling regional markets would fall into even deeper holes. It was never intended that negative gearing would see speculators holding large portfolios of rental housing and outbidding new entrants to the extent that now happens, but how to contain what has become an orgy of real estate speculation through negative gearing is now a problem of monumental proportions. Good luck untangling this one.

Population growth.  We could slow our immigration to a trickle and try ease demand pressure on housing but this could come at a broader cost to the economy. Or migrants could be directed to settle in regions to ease demand in capital cities, but without regional jobs for them, what would this achieve?  The demand side of the equation being population growth is mostly fueled by immigration and until we can get supply in step with demand, this also needs to form part of the discussion around housing affordability. Good luck again with this emotionally charged policy battleground.

Financial reform. The banks, ah what can we say about these great community institutions of conservative and moderate lending, restraint and discipline. Maybe the less said the better. Reform of lending practices has been debated, studied and investigated ad nauseum. While a contributing part of the affordability problem through some of their less savory lending practices, achieving meaningful reforms of mortgage lending practices could be a Sisyphean challenge.

So there you go. If you’re a politician who has worked your way through solving all of these issues, you’ve improved housing affordability by making housing cheaper, through falling house prices. Just think how popular you will be then… in a country so heavily vested in seeing house prices continue to rise. 

Affordable housing in plentiful supply

Australia’s ongoing (some would say interminable) debate about housing affordability was given fresh impetus last month when Federal Treasurer Scott Morrison weighed in with calls for liberated land supply and planning reform by state and local authorities. Scott’s call closely followed a less edifying observation by demographer Bernard Salt that young people simply needed to change their breakfast preferences to afford a house. 

Predictably, discussion swirled around the excessive cost of housing in the inner city markets of Sydney, Melbourne and Brisbane, the declining rate of first home buyers entering the market, the rise of a renting class and the push for higher density apartments of limited size as a means of gaining a foothold in the market. It’s a familiar conversation and one that’s been repeated for a long time now. The same arguments were being thrashed around in the lead up to the 2007 Federal Election: release more land, reduce up front development levies, and free up a notoriously dysfunctional planning system. At the time, I was National Executive Director of the Residential Development Council, and to make the point, we famously sent every Member of Parliament a rubber banana, likening housing to the price of bananas (which when in short supply, rise in price).  The debate got a lot of traction and both then Prime Minister Howard and Opposition Leader Kevin Rudd made a number of statements on the issue.

Fast forward ten years and nothing has happened on the policy front. What’s worse, the level of market analysis in the debate hasn’t improved. One of the realities which ought to get serious attention is that Australia has plenty of affordable housing. It’s just not where the jobs are.

That might sound simplistic but if we continue to push for greater concentrations of employment in the inner city areas of Sydney, Melbourne and Brisbane we will only make the affordability problem worse. And this is what we are doing. Prime Minister Turnbull’s ‘Smart Cities’ plan has been much celebrated by the inner urban cognoscenti but in reality it is mainly an inner cities plan. Infrastructure priorities by State and Local Governments continue to lavish inner city regions with transport and social infrastructure in a vain but futile attempt to keep up with the pressures of further economic centralisation.

More economic centralisation is the last thing we need. It will create an infrastructure challenge we simply cannot afford and will never win. It will add to competitive pressure for housing near city centres and lead to social and economic inequity as wealth splits into the sort of ‘haves and have nots’ more typically associated with the British aristocracy in the 19^th Century.

Yet in all the debate about housing affordability and urban planning, there is a consistent implication that centralisation is the objective. Governments at all levels (with the partial exception of NSW’s Mike Baird) have centralised their considerable departmental operations in central city locations.  Business is encouraged to do the same – via a planning regime which promotes centralization in high density employment zones. Costly transport investment is focused on servicing the needs of a centralized workforce.  Housing increasingly focusses on limited land opportunities as close as you can get to centralized employment areas which often means dwellings that are both idiotically small for a country the size and population of Australia and prohibitively expensive.

Where in all this is the realization that the affordability problem is confined mainly to the inner and middle ring areas of mainly three cities. (Perth is sorting itself out via the deflation of its housing market bubble, as is Darwin. Adelaide firsts need an economy before seriously worrying about affordability and the same largely goes for Hobart).  There are dozens of larger regional towns and cities where affordability is not a problem. Jobs are.

In an era when digital technology has all but obliterated the tyranny of distance, why continue to live with this tyranny? Why don’t we have a genuine strategy to encourage employment growth and opportunities in regional cities and towns? In the US, this has been happening for years. It’s not the New York’s or San Francisco’s but the middle cities like Austin (Texas), Salt Lake City (Utah) or Denver (Colorado) that are the fastest growing economies. Here in Australia however we seem hell bent on ever greater populations and densities in a small handful of cities while we allow regional centres – many with more than adequate infrastructure, good climates, and plentiful and affordable land for housing – to languish.

Australia does have a housing affordability problem but that problem is largely confined to three or maybe four cities, and then mainly to the inner and middle areas of those cities – because that’s where we insist on putting the jobs. Rather than fretting over this dimension of the problem, perhaps instead our debate could turn to expanding and distributing the economic and employment footprint into outer urban and regional centres, where housing is affordable and land plentiful. What’s needed is a slightly larger share of the economic pie. Not only could this alleviate the affordability problem but it would reduce the impossible infrastructure burden associated with even greater concentration of economic activity in a select handful of inner urban areas.  

Footnote: the property featured in the above image is a current listing, in Orange, NSW. The median house price in Orange is $340,000 so this is representative. Orange has a population of around 50,000 within a region of around 100,000 and has quality educational and health infrastructure plus it's a very scenic city and region. (A video is here if you're curious). 

Just consider the difference between being able to earn $100,000 in the Sydney metro region but paying close to $1million for a house and enduring an irksome commute every day, to having the same income, a house for $340,000 and little congestion in Orange. All that's really missing is the job, which is overly simplistic I know, but all that extra money not going into a mortgage that feeds bank profits would find its way into either household savings or productive non-housing investment in the economy. 

Don't mention the war (on negative gearing).

If truth is the first casualty in war, then the current ‘debate’ on negative gearing is the policy equivalent of World War III. There are lies on both sides but as arguments and accusations are tossed liked grenades from the trenches, the underlying problems of housing market dysfunction are forgotten.

There’s nothing new or inherently wrong about negative gearing but concerns about the extent of its use for speculative property investment use have been raised by economists for more than a decade. Those concerns were heightened when in 2014/2015, the value of loans to property investors for the first time exceeded loans to owner occupiers.  Further, it was obvious both from official statistics and casual observance that investors were fighting with first home buyers for established lower to middle priced homes in the suburbs: typically the types of homes sought by young couples and families.

We were eating our young. While on the one hand governments and various industry groups mouthed concerns about housing affordability, we at the same time applauded ever increasing housing prices and the wealth creation that on paper went with it. Mid last year, then Prime Minister Tony Abbott went as far as to suggest that he hoped prices were increasing – on the very same day that the head of Treasury expressed concerns about a housing bubble in Sydney. 

Fast forward to 2106 and a new Prime Minister: Malcolm Turnbull. In February, Bill Shorten - a Labor Opposition Leader (who few give any chance of actually winning the next election anyway) – suggests that negative gearing should be pulled back to apply to new property only and that the capital gains tax concessions should be pulled back from 50% to 25%. In response, PM Turnbull suggests this might lead to a form of economic Armageddon.

Supporters of the status quo are claiming that ‘average mums and dads’ are the biggest beneficiaries of negatively geared property investment, which many indeed are and have been. But equally, there are some obvious excesses which even the most ardent supporter would struggle to hold up as models of equitable tax or housing policy or lending practices or indeed economic policy generally. 

Take the now famous example of ‘Property Investor of the Year’ from Your Investment Property Magazine of 2012. Kate Maloney and her partner, at the age of just 24, won plaudits from various judges (some of them still high profile housing market commentators) for amassing a substantial property portfolio.  (The full copy of the article announcing winners and runners up is here).

“Three years later,” she now writes, “if we were to sell our properties, we would still owe the banks about three million dollars not including arrears interest and selling costs. We are currently in the process of sorting out the debts. The outcome at this stage is uncertain.”

Or what of the story in the Australian Financial Review of the 15th of February, which was intended to paint a picture of some ‘average mums and dads’ using negative gearing, who would presumably in the future not have the same opportunity should Shorten’s proposals get up? The story, entitled “Investors to lose under Labor’s gearing plan” profiled a young couple, Simon and Rebecca Cooney, with two young children and who “are nurses who both earn more than $100,000 and bought their first unit in Darwin in 2006. They now have four properties in the Northern Territory capital, Brisbane and Katherine and owe $1.7 million on the homes worth about $1.95 million.”

That’s right – this level of indebtedness is put forward as an example of people who will ‘lose out’ should negative gearing be changed. If owing $1.7m on a $1.95m portfolio when pulling in a combined $200k with two young kids is now a good thing, then everything I learned at high school economics and accounting was wrong. Everything my parents taught me was wrong. Plus the lessons of history are also wrong. Hell, even the leadership of the country is wrong. Yikes, what a dope I’ve been!

Another frightening yarn (unlikely to be the last) in the Australian Financial Review of the 24^th February told the story of a hedge fund manager and an economist who posed as a gay couple with a combined $125,000 in income who toured the western suburbs of Sydney looking for property, to see what was really happening at the coalface. Like a scene straight from the movie ‘The Big Short’:  “both men encountered many investors who were able to get revaluations on their properties to increase their equity for speculative purposes. ‘We met one who was able to do this 20 times in a year with their portfolio… They (mortgage brokers) wanted to put you into 10 to 15 apartments… (and) the only way they could do that was getting the bank to revalue the property so you could revalue properties quickly.”

Yep, it’s all good. Nothing to see here. Move along.

Sadly, what has become obvious is that we have become a nation divided. There are those exposed to the property sector who will fight against any policies which could even hint at cooling markets and lowering prices. Our ‘battlers’ from Darwin would be just another round of casualties - like Ms Maloney - should that happen. But at the same time, we have a pressing problem with affordability and know that the very high prices of housing in major centres is leading young couples and families – including our own children - to defer entering the market, or to be entirely precluded from it. Their housing choices are being forcibly compromised by social engineers who have deemed it only fair that in the future, we raise families in (mainly small) inner city apartments and abandon private transport in favour of public (or cycling). Evidently, detached homes in the suburbs are now for high income earners or investors, actively accumulating ever bigger portfolios.

Meanwhile, the entire supply side of this discussion has (again) been pushed to one side. We have artificially inflated land prices by creating contrived growth boundaries around urban centres, intensifying competition for development sites to dizzying levels which flow directly to the consumer. Then we choke that limited supply with byzantine planning controls that even senior lawyers struggle to interpret, leading to high compliance and delay costs. For good measure we then tax that limited supply with excessive “user pays” levies for infrastructure that doesn’t yet exist, while buyers of established homes in pampered inner city areas are surrounded by quality infrastructure they pay comparatively little for.

Our housing markets, the policies that guide them and the way in which new supply is controlled, have been allowed for successive years to get progressively worse, with little intervention other than to add complexity. We stand idly by and ‘tutt tutt’ the mounting generational affordability problem, all the while clipping the ticket as our existing portfolios rise in value.

It’s as if the Property Council’s latest campaign to defeat even the mention of changes to negative gearing – posed as it was by an opposition leader that few give a chance of winning – was spot on by picturing our housing markets as one big collective house of cards. Touch or tinker with any part of it, and the entire house of cards might come crashing down. Even raising this as a proposal from opposition benches is apparently perceived an act of war.

I’m not sure whether that was the intention or not but it’s a scary thought to think that our markets might now be so distorted and vulnerable that even a discussion about changes to one aspect of housing policy is something to be attacked with hostile intensity. 

Better it seems to instead cry havoc, and let loose the dogs of war.

Some themes for 2016?

What will we be reading about this year? What mega trends will dominate discussion? What markets are going to shine, and which ones will wane? Everyone has their own ideas on a topic like this, and below are some of my suggestions. Hope you all have a good 2016.

Suburbia.

I’m declaring 2016 the Year of Suburbia! Why? Because I think the penny will start to drop that the CBDs and inner cities are not the be all and end all of what it means to be ‘urban.’ The suburban and even peri-urban economies of some large urban areas have been growing stronger than their inner cities, and the ‘burbs’ are also where most of us continue to choose to live and raise families. I know this runs counter to trendy policy debate which would have us believe that everyone wants to live as close to the CBD as they can, because (supposedly) this is where all the jobs are. But the facts say otherwise (though few bother with the facts these days). Later this year, the MIT Center for Advanced Urbanism is running a conference on the theme ‘The Future of Suburbia’ and they have launched a multi-year project ‘Infinite Suburbia’ which will examine aspects of suburban improvement. I’ll be relaying as much of that thought leadership work, plus ideas from other sources, as I can. Watch this space. 

Apartments. 

There is going to be oversupply in some key markets and it but will increasingly emerge that the flood of one and two bedroom stock is not what was wanted by residents, but rather what was saleable to investors (and their advisors). Rising vacancies and falling values are going to be inevitable as supply and demand rebalance over time. The boosters who claimed that ‘Australians have abandoned the dream’ of a detached suburban home in favour of an inner city micro apartment will no doubt contort themselves with retrospective explanations for settlement failures and rising vacancies – neither of which would happen if the product was supposedly so much in demand in the first place. This at least will prove entertaining. 

Housing prices. 

The Sydney market is going to cool. It has to: sustaining the sort of irrational exuberance we’ve seen in recent years over the long term just doesn’t happen without a hangover to follow. Demographia’s annual survey of world housing markets puts Sydney at the global pointy end of plain nasty when it comes to affordability, at 12.2 times incomes. Only Hong Kong is worse. Pundits who are predicting that as Sydney cools, property appetites will shift to markets that haven’t tested the limits of sanity – like Brisbane – may be disappointed. Queensland’s economy is drifting along in the doldrums, ranked by Commsec as only marginally better than South Australia or Tasmania. Oh, the shame. Without a strong economy, the property sun will struggle to shine brightly, with some regional exceptions. As always, the media obsession with housing will mean we’ll continue to read a lot on this subject. Much of it rubbish. 

India. 

India and talk about India I am guessing will increase this year as markets look for ‘the next big thing.’ And India seems to have it: their population will soon overtake China’s, and their economic growth is forecast by the IMF to reach 7.3 per in 2015-16 and 7.5 per cent in 2016-17, which is more than China’s. Their GDP per capita has a long way to go – it is currently only around US$1,500. China by comparison is around $7,000 and Australia around $50,000.  So maybe the only way is up? They have a western democratic system (much of it, like ours, dysfunctional) and a Prime Minister in Narendra Modi who by all accounts is a good leader and keen to see the economy grow. Which should mean they will need the things Australia is good at – low value add resources which are just waiting to be dug up and sold to someone who knows how to add value. Expect to read more of what India means to Australia in coming years. 

China. 

We’ve become obsessed with China and that’s unlikely to change much. Reports of ‘China’s slowing economy’ are misleading but that never stopped our media, or dimwit analysts in search of a headline.  China’s economic rate of growth has slowed to a reported 6.9%. But this is still growth. It is not a slowing. It may be the slowest rate of growth in 25 years but it is still growth. The global growth forecast, by way of comparison, is just 3.4%. The USA – the world’s largest economy – is forecast to grow at 2.7% and Australia by only around 2%. China’s growth forecast for the year ahead is 6.3%. I’m sure if Australia was growing by even 5% we’d be very happy little Vegemites with roses on our cheeks, but it seems we are paralysed by talk of China’s rate of growth slowing to over 6%. That’s like telling someone doing 100 kph they’re going too slow when you’re only doing 50kph yourself. Logical? No.

Oil. 

It recently fell to below $30 a barrel and is now climbing to the mid $30s but that’s a long way down from over $100 less than 12 months ago. So whatever happened to all that ‘peak oil’ talk and where are those forecasters now? It’s hard to see things staying this way, despite what the hopeful and the faithful believe might happen with renewables. Oil is used in everything, from fertilizer, to plastics, to energy. Plus it’s an unbeatably efficient form of energy and the world seems to have plenty of it, and the ability to find more once the price gets to around $60 a barrel. I’m no expert on commodities but the price of something so essential to our economy is going to have to figure prominently in the news media as the year unfolds, surely?

Ageing.

Demography is destiny. In Australia, we are still to confront the realities of how our ageing population is going to impact on us all. More retirees – the majority on limited incomes or who are pension reliant – being supported by relatively fewer taxpayers, is not a good formula but it’s what we are faced with. Plenty of businesses will find opportunity servicing the upper income end of the retiree and aged care cohort but few are talking solutions for the majority on lower incomes for whom commercial solutions are simply unaffordable. There will have to be significant changes to retirement policy and tax treatment of the family home for pensioners will probably become part of that. Expect this debate to become increasingly prominent as taxpayers resist tax increases to pay for pensioners and pensioners vehemently resist any dilution of their benefits. 

Immigration and population. 

Angela Merkel looked at Germany’s shrinking workforce and population predictions and opened the door to arrivals on an unprecedented scale. Was she hoping to plug a workforce gap? Will Australia likewise look to importing a solution to its need for more working age taxpayers (and maybe in the hope that some rapid fire population growth will stimulate the economy) by increasing immigration intake? The ‘big Australia’ debate never really went away and perhaps it will make itself felt again this year. Given our strong views both ways, and the racial nerve that often flares, this is a topic that will at least bubble away, occasionally surfacing in a blaze of heated opinion. 

Contagion

Some parts of the real estate market are experiencing a new feeling they haven’t known for some time: fear. Initial outbreaks, based on media reports, seem confined to overheated parts of the Sydney and Melbourne housing markets. The question is whether the fear will be contained or will it spread more widely?

It’s always hard to pick the point at which market confidence turns. Australia started the year with unrestrained exuberance. Auction clearances were at record highs and off plan sales to speculative investors seemed like an ocean of inexhaustible opportunity, particularly with rising interest from foreign (mainly Chinese) buyers. Repeated warnings about the extent of investor activity, particularly in new apartment sales, or warnings about record low affordability relative to incomes, were brushed off.  Then along came APRA’s rule changes, and banks also shifted their risk appetites down a notch or two, reducing their LVRs and raising interest rates for investment property.

Sometime in the second half of the calendar year, rising notes of caution crept into mainstream media commentary on housing. By October, the likes of Macquarie Bank, Credit Suisse and Bank of America Merrill Lynch were warning of ‘hard landings’. (See here for an example of the bearish comments). Add to this some ‘tutt tutting’ from the celebrity TV financial commentators and the mood seems to have quickly turned from unbridled optimism to caution. 

That itself is a good thing. Opportunity and risk should be weighed carefully, not approached recklessly. The question now is how much more bad news can the market expect, will the bad news be confined to certain parts of the market, and will the market have the maturity to respond rationally?

That there is still bad news to come seems inevitable. I heard last week that traditional financiers expect that 20% of investors buying off plan apartments will be unable to settle on completion, based on the revised lending criteria. If that’s true, a lot of developers will be caught and a lot of investors will be in a bind. This is likely to be confined, however, to just some parts of the capital city markets – especially the flood of new stock of one bedroom apartments, not designed for living in but for investor price points. I can’t see projects aimed at owner occupiers suffering settlement risk: intending occupiers tend to be more discerning, and have more equity. Many investors are however highly geared and have less emotional attachment to their investment as it was never intended to be their home.

Then there are markets which were supported by exceptional but temporary economic conditions. The mining town real estate booms were never sustainable and there are plenty of investors ruing that lesson already. But even large cities like Perth, where the sagging resources economy is reverberating through employment markets just as more stock arrives, are already feeling the pinch. Even the ever ebullient Real Estate Institute has adopted a more somber tone.

Parts of Melbourne, Brisbane and Sydney do appear at risk of oversupply of a particular type of housing product (particularly very small one or two bedroom apartments). Commentators and analysts will learn that all housing units in commencement or approval data are not alike: some will find a market, others will not. If, as seems likely, there is a surplus of small apartments in concentrated locations, prices and rents must inevitably fall. Some people are going to lose money, and our media loves nothing more than hard luck stories. Expect a lot of these from the nightly ‘current affairs’ shows and tabloid press.

More stable parts of the housing market in these cities – in my view new housing and land, well located medium density projects, quality owner occupied apartment projects and the established housing market generally – ought to be treated separately, because they are working on entirely different dynamics. But will they be?

I know of two banks who are actively gaming this scenario already. They’re asking whether a fall in confidence, led by what’s looking like happening in the investment apartment sector, will spread to other parts of the markets, both by type and location? For example, if inner city apartments in Melbourne become the focus of negative market comment, will that rattle markets in established parts of Brisbane? And will it spread to other types of property?

The answer is that no one really knows - and won't until after it happens. Confidence is a fragile thing. It can go from reckless to reclusive in a very short space of time. Fanned by a tabloid appetite for click bait (bad news gets more clicks on line) and a widespread disregard for accurate or detailed reporting, it’s unlikely that there will be much rational analysis or reporting of real estate or housing markets in the coming year.

Having said that, we should be used to it. There hasn’t been much rational reporting for a long time. Real estate markets have been lumped together as if they’re a homogeneous product, and price movements have been reported on a weekly basis to feed a ravenous media and public appetite for poor quality information. That commentary will likely turn from positive to negative but its quality will remain the same: underwhelming.

On the positive side, most of us know that markets move in cycles and they’re rarely as bad as the media might make out, nor are they as risk free as painted to be in good times. Stability never rates much comment but the reality is that the majority of Australians who have owned or are paying off their home will continue to do through the cycles, both up and down. And if you do need to trade, you tend to buy and sell on the same market. If you are buying for the first time, things might improve.

However the potential of contagion plays out, seasoned players will endure it with cool heads and a rational strategy. Amateurs had neither going into this market and are unlikely to have either of those qualities if they need to head for the exits. 

Why raising the GST could hit new housing hard.

As Governments state and federal begin grappling with harsher budget realities and an electorate disinterested in listening when it comes to the necessity of budget cuts or asset privatisation, it becomes increasingly likely that Australia will follow the New Zealand path and raise the GST. This could hit housing especially hard because of the way new housing is taxed.

First, let’s recap on the current GST. First proposed in 1985 by Labor Treasurer Paul Keating, it was dropped for political expediency. Then in 1991, it was again proposed by Dr John Hewson as Federal Liberal Opposition Leader, but the GST died a quick death at the hands of interviewer Mike Willisee (and Paul Keating), who asked a pointed question about the icing on a cake. Hewson stumbled, momentum was lost, and Hewson lost the election. We didn’t see the GST return until Liberal Prime Minister John Howard took the proposal for the GST and major tax reform to an election in 1998, and won.

The GST, introduced in 2000, was originally to apply to pretty much everything, but lobbying by the Democrats (mainly) led to a negotiated GST which didn’t apply to things like fresh food, or books. The other part of the negotiation was with the states, who in return for receiving 100 per cent of the revenues created by the GST, promised to abolish a range of taxes, stamp duty included.

That’s where the housing equation comes in. Stamp duty on housing sales is a huge impost and a disincentive to more freely trading real estate. It’s also a big money earner for the states, but so was the GST. The GST revenue would have exceeded what the states then received from stamp duty, hence the agreement.

That may well have worked, but they all broke that promise. The states kept stamp duties and other taxes they had promised to abolish, and also said ‘thanks very much’ for the new rivers of gold in the form of GST revenues. As a result, new housing immediately had 10 per cent added to its price, while any compensation in the form of abolished stamp duties didn’t eventuate.

Take a modest $500,000 new home or home unit in Australia today. The purchaser – in addition to various local and state infrastructure charges – is paying 1/11th of that purchase as GST. That’s around $45,500 in GST going to the states - a very big tax bill on a single purchase. Plus, depending on the state, there’s anywhere from around $10,000 or $20,000 in stamp duty. Many first home buyers are exempt from stamp duty, but the nature of grants and exemptions vary.

Those exemptions also apply to second hand homes, while the GST only applies to new homes (houses or units). Plus, infrastructure levies and other ‘developer costs’ only apply to new housing, not to existing or second hand stock. Already new housing is punitively taxed whereas second hand stock isn’t, via the GST and via other state or local charges on infrastructure.

What happens if governments turn to an increase in the GST to fill multiple budget black holes? Plenty are talking about it, as are plenty of economists. Many will argue it’s a good thing, but it isn't if you’re in the market for a new home (as opposed to second hand), or if you’re a developer creating new housing stock.

If the GST was raised to 15 per cent - as many suggest – our $500,000 property jumps by nearly another $23,000 overnight. A second hand house sitting right next door experiences no change in tax treatment. So the new home buyer is now paying $522,727 for our hypothetical house, of which now $68,100 is GST. Add to that the various infrastructure charges, duties, charges and various taxes or levies, and people buying a new house in this scenario could easily be paying well over $150,000 in total taxes on their new home.

Housing in Australia is expensive enough as it is. Failing to create a healthy volume of low cost new housing supply, rather than stoking the already hot fires of the existing second hand property market, has worried a lot of people from the Reserve Bank Governor down.

If changes to the GST in the form of an increased rate are allowed to go ahead without some balance being restored to the new versus second hand treatment of our housing stock, it is likely that genuine new housing supply (as opposed to investor product though even this would suffer) will stall further. Unless I’m wrong, and an extra $23,000 tax bill on a single transaction isn’t something that bothers people these days.

Australia's housing policy?

This could be a very short yarn because despite the almost daily media reports of a housing boom or bust (depending on which media you read) and despite regular jawboning on housing prices by no less than the Reserve Bank, and despite tumbling affordability for young families and talk of generational lock-out from the housing market, we don’t actually have a housing policy as such. Nor does it seem much of an official view. 

It’s almost remarkable that the Federal Government has resisted entering the debate about housing when the topic is so nationally contentious. It is one thing to say that in principle, housing policy is really a matter for the states (which largely it is) but it is another to resist the political urge to intervene in a subject which is so white hot as a BBQ stopper everywhere, from Martin Place Sydney to Moorooka Brisbane.

Even the chiefs of our major banks can’t seem to agree on whether parts of the market are overheated or not, whether negative gearing is contributing to problems in some parts of the market or not, or whether foreign investors are responsible for driving prices up in places like Sydney. Nearly every bank chief has expressed a view and to my way of thinking there has been very little consistency in those views. That in itself is extraordinary. 

Some like the Comm Bank’s David Murray have suggested negative gearing is a problem while Westpac’s Gail Kelly says not. Kelly is one of many resisting moves to introduce tighter capital buffers on bank lending as seems likely to be recommended by the Financial Services Inquiry. Various spokespeople for the Reserve Bank have been muttering their concerns about the housing market in Sydney and Melbourne, perhaps hoping that this voodoo may cast some sort of spell over the market and cool things down. 

But which parts need cooling down, if they do at all? Plenty of commentators talk about ‘the real estate market’ as if it’s one thing. Nothing could be further from the truth. While parts of Sydney are apparently red hot and Melbourne has been heating up, Brisbane is well behind, with perhaps the exception of some inner city apartment locales. As for Hobart or Adelaide or countless regional cities, it’s quite the opposite. Try telling someone on the Gold or Sunshine Coast that the market’s overheated and they’ll laugh at you. 

The problem with big sticks like those wielded by the Reserve Bank is that they have no capacity for regional differentiation. So if they do move to cool things down in places like Sydney, that could have calamitous effects on markets where things never heated up in the first place. Equally it could kill off the only part of the market that seems to be employing people at the moment: without all those high rise cranes on apartment projects, there’s not a lot of other activity in the property and construction sector – a big employer in Australia.

Add to this the oversupply of commentary on an almost daily basis. For sticky long term assets like housing, analysis ought to be based on long term performance. The high transaction costs of trading real estate assets make this even more a reality. But the digital media’s appetite for stories that punters will click on is such that they now print almost anything submitted on the topic of housing prices. So much so we’re getting told, with great authority, that “house prices in city X moved up 0.3% in the month of October but fell by 0.1% in city Y.”  Pfft. Even that paragon of conservative market reporting The Australian Financial Review now devotes a large chunk of space every Monday analysing in detail what happened at auction clearances the weekend before.  Pur-lease!

It’s so ridiculous that in the space of time since our own house went under contract to settlement, I think we’ll have been through a boom, a bust, and a boom again. Who knows, it settles in two weeks, anything could change again according to the media.

On top of this, Liberal MP Kelly O’Dwyer, who chairs the House of Representatives Economics Committee, is spearheading an investigation into foreign investment in Australian real estate. It’s always good to give the punters someone to blame and foreigners are always good targets so this sort of witch hunt makes a pretty regular appearance in Australian public policy. Some of you would remember the early 1990s when there were campaigns against Japanese investment. Ironically, they were led by a bloke called Bruce Whiteside – himself a Kiwi resident on the Gold Coast and this at a time when Kiwi’s were the largest foreign buyers of Australian real estate outside the poms. 

It strikes me that this it is more important now to have a national view on housing policy settings than perhaps ever before. This doesn’t mean we need a Department of Housing (since when did more bureaucrats actually make anything better?) but some effort at a national level to bring some consensus to the issue would be helpful. Here’s why:

• The Governor of the Reserve Bank is worried and says so -  often -  that housing policy settings aren’t working
• The chiefs of our major banks disagree about whether there is a problem or not and what ought to be done, or not
• Most of the respected (or noisiest?) commentators or industry experts are in heated disagreement about housing markets and housing policy
• Global observations from groups like the IMF and World Bank have expressed caution about Australia’s housing prices (not that they’re experts but it is unsettling when they chime in)
• There is an undeniable affordability problem for young families in major cities leading more to renting than at any time since WWII and some of those who buy often enter significant financial stress as the price

I could go on, it’s potentially a very long list.

In fairness, Treasurer Joe Hockey has made a number of comments about the issue – denying talk of a bubble as ‘lazy analysis’ and hosing down talk of regulatory intervention. He has rightly (in my view) identified supply side constraints as a significant problem via the planning policies delivered by various local and state planning agencies – policies beyond the regulatory reach of the Federal Government. 

But is ‘Keep Calm and Carry On’ enough of a policy response when so much is at stake? 

Is there anything wrong with our national government entering the fray to settle debate and point a way forward?

This can’t end well. Can it?

In housing we are eating our young. Investors are competing aggressively with first home buyers for available product, and winning. In what may be the shortest post of The Pulse’s history, there are just two graphs that seem to suggest this might be true. If it is, what next?

My thanks to Leith Van Onselen and his colleagues at Macrobusiness for this one, but it struck such a discord that I thought it worth highlighting.

The Australian Bureau of Statistics figures on housing finance are a measure of activity in housing markets. Something the Reserve Bank watches closely. Their latest sets of data paint a concerning picture.

First up, before we drink the last drop of champagne toasting general activity in housing markets, is the news that investors are clearly on the acquisition trail, and they are hungry. Have a look at domestically financed loans for investment housing. It’s all about investors:

Compare this with what’s happening to the first home buyer market. And remember, we have record low interest rates and allegedly improving affordability metrics:

If this stark contrast doesn’t suggest something is amiss, nothing will. Draw your own conclusions.

If you’re a developer, a deal is a deal and it doesn’t much matter who is buying the stock, provided it makes the project feasible, pays the wages and the consultant’s bills, pays the taxes and hopefully leaves a healthy profit. If you’re in public policy though, you would like to think the ramifications of this distorted playing field might be sinking in.

I’m not sure that it is. The Federal Government says housing is a matter for the States (notwithstanding the Reserve Bank’s clear and publicly admitted interest in housing market dynamics). The States tend to pass a lot of responsibility – in terms of levies and charges and compliance costs associated with the supply of new stock – to Local Government. And Local Governments tend to blame both the States and the Feds for a lack of resources for infrastructure associated with housing supply and growth generally.

Those who point to the obvious problems in public policy settings are faced with the three monkeys rule: first denial, then pass the buck, and if that doesn’t work, shoot the messenger.

We have a very fundamental problem with distortion in our housing markets that is already spilling over into other aspects of economic policy and questions of generational equity. If these two graphs don’t make that obvious, nothing will. 

What we earn.

Discussions about housing affordability focus almost exclusively on the price of the real estate, movements in which are monitored by multiple organisations on a seemingly daily basis. There is comparatively little discussion about people’s incomes, which are equally as important as prices in determining what can and can’t be reasonably afforded. The income profile of what most Australian’s actually earn paints a sobering picture which could more often be taken into account in debates about housing and affordability.

It’s becoming fashionable again for business lobbies to complain about Australia’s high wage structure. It explains, they’ll argue, why we lost Holden, Ford, Toyota, and (almost) Qantas, among other things. And yes, Australia’s wages are high by competitor standards - but so are our costs. One of the most fundamental of needs, along with food and clothing, is shelter. And it’s the cost of shelter relative to incomes which has been stretched to beyond reach for a large proportion of young Australians.

Reducing minimum wages or reducing wage growth further, if at the same time allowing housing costs to further escalate, will only make this situation worse. Arguably, if we could substantially reduce the cost of supplying new housing, this would relieve upward pressure on wages and work towards improving our global competitiveness – along with repairing living standards for working and middle class families, rather than eroding them.

First, here are some of the facts on the infrequently discussed income side of the equation. (I am again indebted to the team at Urban Economics for making these available. These are top line numbers only: if you want more detailed analysis, please contact Kerrianne Bonwick).

Nearly two in three of all Australians earn less than $52,000 per annum. It doesn’t much matter whether it’s Brisbane, Sydney or Melbourne; the proportion is roughly the same.  It’s not much. Slightly more than another one in every eight earn from $52,000 to $78,000 per annum. Roughly eight in ten Australians earn less than $78,000 per annum.

Personal Incomes

	Brisbane	Sydney	Melbourne
< $52,000	64.4%	62.8%	65.4%
$52,000-$78,000	15.0%	13.8%	14.1%
$78,000 to $104,000	7.0%	7.2%	6.4%
> $104,000	6.3%	8.2%	6.5%
Not Stated	7.2%	8.1%	7.7%

Source: Urban Economics

Problem? It is if you’re trying to buy into the housing market. Take a modest house of say $400,000 (very modest depending on location). A worker on $50,000 – and these represent nearly two thirds of all workers remember – is facing a price multiple which is 8 times their gross pre-tax income.  Basically, two thirds of us are stuffed in terms of affording even a modest $400,000 property if we weren’t already in the market. A more reasonable price multiple of say 5 times income would require an income of $80,000 per annum or more. But there are less than 15% of Australians who fit this category.

But wait, shouldn’t we count household, as opposed to personal, incomes? A good point, particularly for younger families and young couples, where dual incomes are the norm due to necessity.

But even based on combined household incomes, a third of all households earn less than $52,000 per annum. Another 14% to 15% earn between $52,000 and $78,000 and another 11% or 12% earn between $78,000 and $104,000. A reasonably healthy 30% of all households bring in a combined $104,000 per annum or more, but seven in ten bring in less than that.

Taking our modest $400,000 home again, and  roughly half of all household incomes fall short of the $80,000 mark required for a price-to-income multiple of five. For one in three of every households, their combined income means a price to income multiple of eight times. They are pretty much stuffed, still.

Household Incomes

	Brisbane	Sydney	Melbourne
< $52,000	32.8%	32.2%	34.3%
$52,000-$78,000	15.5%	14.1%	15.5%
$78,000 to $104,000	12.3%	11.3%	11.8%
$104,000 - $156,000	18.1%	18.0%	17.1%
$156,000 - $208,000	7.7%	8.7%	7.3%
> $208,000	3.6%	5.5%	3.8%
Not Stated	10.1%	10.3%	10.4%

Source: Urban Economics

Hang on, isn’t it more relevant to focus on the demographic that’s more likely to be trying to get into the property market, because older people and retirees, who already own or are paying off homes, may skew the figures? Absolutely: this is the key demographic, especially if you’re a developer of new detached housing product - which is what this cohort mainly wants to buy to raise a family in (as opposed to the apartment they might rent while pre-children).

Personal income profiles of the 25-34 year old age group are pretty much in line with the Australia wide picture. More than half earn less than $52,000 and roughly eight in ten earn less than $78,000 per annum, which means eight in ten of this age group – who are at the peak of their family formation potential – would be faced with a price multiple of more than 5 times incomes on a $400,000 property, and more than half would be faced with a price multiple which is eight times their income, or more.

Personal Incomes 25-34 year olds

25-34year olds	Brisbane	Sydney	Melbourne
< $52,000	55.2%	52.9%	56.2%
$52,000-$78,000	23.1%	21.7%	22.9%
$78,000 to $104,000	9.3%	10.0%	8.4%
> $104,000	5.6%	7.4%	5.4%
Not Stated	6.8%	8.0%	7.0%

Source: Urban Economics

None of this is great news. For developers trying to provide affordable new housing in new greenfield estates in urban fringe locations, the reality of these income profiles can’t be escaped. I had the privilege of visiting one such estate in south east Queensland recently and what I saw was absolutely first class product at very good entry level prices in a very well designed environment. No ‘McMansions’ here – just quality new detached three and four bedroom homes, on small lots, priced from around $350,000 - and in some cases less.

But even at $350,000, only around 15% or so of the target 25 to 34 year old demographic could afford to get in with a price multiple of less than 5 times an individual’s income. That proportion would rise taking into account combined incomes for this age group, but it won’t rise beyond around a quarter or a third.  The reality is that more than half this age group would find an entry level $350,000 home would be six times their combined incomes or more. It would be tough going.

Granted, interest rates are currently very low and some governments are offering stamp duty and other concessions to first time buyers. But these are having next to no impact on this market. Rates of first home buyer activity are at generational lows.  And interest rates won’t stay this low forever. A significant rise in variable home loan rates could tip a substantial number of families in this age group from the ‘just making it’ basket into the ‘we’re stuffed’ basket.

Since the ‘do nothing’ policy approach doesn’t seem to be working, what could be done to turn the situation around? Basically, it’s a simple formula between incomes and prices. You either increase incomes or reduce prices. The first probably isn’t an option unless incomes can gradually creep up with inflation and with productivity gains over time.

But what could also happen is the cost of supplying new housing (not referring to existing stock) could be reduced. New housing is heavily taxed and over regulated (the same cannot be said of existing stock). Something like a quarter to a third of the cost of the new home in an urban fringe location is due entirely to various taxes, charges and compliance costs (which do not apply to existing stock). It is also affected by the rapid escalation in land costs due to policy induced supply constraints in areas of ample available land (the same can’t be said of existing stock in mostly built-out inner or middle ring areas). Most of these additional costs of supply owe themselves to policy changes made since the early 2000s – precisely the time when the affordability gap began to widen.

It does seem a compelling place to start.

We should aspire to a more competitive Australia but this policy effort cannot just focus on labour costs because our incomes, while high by competitor standards, are now generally insufficient to cover one of the basic necessities of life: shelter. We have made this happen because policy makers have deliberately increased the cost of delivering new housing with new taxes, charges and compliance costs, all justified on esoteric planning or sustainability principles but impossible to justify on social equity or economic grounds.

These policy changes were made to suit political agendas at the time: they were not needs-based or market-based policy changes. (It also has to be said the political agendas at the time were in the hands of Labor State governments, starting with Bob Carr in NSW but which spread rapidly to other jurisdictions. Why Labor Governments introduced policies which hurt people on working wages is as mystifying to me as to why Liberal Governments have continued to maintain the same policy positions, with minimal amendment).

The gap between the cost of supplying even relatively basic housing on the urban fringe, and the incomes of the people who in past generations could afford it, will continue to widen unless regulators and policy makers begin to grasp the wider economic consequences of policy-inflated costs for new housing supply.

Footnote: why a five times multiple? There is no strong reason. The authors of the global housing affordability report Demographia will argue that affordable housing should be around three times incomes. Moderately unaffordable they define as between 3 and 4, and between 4 and 5 is defined as ‘seriously unaffordable.’ The multiples of 7 or 8 times incomes, which we’re seeing in Australia, are off the scale. But for the purpose of argument, if even relatively high (by international standards) multiples of 5 times incomes seems like a utopian dream, it illustrates how far incomes need to rise or costs of new supply should fall before we get even close to the situation that prevailed for most of our history. It’s a big challenge.