Monday, October 29, 2012

The housing recovery that wasn't...

With all the talk of the new Boarding Houses Bill throughout last week, you could be forgiven for missing all the discussion about the Mid-Year Economic and Fiscal Outlook (MYEFO). Then again, perhaps you've followed all the rantings and ramblings about company tax and cash-flow, changes to the Baby Bonus scheme, and the removal of research funds from the tertiary education sector - all in the name of a budget surplus - far more closely than we did... which is, to say, not really very closely at all.

But because we're tenancy nerds, and because tenancy is all about housing, we couldn't help but notice when Michael Pascoe declared "Swan bets big on a housing recovery"... before explaining, with more than a hint of skepticism, that Treasury is expecting an upturn in the housing market to be one of the few positive drivers of our economy over the coming years. He says:
More important for the credibility of the government's outlook is the belief that the housing industry will finally turn the corner.
Says Treasury: “Dwelling investment is forecast to be flat in 2012-13, before growing 4 per cent in 2013-14. Dwelling investment declined 3.3 per cent in 2011-12 on the back of continued weakness in the detached housing market. Conditions across the sector are expected to improve gradually over the remainder of 2012, consistent with the solid growth in dwelling approvals and commencements seen in the June quarter.
“The recovery is expected to gather momentum into 2013-14, driven by a pick-up in home buyer demand, improved affordability following declines in house prices over the past two years and the assumption that interest rates will remain below average across the forecast period.”
Low interest rates, 'affordable' house prices, and an increase in the construction of new homes means more and more money will be changing hands, forever into the future. We'll all be back in silk ties and handkerchiefs before you can say "put on a happy face"!

If Treasury's predictions are correct then tenants should be happy, as the construction of any new dwelling should create a potential vacancy in the rental market. That vacancy would come from either a tenant of means opting to buy and occupy a new dwelling; or a new-home-buyer seeking to rent their dwelling to a tenant. Each scenario adds a property to the pool of available rental stock.

Of course, this 'one-for-one' formula would be skewed a little each time a first-home-occupier turned out to be a home-leaver, rather than a tenant... or whenever a new household of home-buyers was created by the partial dismantling of two or more existing households of tenants. But, in simple terms, the injection of new housing into the marketplace should be good for tenants. It would create new vacancies, and the reduced competition amongst tenants would put downward pressure on rents.

It should also slow the rate at which the price of property increases (read: capital gains), as supply starts to kick back against demand. This would see the trifecta that should help keep our economy ticking along (low interest rates, 'affordable' prices and increased construction of housing) on some kind of sustainable footing...

But wouldn't both of these things also reduce the incentive for 'Mum & Dad Landlords' (read: amateurs) to speculate on rising property prices? Indeed, if yields from both rental incomes and capital gains were to stabilise at a relatively modest level, speculators might look to other ways to make their rapid gains. Those in the game might take their money out of property, while potential new-comers could avoid it altogether - putting their savings into, well... into savings, instead.

The effect of this would be to put further downward pressure on the price of property, which might see more people realising their aspirations of property-ownership, creating more demand for the construction of affordable homes. The nature of that aspiration might undergo some form of transformation, as the incentive to speculate is diminished. But the increase in transactions tied to the production of new housing would surely outweigh the loss of quick speculative gains associated with the buying and selling of second hand dwellings. We might have to cut back on silk ties and handkerchiefs, but we could probably manage to hang onto one or two, to bring out on special occasions.

... and tenants, on the whole, would be much better off. They'd have landlords who wanted to be landlords, rather than amateur property magnates.

But there's a problem with this scenario, and it's illuminated quite starkly in today's Sydney Morning Herald. Matthew Kidman writes:
There are three fundamental ways of increasing housing affordability. First, house prices could drop significantly. This is a disastrous result because it creates financial pressures on the entire financial community. Second, wages could skyrocket, producing unacceptable increases in inflation. Finally, interest rates could fall, reducing the cost of borrowing. This is the most acceptable path, and the only one the RBA has control over. One year into a rate-cutting cycle, housing in Australia is the most affordable in eight years, but there are only tentative signs that this tactic to raise housing from its slumber is working. The broader community is now conditioned to the process of our banks passing on only about 75 per cent of the RBA cuts to customers. This may mean the RBA just has to keep cutting until there are signs housing is affordable.
The problem lies not with any profound truths contained in the words Kidman has written - his basic premise should be routinely questioned. The problem is that our entire economic framework is based on an acceptance of such words as truth.

Apparently, if house prices fail to increase at rates to which we are largely accustomed, the banks will go broke. If this happens, we'll all go broke, because we wont be able to borrow the money required to fund our most basic consumption needs. The banks will have to charge us a fortune for it, and they'll steer clear of most of us as too high a lending risk...

Without debt-fueled consumption, production would start to falter, the economy would grind to a halt, and we'd all lose our jobs. Without jobs, we'd end up losing our homes, too... and because our landlords borrowed too much to pay for them in the first place, we'd all be jobless, homeless and indebted for life.

This, at least, is the conventional wisdom.

Notwithstanding the fact that Australia's love affair with debt seems to be wavering, it seems that nobody is prepared to take this kind of a hit - not even in the name of a productive economy. We'll all just have to accept that the pathway to prosperity is not affordable housing, but affordable debt.

Pascoe, for his part, doesn't seem to buying it. Neither does Leith van Onselen who writes in the MacroBusiness blog that 'housing wont fill the void'. Accordingly:
Housing construction is unlikely to pick-up considerably until land prices deflate back to levels that are affordable and represent value to the home buying public. Tinkering around the edges by cutting interest rates and increasing subsidies does not resolve the fundamental problem that Australian vacant land prices are far too high.
 ... and all of this brings us right back to the speculators. It's the highly leveraged speculators who stand to lose the most if land prices go down. And as we've said before on the Brown Couch, it's negative gearing that entices speculators to take on more and more debt. At the same time it drives up the cost of housing, pushes up rents and restricts the availability of affordable rental housing.

As we've also said before on the Brown Couch, negative gearing costs our economy a whole lot of money. Which makes us wonder - if you were the Treasurer and you were looking for savings in order to produce a surplus amidst a revenue downturn, why wouldn't you have a look at negative gearing?

As it happens, we're not the only ones to ponder such potential savings. Saul Eslake appeared on the ABC's The Business last week and suggested that its abolition:
...would reduce the loss of revenue arising from negative gearing that, according to my own estimates, runs in excess of $5 billion per annum...
It might hurt a few speculators in the short term, and it would create a period of financial uncertainty for those property owners who are borrowing outrageous sums of money in order to 'get onto the ladder'.  But if you were looking to come up with a budget surplus, with a wink and a nod to the future, then taking a good long look at negative gearing might just have been the way to go.

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