Mark Twain said, “Buy land young man they are not making any more of it.” Some years later he also filed for bankruptcy.
That happens with booms heading to busts. One sign is the emergence of crazy financing schemes. Remember the inter-generational loans during the Japanese property boom of late 1980s – just before it crashed.
So those who have missed out on the most recent property boom should be wary of the new scheme publicised this week by Wizard, Australia’s largest non-bank lender — not just because it might be harbinger of a crash, but because it might not be a good investment.
There may not be a crash. Normally, people pay a deposit and borrow around 80 per cent of value. The lending institution holds a mortgage (from the old French meaning dead hand). You cannot sell without paying the money back.
It is safe for the bank. It can always put a for-sale sign up and sell for 80 per cent of value within a few days.
But with rising prices, people cannot afford the deposit or repayments. So Wizard comes to the rescue. People need only 70 per cent of the usually deposit and 70 per cent of the repayments. In return, Wizard takes 30 per cent of the ownership (or equity). When the house is sold, however, Wizard takes 60 per cent of the capital gain. Note, not 30 per cent which would match their equity share.
Does not sound like a good arrangement to me.
Will the gain be adjusted for inflation? By CPI or average weekly earnings? Will it be adjusted for improvements? People spend their lives fixing up and extending houses and improving gardens. When the house is sold, will Wizard regard the added value as capital gain and take 60 per cent? If so, will people be reluctant to improve their homes.
The scheme arose out of the Prime Minister’s Home Ownership Taskforce and is the brain child of merchant banker and Liberal Party Treasurer Malcolm Turnbull, among others.
It fits an historic pattern of booms – in property and shares — going back to the South Sea Bubble in the 18th century. As the boom peaks everyone wants to get on board and then financiers try to “help” those for whom the boom would ordinarily be out of reach.
Those who like the Wizard scheme say it will help into home ownership people who would otherwise miss out. But it is a bit like the Vietnamese village – we have to (partially) extinguish your home (ownership) in order to preserve it. Usually with housing, over the long-term, the capital becomes the lion’s share of the value. The gain enables people to move to better dwellings later in life.
If the financier is to get its maws on 60 per cent of the gain, you might be better off renting. Bear in mind a lot of houses will become available as a result of the boom. Also, renters are being indirectly subsidised by negative gearing as landlords seek to get their returns from capital gains rather than rent. (Take note Mark Latham.) You can rent $500,000 worth of house for $20,000 a year. But if you rent $500,000 in cash from a bank it costs $35000 a year – and that does not factor in the cost of rates and upkeep if you bought a house for that $500,000.
The aim should not necessarily be home ownership but having a decent place to live.
Others who like the scheme say it will help financial institutions diversify their investments. This might be the key. The financial institutions are mightily miffed that they have missed out on this boom. They have borrowed money from conservative investors at 4 per cent and lent it to investors at 6 or 7 per cent. Those investors have then made between 10 and 20 per cent based on rising equity in real estate. The financial institutions now want a cut of the action – given that most other investments look pretty flat.
But by the time Wizard gets its new lending product off the ground, the boom might be over and houses will be more affordable.
How long can the boom last? Will the fall be dramatic or gradual?
This boom has been unlike other property booms. It has been driven by an unusual confluence of about 10 factors in the past five years. The gradualness of the boom’s end will depend on how many of those factors change and how quickly they change.
Let’s look at them.
Changes to housing finance.
Companies like Aussie Homes Loans and Wizard have put competitive pressure on the banks. So lenders have been throwing money at people, especially targeting people with a lot of equity in their home.
A lot of money went on toys, but a lot went to investment housing. In 1980 housing debt was just 10 per cent of housing assets. A large percentage of people owned their own home outright. Now housing debt is 20 per cent of housing assets. Refinancing is booming, causing money to pour into investment housing thus pushing prices up.
Can it go on? Perhaps a little more. Australia still has a very low level of housing debt as a percentage of housing assets. In Australia debt is 20 per cent of assets. In the US it is 40 per cent and in the UK it is 25 per cent.
If it stops, what will be the effect? Property markets are more stable than sharemarkets. Shares are valued daily. An investor can borrow up to 80 per cent of the value of shares, but if the value of the shares fall so the debt is greater than 80 per cent, the lender demands an immediate equity top up. Investors then sell to provide the top up, causing further share falls. With housing, however, lenders do not revalue daily and do not care if the value of the investment house falls, provided the repayments are met. Moreover, rent usually provides a higher return than dividends, and does not fall as dramatically, so the pressure to sell is lower.
Bear in mind, the price of housing has little to do with the raw cost of servicing the land and cost of construction. It is more directly related to what the market will bear. If there is a lot of money sloshing about, prices go up.
Changes to investment environment
In the past three years, the share market has been a dud, so people have put more money into investment housing, pushing up prices. This cannot go on. Even Japan – the worst case – proves the point. In 1989 the Nikkei index hit a record 40,000 and fell steadily until a low of just 7700 four months ago. It is now recovering at 9500.
Interest rate stability
This is a big contributor to the boom. People are now confident that interest rates will not rise suddenly. They have been unchanged for 13 months. The Reserve would like to increase rates to stop the housing boom, but the international climate prohibits it. Other nations are cutting rates. If Australia increases rates the dollar will go up and that will hard exporters.
Changes to the tax system
The change to the way capital gains are taxed has fuelled the boom. Taxpayers now pay tax on only half their capital gains. It makes the conversion of income – through negative gearing – to capital very attractive. Buy a house and rent it at a loss – which is fully deductible. Wait for the gain and sell at a profit, only half of which is taxed.
There is no sign this will end. The boom will be over before Latham (if ever) is Treasurer. But the Tax Office has rightly warned of a tightening up on deductions against rent. Claims exceeded rent by $600 million last year. That is a lot of negative gearing. Nonetheless proposals to quarantine rental losses against rent income (and not allowing deductions against wages income) have been short-lived in the past.
The First Home Buyer Scheme
The Government’s buy-a-vote scheme has now run out, but it poured a lot of money into housing investment. The allure of a $14,000 gift brought people into the market who otherwise would have stayed out.
Land shortages
Environmental concerns have slowed greenfields developments. Immigrants have flooded into Sydney and Melbourne.
Rural depopulation fuelled by the drought has meant more people coming to the cities. We have seen huge price falls for housing in rural Australia. In some places councils cannot give away blocks. The depopulation has followed reductions in services and employment opportunities. This trend might turn as political pressure causes restoration of services and people see the value of rural lifestyle.
Larger cities
As cities grow the percentage of their dwellings in their centres decreases, but the demand for them continues. It means prices in the centre go up exponentially, adding to the overall boom.
Occupancy rates
The reduction in the number of people per dwelling and the increase in dwelling sizes has added to the boom.
Summary
Because this boom has been fuelled by so many factors it is less likely to come off the boil quickly, especially with the improved economic management that comes with greater information in the computer age.