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Property investment under the microscope |
House prices have doubled over the last ten years pushing large numbers of potential first homebuyers onto the sidelines. Loans to first homebuyers are now at record lows – at about 12% of all loans approved by financial institutions.
In response the Federal Government has asked the Productivity Commission to investigate why house prices have soared and what, if anything, can be done about it. The Commission is in the process of taking submissions. The results could have major implications for property investors.
As expected, self-interest has come to the forefront. The Housing Industry Association for example wants local government to reduce developer contributions to council infrastructure, which it says is pushing up the price of new housing. But these charges are levied on developers to cover the costs of the extra infrastructure that councils have to provide to cater for the increased population. Without these charges, the extra costs would have to be borne by existing residents - a proposition that is widely regarded as being unfair. Hopefully its submission will be seen as having no legs.
A more interesting one has come from the Reserve Bank of Australia. It has taken a look at the numbers and decided that a large part of the surge in house prices is due to the reduction in interest rates over the last ten years. This makes home loans more affordable and, it says, a rise in house prices was to be expected.
But there’s more. It says the surge in demand for housing has gone well beyond what a drop in interest rates can explain. It claims there are no overall supply problems in housing and there has been no untoward increase in migration or new household formation. It rejects claims that State Government stamp duty is to blame and discounts the first homebuyer scheme as having a significant contribution. A lot of the blame, it concludes, lies with investors. Many of these investors it seems have unrealistic expectations. They have easy access to finance, are focused on capital gains and not income, and are helped by a favourable tax regime.
As the Reserve says: “Perhaps the most important distinguishing feature of the current housing price boom has been the very strong demand by household investors for the purchase of residential properties to rent. The extent of this demand is unprecedented, both in terms of previous experience in Australia and experience overseas. The prominent role of investors in the Australian housing market can be seen both in the high and rising share of housing finance going to investors, and in the relatively high proportion of households in Australia owning rental properties.”
In recent years the value of loans going to investors for residential property has grown at more than 33% a year. and has not slowed down. Around 40% of every dollar lent by financial institutions for residential property now goes to investors – a level that we have not seen before. In other comparable countries the proportion of investment loans of this sort is in single figures.
About 13% of Australians own investment property compared with around two per cent in the UK. Why? According to the Reserve, many residential property investors believe that housing is a safe investment and that prices will continue to rise. This is based on some evidence. For example those who bought at the height of the property boom in the late 1980s have now made money - although it took a while and was helped by the drop in interest rates from record highs to 30 year lows. Also, house prices often stay stagnant for a period rather than decline in value when the market goes soft.
However the experience overseas has been different. In Japan residential prices are still 30% below what they were in the early 1990s. Prices have also declined over recent years in Hong Kong and Singapore. House prices in Germany and Switzerland have not changed since 1995 even though the drop in interest rates has been worldwide.
“To the extent that past experience has been extrapolated many investors may ultimately be disappointed with their returns on their property investment,” the Reserve says. “While lower interest rates have clearly justified a higher level of house prices, they have not justified higher rates of increase on an ongoing basis. Many investors have probably not fully recognised this distinction.”
Residential property prices have now moved so high that rental returns have plummeted. Gross rental returns to investors now average 3.5% compared with 8-9% overseas and 7-9% for commercial properties here. The easy access to finance (home equity loans, interest only loans, deposit bonds) is adding to investor demand
In addition the tax system, including a 50% capital gains tax, negative gearing and generous depreciation allowances all reduce the cash outlay and improve the return. For example the Reserve calculates that an investor on the top marginal tax rate can buy a $400,000 investment property using an interest only loan facility for the entire amount and be out of pocket by only $81 a week. Without negative gearing and depreciation allowances, the outlay would be four times this amount.
The Reserve also points out that many investors will not see a positive rental return on their property for decades even with regular rent increase. This reduces tax revenue.
The Reserve has called for a review of the tax incentives, more regulation of the property seminar business and a continual monitoring of the credit risks being borne by banks. Interestingly it does not suggest a ban on negative gearing but possibly some limitations.
Whether the Federal Government or the Opposition will take up these suggestions remains to be seen. But given the popularity of residential property investment, don’t expect too much action soon.
An election is due.
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