By Daniel Brown, 13 February 2017
Often in Australia people talk about a housing bubble as something that will inevitably burst. This is seen as a bad thing for investors as property prices will tumble below what they paid and they may be forced to sell, losing a lot. For first home buyers, some people are actually waiting for such a moment to get into the housing market and are told that it will come eventually. This false optimism is dangerous and based on wrong assumptions on what an economic bubble is. Economics is basic maths, people make assumptions based on trends and locations but what the ‘experts’ never seem to factor into their equation is the collective magnitude of human greed.
A regularly cited example is the prices of houses in mining boom towns. When these mines opened, demand was huge so naturally house prices in areas where they were very few to begin with, was high. As the prices of the ore went down (or it just got mined out) and people eventually had to leave these towns, the houses lost a significant amount of their value.
This example is incredibly inaccurate for anyone to ever cite as why there would be a bubble in major cities as there was always the very real chance that housing would be a short-term solution for the people who bought the houses, not the ones who paid to get them built. This is a big difference that does not apply at all to growing capital cities. Investors in these sorts of towns are at fault for losing money here, it was expected. They are just as much at fault as a retail manager who doesn’t hire a group of Christmas casual staff and loses a lot of potential sales over the holiday period.
Commodity prices suddenly falling and the mining town house prices falling can be considered a bust because this was not in control of the investors, although it was always a possible scenario. This matters because the supposed housing bubble going on in major cities is not unexpected, it is completely controlled. Since this situation is controlled, it is not a bubble and can’t burst when left under their supervision. The people who would be at risk of it crashing are the exact same people doing the carefully planned steps to ensure it never crashes and will rise instead until a war or recession happens.
In major cities there is not a critical shortage of area, there is a critical shortage of high density living area as it is vigorously opposed by existing home owners as it will lower their property value. It is very important to understand that property values are not going to be lowered because of a view being blocked by an apartment building, it will be lowered because it will cool off demand in their area. In Sydney there are 4.575 million people with the average household having 2.7 people, this is completely within normal ranges of many cities that have normal housing prices and in other western countries too. Housing availability is slightly below average but it is not responsible for prices being 2-3x higher than other comparable cities.
The only statistics that matter when determining the prices of houses are the proportion of dwellings that are available to buy compared to renting and the rate of increase of population and that of dwellings total. This is the core of this article and I will explain why.
Supply and demand comes into play here but is is not a true example of it because unlike most examples of the logic which are applied to commodity prices, the demand is artificially created by the suppliers. The overall effect is the creation of a disorganised cartel.
Cartel: Noun. Car-tel
“A combination of independent commercial or industrial enterprises designed to limit competition or fix prices”
Investors are not working together to create this but their actions compound with each others to only profit themselves. The more profit other investors make, the more they make. Investors can not claim innocence in this as this is explicitly what they are trying to achieve through buying investment properties. Note that this is explicitly regarding buying existing properties as investment properties. Buying vacant blocks of land or subdividing properties is the solution to this crisis. Unfortunately, there is not enough of this happening which is a big problem.
In a 5 year period, Sydney’s population grew by 345,357 people while in the same time period, 77,041 dwellings were added. With a rate of 2.7 people her household, this is grossly inefficient for dealing with a swelling population. The rate of new houses needs to increase by 66%. Over the past 25 years, the trends look bad. The following two graphs show the same data just graphed differently to highlight total values and the rates of change.
In order to maintain a normal 2.7 persons per household, the new dwellings must be built at a rate of at least 37% population growth. The most important trend to notice is that the rate of new dwelling development has been steadily decreasing for over 25 years while the rate of population growth is increasing. It is physically impossible to sustain this. The net result from all this is clear, the amount of young adults living with their parents will increase as the only answer to inefficient new housing developments. Even despite this cooling of the demand for new housing, that has no effect on the demand for existing housing by investors. This is the key to the housing affordability crisis; all of the power to reduce prices lays in the hands on investors who jump at the opportunity to purchase every house that a young adult deliberately stayed out of the market for so they could afford it. You can’t allow suppliers to control demand, it will always result in a cartel situation.
People may explain the housing affordability crisis as the fault of record low interest rates, but interest rates have nothing to do with to deliberate choice of investors to keep choosing existing properties over building new ones. I absolutely must stress the difference between buying existing properties, building new houses or demolishing and subdividing land plots. Obviously buying an existing property is a safer investment and I would not say that investors who do this are guilty of strangling the supply but when you mix 25 straight years of population boom while reducing new developments, you get price hikes.
It seems obvious that interest rates are the problem but consider the fact that interest rates are not biased towards first home buyers or investors. Low interest rates are not putting 4 high-bidding investors at an auction where there used to be 2 first home buyers, a situation becoming more and more common. I have included this graph as I am aware of the effects of interest rates on house prices but this needs to be considered as only a factor of house prices. As my other graphs show, there is higher correlation between investors buying existing properties and house prices rising (through refusing to build new houses and keeping the supply low despite record sums of money going into it), than there is of interest rates considering the interest rate correlation only exists over 4 years and does not explain first home buyers being unable to use this to their advantage.
I believe this is a classic case of correlation not equaling causation because we have a reduction in supply with cutting of interest rates sending the house prices skyrocketing at the same time making it impossible to deduce the overall effect of each problem. I want the reader to not consider the price of houses in a vacuum but to understand that more and more people are being locked out of the housing market in favour of investors setting up rental properties. This is what sends house prices skyrocketing as auctions go out of control.
In true supply and demand scenarios such as commodities, there is a very clear distinction where the suppliers are not in control of the demand through either increased competition or just less demand in general. This is why monopoly laws exist as buying out the competition is generally bad for consumers. If a supplier constrains the demand by controlling or colluding with other suppliers to do the same, they become a cartel and this is illegal or strictly regulated for good reason.
Consider also the predator-prey model. This model works in nature because the participants aren’t colluding with each other. This is why the predator-prey model does not apply to humans and animal farming, because humans simply control the supply. You can’t have a model like that where one side literally has total control over the others population where they grow it at a sustained rate to keep their own alive at an increasing rate. When you skew the predator-prey logic like that, it begins to apply more than supply and demand ever did. Understanding those two logic operations is important.
The demand, or the customers, have to have some sort of power for the supply and demand logic to work. If the majority of investors are working towards the same goal of valuing their properties higher, the customers can not win.
Leaving housing empty is both profitable and subsidised by government
Syndey Morning Herald
When it is more profitable for an investor to buy a property with the intention of taking it off the market, this is a clear indicator that the strangulation of supply is what is driving house prices up. It is not the only cause, but the fact that this is even a possibility is outrageous.
Look at Sydney in 2006. If we were to take a random set of 100 houses and look at a 5 year window, the proportion of renters has increased from 32 to 34%. This is a trend which is continuing. It doesn’t seem like much, but compound it with population growth and most importantly, a deliberate effort to not build new properties but buy existing ones, it quickly gets out of control. The government has failed to stop this with appropriate regulations and even encouraging it.
In 2006, 68 of those 100 houses were available to buy. In 2011, 2 homes were taken off the buying market and population and demand has now increased. 2 families who represented the lowest sum of money for any given property value range in the pool of 32 prospective owners have now been pushed down into the pool of 66 (now 70 from population growth while only adding 1 extra house) and represent a high percentile of renters for similar budgets. The entry point into the home ownership market has been shifted upwards since now the lowest level of competition is now spending more money to challenge these new highest earning renters. 1 extra bidder can easily push house prices up hundreds of thousands of dollars, now add 3 more. Every single time a house is taken off the ownership market and into the rental market by someone who already owns a home, this increases the price of ownership by artificially suppressing the supply. To understand how this can be controlled to raise prices, look at it from another way.
Consider a single person that owns all of these 100 houses and had 50 currently being rented with 50 about to go on the market. If this person decides to move 5 around by making 55 rented and 45 for sale, all of the houses for sale are now going to sell for much higher than before. There is a controlled pattern of the next lowest property having more demand while increasing the value of the houses for rent since they are tied to the value of purchased houses. Repeat every few years for a compounding effect. Those who were previously renting are now fighting even more investors to buy a house, possibly even the same people who locked them out the first time. This is going to drive up the sale and rental by huge amounts with such a large demand. Renters just can’t get a break, coming up against an increasing amount of people who already own homes and have a lot more money than them.
The person responsible for this is artificially suppressing the supply. By using their huge wealth, they are literally buying out owners and forcing them into rentals which drives up the price of everything. In any other business, this would be a monopolising scheme. It is like if a given petrol company which was normally priced above market value, bought out all other petrol stations and raised their prices in an effort to get people to go to their original stations. There is nothing anyone can do about being force to pay more.
Now consider if in this situation would it be any different for the hopeful buyers if it was one person owning 100 of the homes, or 50 people owning 2 homes? In both situations, 50 become user occupied and 50 become rented. Is there a difference? For the buyer, there is none. House prices go up all the same. Anyone trying to get into this group from the outside is literally buying against people who are valuing a property at a high amount because they themselves reduced the supply in the area to over-value their existing properties. This phenomenon is real and it is dangerous. Far too often I read stories of investors buying properties and setting the rent far higher than usual with the justification of the area being worth more. Other investors follow suit and you get a self-fulfilling prophecy. It is worth more purely because other investors made the same decision in a feedback loop. It has nothing to do with the intrinsic value of a property and everything to do with the average price determined by investors.
Four years ago, Candice McLaughlin, 29, and her fiance, started renting in Picnic Point for $500 a week. After their lease ended, the landlord put the rent up $50 – a 10 per cent rise.
Her most recent home, in Earlwood, was rented at $610 a week – which the couple could afford to pay with a roommate.
“Now the rent has gone up to $630 a week. [The landlord] said the area is valued at more … so we’re moving again,” Ms McLaughlin said.
Domain
It might seem like this scenario will inevitably play out no matter what anyone does in western civilisation, a late-stage capitalism scenario. This is not true because what we are witnessing with this housing affordability crisis can be controlled with more supply, it is not inevitable.
Artificial inflation like what I have described would normally be dealt with by buyers simply moving to another suburb. Except this exact situation I described is happening there too. Its happening everywhere. I just described Sydney, the sets are all just smaller examples of the general state of housing in Sydney. This is not an over-simplified analogy. Every time you go to an auction for an existing property and there is an increasing amount of leading bidders going against each other who are also investors, this scenario is playing out right in front of you and this happens at a very dangerous regularity. Meanwhile houses that are sold normally are priced artificially high by literally the same people buying neighbouring houses. If an investor purchases multiple houses in different suburbs, the effect is identical to had they bought all the houses on a street. They are not explicitly bidding against themselves, they are bidding against people doing the exact same thing as them with the same overall effect.
It seems so easy to blame a single person for actively suppressing the supply but when it comes to multiple people they seem to get a free pass. In reality, having multiple people do this is worse than a single person doing it. Individually they may not have pure greed as their intent to buy an investment property, but their actions combined are actually more detrimental than a single person literally buying people out of their homes. 1 person can not feasibly get away with price gouging like this. If many of people do it, should it be acceptable? I believe not and it needs to be discouraged, the exact opposite of what is happening though. I will not place all the blame on investors though because I believe this behaviour has been encouraged by the government in its failure to control the supply and giving incentives to investors doing this who are likely to be completely innocent, unaware of what is happening elsewhere when others do the same thing.
The population is increasing at a rate higher than new homes are being built to sustain them which can be controlled by building more houses. By deliberately buying existing properties, all of their efforts combined will drive up the competition, therefore the rent and therefore the price of their own properties. This doesn’t even negatively affect them from buying more properties at an inflated rate because of negative gearing. I left this part out until now to show that the only weakness to this system someone might deduce is already completely covered.
How can the housing bubble actually burst, if the only thing controlling house prices, is the ever-increasing amount of landlords? Either demand has to drop, or supply has to grow. Demand won’t drop as the population grows and supply won’t grow for as long as they buy existing properties over new ones. The answer is simple; it can’t, they won’t allow it. Housing prices in Sydney are not in a bubble. It is fundamentally impossible for housing prices to go down for as long as this is happening. This is nothing like a mining town boom where the demand can drop by means outside of the landlords control, it is 100% controlled by them.
Fundamentally, what it comes down to is that the market is driven by landlords with a single interest.
Domain
There are only a few solutions to this;
1) A dramatic drop in rate of population growth can stop this by reducing demand.
2) Force existing home owners to build new properties before buying existing ones.
3) Remove negative gearing entirely and heavily tax existing owners looking to buy an investment property.
Increasing the first home owners grant is not the solution. The suppliers have total control over the demand and this is a toxic situation to find the market in. It absolutely must be reigned in through disincentives to propagate the problem, driving prices down. This is not a bubble, this is a very well controlled scheme even if the participants are totally unaware of what they are doing. It can not burst barring a recession or war to cut the population down.
Those solutions might seem harsh but it is the only way. When the suppliers control demand, they become a monopoly. They must be regulated in ways that are healthy for the market. Every new investment property owner that is not building a new property joins a group which is collectively driving the market up in a feedback loop. There more there is, the faster the rate at which this happens. Not only are the amount of investment property owners growing, the rate of them is growing too. Note that at no time have Chinese investors affected anything here, they do not cause this problem. Their presence certainly doesn’t help, but they are not responsible for the governments lack of action about taking real solutions to deal with this.
There is no housing price bubble. The sooner people realise this, the sooner they will be able to understand how skyrocketing house prices need to be controlled without waiting for it to burst. Economic bubbles have defined characteristics. What you are witnessing is a cartel made up of tens of thousands of unwilling, but profiting, participants. When a business starts pushing the limits of monopoly laws, they must be controlled or you get the USA pharmaceuticals/health insurance system. Real estate in Sydney is not a market, it is a system. It is free from usual forces that balance out markets.
Home owners building new houses to use as investment properties are incredibly beneficial to society. Buying lots and demolishing them to sub-divide is also perfectly fair in an age where people don’t really want big gardens. Home owners buying existing properties to rent them out directly are 100% to blame for out of control housing prices. They can not claim innocence when they have every opportunity to learn what their actions cause, but chose to blame Chinese investors instead. An exact opposite to negative gearing is the only real solution.
Existing home owners must be financially restricted from buying new properties and rewarded for building new ones. It is the only method to curb population growth and break the cartel system of raising each others prices.
References / extra reading
Real estate market treating buyers like produce
Increasing proportion of rental propterties
Statistics for Sydney’s population
And finally, an example of the sort of articles that spurred me on to write this and specifically this statement
“While some agents say vendors who wanted to sell have done so in the boom of the past four years, the low stock now may be due to other factors.
“People won’t sell because home owners can’t go to where they want to,” LJ Hooker’s Peter Tannous said. “The prices are ‘wrong’.”
By “wrong”, Mr Tannous means prices are now “too high”. Sydney housing prices have risen over 61 per cent since 2012 and the median house price is now close to $800,000, according to Corelogic. Ten years ago it was half that price.”
afr.com.au
I want people to read through that and think for themselves, is it more likely that supply has been cut down by a pure lack of housing developments, or is it because prices are simply high? It is these sorts of comments put out into the public which do absolutely nothing to help the situation by ignoring the glaringly obvious lack of housing. Why has this commentator completely ignored the disproportionate rate of population growth to new houses being built or the fact that investors are swooping in all over the place, in bidding wars among themselves? This is not a healthy market and a dangerous path to go down. How can people simply say ‘It’s because of a strong economy’ while much stronger economies around the world don’t have 9x median income houses?
If what this author says is true, then people can expect $2M median house prices in Sydney within a decade. The only other alternative they offer is a ‘bust’. The problem is, a bust can only happen if the supply exceeds the demand, that’s the entire premise of the bubble theory. Will housing in Sydney ever exceed the demand without implementing the changes I suggested? I’ll let the reader think about that one. Because if a bust can only be controlled with intervention, a sign that it was within peoples control, then we might have just had an unwilling cartel operating in Sydney for decades. The only reason this formed is because the government gave incentive for investors to engage in this behaviour, that needs to stop now. No more waiting for a bust, it is not going to come.