The fundamental distortion in the Australian economy is extremely high house prices. It has created a damaging generational divide between those who were lucky enough to buy cheaply and those who are unlikely ever to be able to afford a house, or are saddled with long term burdensome mortgages.
Just how bad the situation is was underlined by the US journalist Tucker Carlson when he visited the country recently. Although presumably well off, he said he was shocked by the prices – he initially thought they must be ‘in pesos or something’ – and noted that even he could not afford to purchase.
The problem has no obvious solution because governments will not change the negative gearing and capital gains tax mix that triggered the bubble in the first place. They know it would be electoral suicide. The other main factor, interest rates, governments do not control – the central bank does.
So what they do instead is tinker at the edges, talking about the availability of land and giving limited hand-outs to first home buyers. The first option is usually short circuited by property developers who are big funders of political parties. The second option just drives prices up more, or at least puts a floor under them.
It does seem to be a problem for English speaking colonies, and also the UK. The same cul-de-sac faces Canada and its government is similarly impotent. Like Australia, house prices have approximately tripled over the last two decades, fuelled by the combination of aggressive bank lending and, until recently, falling interest rates. The Trudeau government did introduce in its last budget a small change in capital gains tax, but it, too, is just tinkering around the edges. Canada has the same mix of relatively modest government debt and soaring household debt that is the case in Australia.
So here is a suggestion. Instead of trying to manage prices with changes to housing regulations, why not look to boost other kinds of investment to encourage property investors to look elsewhere? There is a dearth of investment options in Australia. This is confirmed by the fact that almost a quarter of the funds in superannuation companies are invested offshore.
If governments set out to assist with more diversification of domestic investment opportunities, then it may take the heat out of the property market. At the moment, the main avenues are the stock market, which many people wrongly regard as being like a casino; fixed interest with low interest rate yields and taxation on the income; or property, which is tax-advantaged and easy to understand.
'There are some small signs that property investors are starting to head for the exits. But it would be better for first home buyers if investors had more choices and decided that making losses in the short term in order to benefit in the long term is not such a smart play after all.'
Over two million taxpayers in Australia, about a fifth of the total, are property investors while 3.25 million Australians own investment properties. That is an awful lot of people who are punting on an investment that is not very logical. A comment made by this writer’s brother, who owns an investment property, underlined to me the dubious nature of relying on negative gearing. He lamented that things had gone ‘wrong’ because the rent on the property actually covered the interest costs and other expenses, so he did not get a tax deduction. He considered this to be a failure.
What kind of investment relies on losing money? One that is a punt on sharp rises in the capital value, which is perfectly sound – until it isn’t. If property prices start to fall dramatically, expect investors to bail out with great speed as they start to realise the implications of their gamble. Should that happen, property investment would go from being the nation’s greatest financial distortion to its greatest vulnerability. Which is another reason to diversify the investment opportunities.
A pointer to how this can be done is provided by the industry super funds. One of the reasons they have outperformed is that they have been able to invest in more asset classes, such as private equity and infrastructure vehicles. If there is one incontestable rule in investment it is that diversification reduces risk and ensures sound returns over time, which is what the industry funds have achieved.
So why not seek ways to offer different possibilities to the whole population? At the moment the stock market is heavily skewed to banks and mining companies. There is little or no opportunity, for instance, to invest in a diversified agriculture vehicle: Australia’s oldest industry and one where we have a durable competitive and comparative advantage.
Venture capital is virtually non-existent here. Anyone with a strong start up idea usually heads to the United States. There is no way for individual investors to participate in relatively low risk and reasonable yielding infrastructure projects, it is only available to institutional investors.
Some lateral thinking is desperately needed because the property bubble is inequitable and damaging to Australian society. There are some small signs that property investors are starting to head for the exits. But it would be better for first home buyers if investors had more choices and decided that making losses in the short term in order to benefit in the long term is not such a smart play after all.
David James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.