remove -ve gearing some, not all investors bail out, remove their capital - Agree, but this only happens in the short term (5 years) house prices go down - Agree, but only in the short term cheaper for owners - ditto cheaper for investors also - ditto
The number of investment properties would be reduced (as richer renters would likely become home owners) The number of property relative to demand will reduce - because prices will fall below the cost to build. No-one really likes building for a loss (despite the wish to the bears). This creates an imbalance in the rental market, and rents rise
However, as above, number of renters will also reduce. The total number of people need a roof over their head remains the same. It does not matter whether they are renters or woners. the supply of stock will fall short of the need, and prices will bouce back, and rents just keep risingas purchase price to i
investors is lower, they would require lower yield Investors will only come back into the market when the after tax returns is eual or greater than what is was under NG. That means rents relative to price (yield) has to be higher
hence rents would decrease. Hence rents rise
yield would be a higher percentage than now, so there is an incentive for people to still invest in IPs. Agree
What it does is get rid of the speculators, tax dodgers, highly leveraged high income earners etc, who rely only on capital growth as their return. The market needs specualtors - since they push up prices and encourage supply. this is important since housing is a social good.
Supply would improve as land prices would be cheaper and govt can reduce their income from developers as they are no longer handing out massive funds from NG. Supply will be low in the short run - but improve once rents increase enough to offset the loss of NG.
Theoretically, I agree with your thinking b_b – but not completely. It really depends on an analysis of where replacement cost “hits” the property market.
To recap your earlier point: Remove negative gearing, and we see a short term sell off. Prices go down. Agreed.
According to your argument, if prices fall below replacement cost to build, we see shrinking rental supply, rentals go up, and therefore pushing house prices up. Agreed.
In the event that price falls below replacement cost, price must eventually rise to stimulate supply. Also agreed.
The key point that I have issue in all of this is your replacement cost analysis. Now, I’m happy to assume that you are generally correct about high replacement cost being the driver of new property prices. That’s a logical economic analysis. (Personally, I am still unconvinced that this argument applies completely to Melbourne because I just can’t see how it agrees theoretically with the rather large construction figures we have seen. All indicators are now pointing to oversupply which shouldn’t happen in a low ROCE environment. However, you have presented enough evidence that I am happy to consider it here.) So – back to the analysis. I agree that property at the fringes (new developments) can’t go lower permanently.
So perhaps they won’t. As you have pointed out, the replacement cost acts as a “floor” on the market – eventually, house prices will have to rise above this point to stimulate new supply.
But what about the rest of the market? Surely the inner suburbs aren’t limited by replacement cost in the same way that new homes in the outer suburbs are? So in my opinion, it is at least possible to see house price drops across the rest of the market, without getting below replacement cost at the fringe. Perhaps we will simply see a “compression” (for lack of a better word) of the market – where established suburbs no longer display the large price differences as you increase your distance from the city. These suburbs will see a lower price, and therefore an increased rental yield – all of this without causing the price to drop below replacement cost.
This would make sense to me, economically. Firstly, yields would recover to a more “normal” level - again, I’m referring to Melbourne, because they are currently quite pitiful (and only dropping).
Secondly, we wouldn’t see the large price difference we currently see in Melbourne, which to me makes little economic sense currently. Take, for example, the south east corridor in Melbourne. Along Princess highway we have clayton (median $510000). Literally down the road (3-4 minutes away) we have Oakleigh (median $750000). Then next suburb we have Malvern East (1.1 million). Then Malvern (1.6 million).
Driving from Clayton, to Oakleigh, to Malvern along Princess Highway takes about 5-10 minutes in total. All are serviced by princess highway and the SE freeway. All have equal access to public transport, with similar looking houses in similar looking suburbs. Should Malvern>MalvernEast>Oakleigh>Clayton because of increased desirability as you get closer to the city? Of course they should. Should the price differential be $1 million???? I certainly do not think so. This can be displayed for basically all of Melbourne - very steep relationship between distance and price
The median rents, by comparison are 220, 225, 241, 241 per week in each respective suburb. Enough to convince me.
Very interested in hearing your thoughts, as always, b_b.
remove -ve gearing some, not all investors bail out, remove their capital - Agree, but this only happens in the short term (5 years) house prices go down - Agree, but only in the short term cheaper for owners - ditto cheaper for investors also - ditto
The number of investment properties would be reduced (as richer renters would likely become home owners) The number of property relative to demand will reduce - because prices will fall below the cost to build. No-one really likes building for a loss (despite the wish to the bears). This creates an imbalance in the rental market, and rents rise
However, as above, number of renters will also reduce. The total number of people need a roof over their head remains the same. It does not matter whether they are renters or woners. the supply of stock will fall short of the need, and prices will bouce back, and rents just keep risingas purchase price to i
investors is lower, they would require lower yield Investors will only come back into the market when the after tax returns is eual or greater than what is was under NG. That means rents relative to price (yield) has to be higher
hence rents would decrease. Hence rents rise
yield would be a higher percentage than now, so there is an incentive for people to still invest in IPs. Agree
What it does is get rid of the speculators, tax dodgers, highly leveraged high income earners etc, who rely only on capital growth as their return. The market needs specualtors - since they push up prices and encourage supply. this is important since housing is a social good.
Supply would improve as land prices would be cheaper and govt can reduce their income from developers as they are no longer handing out massive funds from NG. Supply will be low in the short run - but improve once rents increase enough to offset the loss of NG.
Theoretically, I agree with your thinking b_b – but not completely. It really depends on an analysis of where replacement cost “hits” the property market.
To recap your earlier point: Remove negative gearing, and we see a short term sell off. Prices go down. Agreed.
According to your argument, if prices fall below replacement cost to build, we see shrinking rental supply, rentals go up, and therefore pushing house prices up. Agreed.
In the event that price falls below replacement cost, price must eventually rise to stimulate supply. Also agreed.
The key point that I have issue in all of this is your replacement cost analysis. Now, I’m happy to assume that you are generally correct about high replacement cost being the driver of new property prices. That’s a logical economic analysis. (Personally, I am still unconvinced that this argument applies completely to Melbourne because I just can’t see how it agrees theoretically with the rather large construction figures we have seen. All indicators are now pointing to oversupply which shouldn’t happen in a low ROCE environment. However, you have presented enough evidence that I am happy to consider it here.) So – back to the analysis. I agree that property at the fringes (new developments) can’t go lower permanently.
So perhaps they won’t. As you have pointed out, the replacement cost acts as a “floor” on the market – eventually, house prices will have to rise above this point to stimulate new supply.
But what about the rest of the market? Surely the inner suburbs aren’t limited by replacement cost in the same way that new homes in the outer suburbs are? So in my opinion, it is at least possible to see house price drops across the rest of the market, without getting below replacement cost at the fringe. Perhaps we will simply see a “compression” (for lack of a better word) of the market – where established suburbs no longer display the large price differences as you increase your distance from the city. These suburbs will see a lower price, and therefore an increased rental yield – all of this without causing the price to drop below replacement cost.
This would make sense to me, economically. Firstly, yields would recover to a more “normal” level - again, I’m referring to Melbourne, because they are currently quite pitiful (and only dropping).
Secondly, we wouldn’t see the large price difference we currently see in Melbourne, which to me makes little economic sense currently. Take, for example, the south east corridor in Melbourne. Along Princess highway we have clayton (median $510000). Literally down the road (3-4 minutes away) we have Oakleigh (median $750000). Then next suburb we have Malvern East (1.1 million). Then Malvern (1.6 million).
Driving from Clayton, to Oakleigh, to Malvern along Princess Highway takes about 5-10 minutes in total. All are serviced by princess highway and the SE freeway. All have equal access to public transport, with similar looking houses in similar looking suburbs. Should Malvern>MalvernEast>Oakleigh>Clayton because of increased desirability as you get closer to the city? Of course they should. Should the price differential be $1 million???? I certainly do not think so. This can be displayed for basically all of Melbourne - very steep relationship between distance and price
The median rents, by comparison are 220, 225, 241, 241 per week in each respective suburb. Enough to convince me.
Very interested in hearing your thoughts, as always, b_b.
Hi AK4,
Firstly let me just say, that my views on replacement cost are certainly not uniform across the entire Australian market.
There is no doubt the big price increases in Melbourne and Perth (versus say Sydney) has ensured very healthy development margins in those markets. This is the main reason why supply is surging (and did surge) in Melbourne and Perth.
Look at the developers in Perth. Finbar, for example, is generating +30% return on capital and trading at a significant premium to book value.
I’m a Sydney person so I guess most of my commentary relates to that market. That is, if marginal cost of production = $500-$550k and median house price is $630k (in a medina location), the downside in Sydney looks limited. I am far less confident of the same “floor” in Perth or Melbourne.
But you raise an interesting point in terms of high end real estate (+$1m). With this I am torn between my gut feel (market will fall) and my MMT upbringing (market will rise). I’ll explain below.
The bear case for the $1m market is exactly what you have outlined. My sense is the +$1m is trading well above replacement cost. It is hard to measure because you can’t put a replacement cost figure on inner city land production since the exercise is purely theoretical. But from what I hear from the building Industry, margins are very good for the high end homes. So in that sense I think the +$1m homes could suffer a serious correction (in all markets).
The MMT side of the brain says the opposite. As you know, all money is backed by debt. That is, for every mortgage / loan there is a sister deposit. Now if you accept most debt (mortgages) occurs for FHB and the middle market, then the deposits (cash) is more prevalent at the top end of the market (ie: less mortgages). This means the top end is not likely to suffer from mortgage stress (of course there will always be isolated cases).
Maybe the answer lies in between. The top end may not crash, but will suffer years (decades?) of flat nominal / negative real growth.
I’m a Sydney person so I guess most of my commentary relates to that market. That is, if marginal cost of production = $500-$550k and median house price is $630k (in a medina location), the downside in Sydney looks limited. I am far less confident of the same “floor” in Perth or Melbourne.
For Perth production cost would around $400k in one of the outskirt suburbs or $300k if one was prepared to move over 60km away from Perth.
Firstly let me just say, that my views on replacement cost are certainly not uniform across the entire Australian market.
There is no doubt the big price increases in Melbourne and Perth (versus say Sydney) has ensured very healthy development margins in those markets. This is the main reason why supply is surging (and did surge) in Melbourne and Perth.
Look at the developers in Perth. Finbar, for example, is generating +30% return on capital and trading at a significant premium to book value.
I’m a Sydney person so I guess most of my commentary relates to that market. That is, if marginal cost of production = $500-$550k and median house price is $630k (in a medina location), the downside in Sydney looks limited. I am far less confident of the same “floor” in Perth or Melbourne.
But you raise an interesting point in terms of high end real estate (+$1m). With this I am torn between my gut feel (market will fall) and my MMT upbringing (market will rise). I’ll explain below.
The bear case for the $1m market is exactly what you have outlined. My sense is the +$1m is trading well above replacement cost. It is hard to measure because you can’t put a replacement cost figure on inner city land production since the exercise is purely theoretical. But from what I hear from the building Industry, margins are very good for the high end homes. So in that sense I think the +$1m homes could suffer a serious correction (in all markets).
The MMT side of the brain says the opposite. As you know, all money is backed by debt. That is, for every mortgage / loan there is a sister deposit. Now if you accept most debt (mortgages) occurs for FHB and the middle market, then the deposits (cash) is more prevalent at the top end of the market (ie: less mortgages). This means the top end is not likely to suffer from mortgage stress (of course there will always be isolated cases).
Maybe the answer lies in between. The top end may not crash, but will suffer years (decades?) of flat nominal / negative real growth.
There's nothing wrong at all with your MMT reasoning. But, I don't think that mortgage stress is the only factor that can make the market capitulate. I think it is possible for the mid-to-top end to capitulate without any mortgage stress at all.
If property prices falter for any decent period of time (as they have been in the past year across the country), the expectation of capital gains slowly begins to erode in investors' minds. Thus property quickly becomes a less attractive investment and a few PI's begin to pull out. In an oversupplied market (such as Melbourne or Perth) this contributes to high stock levels, making it harder to shift stock, thus lowering sentiment, which then lowers prices etc etc.
So really, there is no requirement of mortgage stress at the top end; all it requires is a shift in sentiment such that PI's don't believe capital gains exist at a desirable level. When/how this shift in sentiment reaches "tipping point" is hard to say.
Now that you mention MMT though, it's interesting to consider what effect the aimed budget surplus will have on house prices (and the economy generally). If you accept that surpluses remove money from the economy, then you must accept that this means the private sector will effectively have less to spend, since they must dis-save collectively. The only way to continue at the same consumption level is to turn to cheap credit.
The issue there isn't the banks ability to home lend - in any case, you've got the RBA creating funds and buying residential mortgage backed securities every day (they openly state it on the RBA website - since 2005 government bonds aren't the only thing that the RBA accepts in it's daily interest rate targeting operations - it also accepts high quality RMBS).
But I don't think the private sector is able to take on any significantly higher amoutns of credit, at least not without much lower interest rates to make up for the fact that (a) they are pretty highly leveraged at the moment (the private sector in general) and (b) they will be dissaving as the budget approaches surplus.
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