Why the Australian government loves high property prices

If you have read any of my blogs in the past you will see that I like to take aim at inefficiencies I see and today it’s going to be at the good ‘ole Australian government. 

“Why they love high property prices in Australia”

 

On Saturday, Bill Shorten-  the labor government leader came up with some brilliant ideas to stop what they think is pushing house prices up – negative gearing and high capital gain tax exemptions. While it is unlikely labor would win the next election based on polls, it is still a possibility.  http://www.alp.org.au/negativegearing

When I read them I find it hard not to laugh because it’s like rocking up to the end of a party and saying “right I’m glad you all had a good time but lets turn the music down”

In my opinion this move from the Government are too late because house prices are already heavily inflated and trying to slow them down with future tax reform won’t help the people who need help the most – First Home Buyers right now.

Whilst I admire their ambition and what the proposals are trying to achieve, I believe they are missing the mark. Part of their approach was all current negative gearing is grandfathered and will not affected.

Great, so the ones using the tax advantages now can benefit but the people who want to buy in the future don’t get that opportunity? 

It’s been good for Paul, but not good for young Pete who might want to buy an investment property. This is something my clients have done numerous times to allow them to afford their first place – take that away and it becomes even harder for them to achieve buying their home as the debt is not deductible.

 What worries me even further is that the Government proposed to allow negative gearing but ONLY for new properties. Surely they understand the risk that new property represents to first home buyers..? This is not a good idea.

I won’t rant on this issue any further but I hope this article gives you an insight into why I believe the government loves high property prices.

Australia is lucky enough to be one of the largest countries in the world – with land for many more millions of people. Then why is it, even with so much land we still have some of the most expensive property in the world?!

A bad example but India is 0.4 times the size of us. It uses ½ of their land for food production and has 66 times our population. The USA for example is about 1.3 times our size but has 16 times our population. Brazil is about the same size but has 9 times our population. One of the only developed countries that is similar to us is Canada and and they have pulled off a similar story with their property prices.

So why is that?

What drives our property prices up by so much when we really have unlimited space around our country for many more?

The way to push prices up is to carefully control the supply and demand of property in Australia. In order for prices to push up you need an increase in demand with a shortage of supply. Let us be blunt here firstly, everyone in Australia wants higher property prices.

Some would say – "but what about the people who do not own property?”  Sure right now they do not, but as soon as they buy they do.

This cycle has been going on for decades and will continue for the foreseeable future because we have a whole system built around the strength of our property market. 

One of the biggest factors contributing to personal financial security is high property values. In the USA in 2003, George Bush kicked off a stampede in property prices by making interest rates very low and encouraging everyone to follow the American dream of owning a family home. http://georgewbush-whitehouse.archives.gov/news/releases/2003/12/20031216-9.html This is pretty much the strategy the UK used to pull itself out of the recent recession and it’s what the Australian government is hoping will keep us out of one now. 

Governments love to push prices up because if they do, people feel richer. The richer we feel, the more we spend. The more we spend, the better the economy does. The better the economy, the better Australians prosperity will be.

So as you can see there is a clear link between high property prices leading to a better economy from a financial point of view. 

In a lot of cases however property wealth is really just paper wealth. You feel rich but it really is not something you can spend unless you sell.

 A common misconception I find is that families believe that they are not personally overspending if they are paying off their home loan at the agreed principal and interest repayment amount over 30 years. If the bank says $2,500 and they pay $2,600 that is a good result.

The problem with this mindset is that banks want you to pay your debt off over 30 years and potentially never at all. The minimum repayment is what banks and the government want you to pay, not what you should. The less you repay the more you spend and the more you spend the better the economy and the bank will do.   

Secondly, rising property prices make people feel more financially comfortable. The $1,000,000 debt is now on a property worth $2,000,000 and not on one they bought for $1,200,000.

Fundamentally however unless they sell, their repayments each month and life stays the same. The $1,000,000 debt will stick around and be a burden on the family budget but they feel safe because if it all hits the fan they can sell and downsize.

So if we accept there is a fundamental motivation for governments to keep prices high to keep the economy confident and spending.

The other side of the coin is how governments benefit financially from higher prices in property.

The first way is through Stamp Duty – the NSW government alone received a record $7billion last year. http://www.smh.com.au/nsw/nsw-state-budget-2015-7b-in-stamp-duty-drives-record-surplus-20150622-ghua76.html

Not pocket change for the government. The recent 60% rise in Sydney prices means that their revenue has likely gone by at least 60% and most likely more due to their system.

Another cheeky way the governments make money is from Land Tax. Land Tax is a state tax that is paid by investors who own more than $480,000 roughly in NSW in Land. I do agree with the premise of this tax in terms of stopping people accumulating huge land portfolios and asking them to pay but really anyone who has more than $500,000 pays 1.6-2% tax. Hardly just a tax the rich pay and it’s not a big difference between 1.6-2%.


Another way is through is through banking profits. The government loves profitable banks because a profitable banking system underpins an economy we are always told. “We wouldn’t have an economy without banks and you need to bail us out no matter what” has been the story peddled for many years now.

In Australia, we have some of the most profitable banks in the world and the government loves that because they take 30% of their profits in company tax. The big four banks made $30-40 billion last year so you can see why they love that tax revenue each year. I have looked around and found it hard to find the data but I would say one of, If not the biggest income stream for these banks is lending by the bank on the back of higher property prices – mortgages, business lending, commercial property. Without the higher prices, they may not be able to lend.

Another way is through capital gains tax. At the moment the government add the profit on an investment property sale on to the top of your income. These gains are usually over $100,000 and are taxed at least at 38% but usually closer to 49%. While they give a discount of 50% on any properties held longer than 12 months, this still gives them around a 20-25% tax bill on any rise. If a property goes up $500,000, the government will kindly take around $100,000-125,000 of their troubles. At present, the government does not tax the growth on your principal home but this is something they are thinking about introducing. The proposed change by Labor is to reduce this concession to 25% not 50%. This is ok and may stop investors but the damage is already done and capital gains tax is only due if you sell. 

What happens if you never sell? 

Another area the government loves is building construction. Building construction is a great employer in Australia and construction usually leads to more construction. The Sydney, Melbourne and Brisbane skylines are currently  filled with cranes. Our high property prices and low interest rates, means developers can make money through building. If Property Prices were not so high, the developers would not be able to make a big enough profit and so they wouldn’t build. Higher prices lead to development which leads to jobs which leads to more tax from the workers and less unemployment. It’s good for all.

On top of this construction, a lot of these apartments and building are being sold toforeign buyers especially the Chinese. When the settlement takes place the developer in a simple sense takes the money from the Chinese economy and injects it in to the Australian economy. High property prices create confidence and a strong history of rising prices encourages investors to invest. The longer the prices stay high and keep on rising, the longer overseas investors will want to invest in Australia which is brilliant for our economy. 

 It might not make sense to astute investors but investors sadly follow where the best returns were, not usually are.

A big part in future construction is local councils. Local councils control the development of suburbs. New developments and new land releases must go through them and there are many arguments that they benefit greatly by overcharging the costs of these new developments. They do this to maximise their income from releasing land. By cutting down the supply it allows them to increase the cost and in to how much their profits are. They also charge their rates on the value of the land and obviously the goal of the council is to increase the value of the land. As you can see, like every other level of government- higher prices are good. 

The final part is Superannuation. Due to our under diversified and tiny economy we have a huge part of our Superannuation in the banks. Outside property, this is where the majority of Australians have their wealth.

If there was to be a collapse to our banking system because property prices did not stay strong then our superannuation would suffer immensely. The key thing to understand here is that the banks need high property prices to lend more and the more lending the more money they make. They would also endure significant loses from a fall in prices. Superannuation is the governments "get out of jail card" for providing for our ageing and long living life of Australians. The government need superannuation to stay in good shape.

As you can see there are many reasons why the government want high house prices. To be honest, anyone who owns property probably wants higher prices and those that don’t, once they purchase they do. 

But high property prices are a strange way to view wealth. They distort what managing debt can cause to your family. A higher debt will lead to an increase pressure to earn a higher income. This may lead to pursuing work for money not meaning. This may mean family unrest from working in a job too long or not suited to your strengths or passions. This may lead to community unrest between inequality. This may mean many things but we are constantly reminded that higher property prices are good for the economy. 

In fairness, I wrote this article because a lot of the work I do is help people bridge the gap between the costs to live the life they want and their current financial situation. We do this a lot of the time by investing and investing in property is a big part of this picture.

Part of why Property is a good strategy is because of the reasons we have discussed here. There are many stakeholders who are also heavily invested in to maintaining the soundness of our property market. No politician would ever want the property market to crash on their watch and therefore it’s important to understand just how unlikely they would do anything to put this at risk.