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The Victorian Government should remove stamp duty from the sale of property to increase housing affordability, support first home buyers and give the economy a much needed boost according to the Stamp Out Stamp Duty Campaign.

The Stamp Out Stamp Duty campaign calls on the Baillieu Government and Treasurer Kim Wells to heed the advice of their own departments and scrap stamp duty in favour of a small value based land tax on residential property. The proposal is revenue neutral.

Campaign spokesperson David Collyer said that stamp duty created an unnecessary barrier for first home buyers and was an economic dampener which prevented easy property transfers and best use by owners.

“First home buyers are hit with a huge tax at the same moment they take on a giant mortgage debt. Stamp Duty also takes advantage of people forced to sell due to the death of a family member, illness, unemployment, family breakdown or a change in circumstances. It’s an unfair and poorly targeted tax that serves no real economic purpose.

“Stamp duty also adds around $25,000 to the cost of an average block of land, which just makes already expensive properties even more expensive.”

To make up the lost revenue from stamp duty, a small efficient value based land tax should be introduced, a proposal supported by leading economists such as Dr Ken Henry and the Victorian Department of Treasury and Finance.

Mr Collyer said “Victoria already has a State Land Tax, however owner-occupied properties are exempt at the moment. We are calling for this tax to be extended to residential properties with appropriate measures to safeguard community housing and those who have recently paid stamp duty from an unfair burden.”

“This change would provide a genuine spur to development on high-value land and reduce the pressure for more urban sprawl. Both the supply and affordability of rental housing would be boosted as a broader land tax base would put landlords and home owners on an equal footing. For the vast majority of Melbournians, this change would lead to a net cost saving.”

Economic modelling of this key recommendation of the Henry Review by Australian Housing and Urban Research Institute shows landowners in Melbourne, Port Philip Boroondara, Bayside, Stonnington and Yarra municipal areas would overall pay more while the vast majority of homeowners elsewhere would pay considerably less.

“For too long discussion on tax reform has been stifled by vested interests. We now have quality economic modelling that shows wealthy landowners benefit most from Victoria’s very bad tax system.

“This modest change would galvanise economic activity in Victoria, something the Baillieu government – and every Victorian government before them – proclaim loud and long is a key objective,” Collyer concluded.

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Stamp Out Stamp Duty facebook page

References:

• the AHURI economic modelling paper
• the Henry Review on replacing Stamp Duty
• Jessica Irvine on Land Tax for Stamp Duty
• VCOSS on Stamp Duty (PDF)

Media contact: David Collyer david.collyer@prosper.org.au

About Prosper: Prosper Australia is a tax reform lobby group and think tank that is now 120 years old. It seeks to move the base of government revenues from taxing individuals and enterprise to capturing the economic rents of the natural endowment, notably through Land Value Tax and Mining Tax.

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The Productivity Commission has just released a draft report on climate change adaptation for public comment. The report examines economic reform options in two broad categories: adaptations to uncertain future climate trends with benefits only under certain climate change scenarios – to which it gives low priority; and, low-cost, reversible actions that can be taken to prepare for future climate change.

The PC is staffed with economists not climate change scientists, so this report looks at economic resilience rather than carbon dioxide or sea levels. In its area of expertise it is bold and clear: change the tax base to increase flexibility and adaptability. Naturally, it condemns Stamp Duty which traps citizens in their homes and endorses Land Value Tax which promotes mobility and the matching of needs to resources. It says:

“Economic reform can build the adaptive capacity of the community

“Economic reform that addresses market failures, or addresses the unintended consequences of current policies, could improve people’s management of current climate risks. Existing policies may limit the ability of markets to reallocate resources in response to extreme weather events and future climate change. For instance, taxes on property transfers (stamp duties) can inhibit the movement of labour and capital and the efficient use of land, and state and territory insurance taxes and levies can distort the ways in which households and businesses manage the risks they face. Replacing these inefficient taxes with less distortionary taxes, such as broadly based land taxes, would likely enhance economic performance, as well as the community’s ability to respond to a changing climate.”

The PC calls this a ‘no-regret’ reform with economic and social benefits whatever the climate change outcome. In a country of “drought and flooding rains”, tax reform that enhances our hardiness and capacity to change wins whatever one’s opinion on the divisive issue of climate change.

Sign the Stamp Out Stamp Duty petition here.

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Today’s Sydney Morning Herald has a breathless article about a flipper couple who bought, renovated and have for sale a Marrickville terrace. The underlying message: there’s profit in the renovation game.

My back-of-envelope calculations based on the article’s figures show they will lose around $43,000 on the transaction if they sell for the $680,000 mentioned – a reality more sober than Toby Johnstone’s writing.

Cathy and Antonio Leonardi bought the two storey in poor condition for $550,000. Stamp duty is $20,240 and they spent $105,500 on renovation. A selling agent at two per cent will cost another $13,512.

Let’s not forget the opportunity cost, the price of the money tied up in the project. The lowest conceivable figure would be the mortgage rate, currently 7.5%, on the $675,740 invested in the property for eight months. I make no allowance for State Land Tax which may or may not be payable, or legal costs or building permits. The un-billed labor contribution of the flipper couple is disregarded too.

Total cost to the happy renovators: $723,039. If they can execute a quick sale at their desired price they may contain their losses to the $43,000 mentioned. Delay or discounting immediately worsens their bottom line.

Australian house prices are falling. That and Stamp Duty make it very difficult for flippers to profit. Many renovation projects during the long boom were saved by rising land prices. That kicker is no longer available, as Mr and Mrs Leonardi are about to discover.

Don’t Buy Now!

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In his second budget, Victorian Treasurer Kim Wells is aiming for a surplus of $155 million, of which $109 million is due to increased fines. The Government has budgeted for $662.5 million in total fines, including $306 million from road-safety cameras, in 2012-13.

Exceeding the speed limit by less than 10km/h will now cost you more than $175.*

The Government assures us that this is for our own safety. Considering that travel by public transport is at least 20 times safer than travel by car (estimates of the factor range from 20 to 170), I would have thought that the surest way to make commuters safer is to get them out of cars and into public transport. The budget fails on that score. V/Line gets 30 new carriages, but the new and modified routes conspicuously favor road users rather than public transport users. There’s $350 million over 3 years to remove three level crossings in Springvale and Mitcham. There’s $42 million for duplicating the Western Highway from Buangor and Beaufort. There’s $13.7 million over four years for the Dingley Bypass. And there’s $15 million for a “business case” for the long-awaited East-West Link, whose actual construction depends on federal and/or private funding!

Of course, if any of these road projects passes a cost/benefit test, the uplift in land values caused by the project will exceed the cost. If a sufficient fraction of that uplift is clawed back through the tax system, the project will pay for itself without burdening any taxpayers who do not share in the benefit. Instead, Mr Wells hopes that car registration revenue will jump by 16.6%.

The same logic applies to funding of public transport projects. The biggest free-riders on public transport are property owners whose land values are increased by the availability of the service. If travel by public transport were free (except perhaps for peak-time congestion fares to encourage off-peak travel), the uplift in land values would be even greater. But only minuscule fractions of such uplifts are recycled through the State tax system (chiefly by land tax). Meanwhile, if you absent-mindedly put your foot on a seat, or forget to validate your ticket, or miss your stop and consequently overtravel your zone, you’ll be hit with a fine of more than $200.*

The same logic applies to funding of schools. Real estate agents love to spruik the proximity of schools when talking up the price of the property. Yet the budget finds funding for only one new school – at Doreen South, where the local land owners will profit at your expense and mine.

The budget forecasts an 11.9% increase in land tax receipts, not from any increase in rates or lowering of thresholds, but from a tightening of the rules on companies and family trusts. In view of the continuing decline in home prices, which is really a decline in speculatively-inflated land prices, any increase in receipts must be regarded as optimistic. If speculative bubbles are to be prevented, and if infrastructure such as transport and schools is to be adequately and equitably funded, then land tax – or some alternative mechanism for capturing uplifts in land values – must become the mainstay of State budgets.

The Government says that from mid 2014, it will save business $715 million a year by cutting red tape. Getting rid of the job-destroying and arguably unconstitutional payroll tax would surely help on that front.

The building industry, reeling from the long decline in new home sales, has been shoved under a bus with the abolition of the First Home Bonus, a State-funded supplement to the First Home Owners’ Grant.

Up to the end of 2006, the Bonus made no distinction between new and established homes. From January 2007 to June 2009, it was $5000 for a new home and $3000 for an established home. In 2009-10, it was $11,000 and $2000 respectively. Since then, it’s been $13,000 for new homes only. Had it been that way from the beginning, it might have slowed the growth of the price bubble. After 30 June it will disappear altogether, along with the Regional Bonus (currently worth an extra $6500). Instead, first home buyers are to receive a stamp-duty discount of 20%, rising to 30% after one year and eventually to 50%.

If the abolition of the Bonus is meant to prop up home prices by squeezing supply, it will fail. If it is meant to prop up rents at the expense of the poor, it will succeed. The supply-demand argument is more immediately applicable to rents than to prices. While prices cannot decouple from rents indefinitely, they can do so for years at a time, following a momentum of their own. For almost two years the momentum has been downward. When the market showed a similar downward momentum in late 2008, it took 425 points of interest-rate cuts plus the First Home Owners’ Boost to turn it around. A piecemeal cut in stamp duty and a further slowdown in construction are not in the same league.

Nevertheless, Mr Wells somehow reckons that a recovery in the housing market will raise stamp duty receipts by 4.9% (what? — 4.9% rather than 4.8% or 5.0%?), in spite of the end of the Bonus. Similarly unrealistic is the unemployment forecast, which has been raised from 5.5% to 5.75%, although the current rate is 5.8% and the State is probably in recession as I write.

Then come the unoriginal tricks, such as instructing departments to find another $180 million in savings (delegate it!), laying off 4200 public servants instead of the initially planned 3600 (out of 36,000), and extracting about $700 million in additional “dividends” from WorkCover, water authorities, and the State Electricity Commission.

Some downward trends are acknowledged, however inadequately. The expected surplus for the current year has been revised down to $126 million from $148 million. The $155 million surplus for 2012-13 is less than the $220 million predicted six months ago. Revenue from GST has been written down by $1.6 billion for 2012-13. Revenue from State taxes has been written down by $827 million for 2012-13 and by more than $3 billion over four years. Since late 2010, total revenue for the next four years has been written down by $8.3 billion.

Will Mr Wells hit his surplus target? Considering the housing market and its effect on stamp-duty receipts, the labour market and its effect on payroll-tax receipts, and the heavy reliance of State governments on these two ridiculous taxes, I think not.

__________

* At the time of writing, only “estimates” had been reported in the media. However, the “penalty unit” is to rise from $125 to $140.

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1 May 2012

• ABS House Price Index -4.5% YOY

• RBA interest rate cut -0.5%

The solid new trend of falling house prices is confirmed by the ABS today with real prices now in retreat for seven quarters and the downward path accelerating. Property markets operate on a very long cycle. Once broad trends are established, they continue, says Prosper Australia.

Today’s ABS House Price Index 6216.0 is a lagging measure, but fresher statistics like building approvals, housing finance and auction clearance rates have been consistently weak for 12 months or longer and show no change to conditions.

“There is a seller strike and a buyer strike,” Prosper Australia Campaign Manager David Collyer said today.

“We are seeing a house price ‘slow melt’ as sellers hold out for peak prices while buyer indifference means few properties are sold.

The stand-off is now nearly two years old.

“Arguments today’s -0.5 per cent interest rate cut by the Reserve Bank of Australia will raise house prices have no basis in fact.

“I say, the strike will end in seller capitulation. After all, buyers do not have to commit, while the need for owners to reposition their balance sheets simply becomes more and more urgent.

The Negative Gearers are approaching exhaustion. Their strategy requires strong capital gains and makes galloping losses in a steady or declining market. For how long will they be content to subsidize the renter of their investment property?

Baby Boomers downsizing cannot hold out either – retirement looms. For many, current prices are so utterly divorced from what they paid that a few per cent less now will not make much difference to their giant gains.

Either seller group is capable of blocking the exits and tipping the price falls into a steep decline. For both, the first-mover advantage to meeting buyers in a falling market are profound. They get the best price, the flexibility of cash and they sterilize risk.

“Prosper repeats and restates its price projection of a 15 per cent price fall this calendar year, with a 20 per cent fall entirely possible,” Collyer concluded.

“Don’t Buy Now!”

Media contact: David Collyer david.collyer@prosper.org.au

About Prosper: Prosper Australia is a tax reform lobby group and think tank that is now 120 years old. It seeks to move the base of government revenues from taxing individuals and enterprise to capturing the economic rents of the natural endowment, notably through Land Value Tax and Mining Tax.

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Bryan Kavanagh blogs at thedepression.org.au His latest tirade nails rentiers and land speculators.

Many attempts to analyse the cause of the GFC contain more than a grain of truth. The vast majority, however, provide no useful hint to a remedy. As the process is structural and extremely repetitive, a cure needs to be found.

Banks did, indeed, extend excessive credit for the purchase of residential real estate without due regard for the bubble developing in the background. Where was their credit management during this time?

Whether the failure of banks merits bailouts from public funds warrants far greater debate than has occurred internationally.

Who makes the decisions that people have to be further fleeced in order to retain public trust and confidence in an errant banking system? Would not private takeovers following due diligence investigation be more orderly and appropriate? Why exactly are banks different when they fail?

And, yes, the world’s reserve banks were also at fault in their poor monitoring of bank exposure to the gigantic bubble in land prices.

When Federal Reserve governor Edward M Gramlich urged examiners to investigate mortgage lending in 2000, it was Alan Greenspan chairman of the Fed who personally intervened to thwart the initiative. In 2001 US Treasury official Sheila C Bair met with the same lack of success in having subprime lenders either adopt, or adhere to, a code of best practice.

But the failure of banks and their overseers simply aided a pathological process that was long before underway. It remains largely unrecognised and is based upon mistruths about revenue sources.

In days of yore we captured a far greater proportion of the economic rent of land for revenue, whether in the fifteenth century and first quarter of the sixteenth (when the English labourer with a family of five still retained two-thirds of his wage after food clothing and rent) or before the US turned to income tax as a ‘temporary’ measure at WWI. (It was not until WWII that the Australian federal government also assumed the income taxing power from the states.)

In Unlocking the Riches of Oz: A case study of the social and economic costs of real estate bubbles 1972 to 2006, I mentioned the more recent decline of property-based revenues as a proportion of all taxation. It became a worldwide fashion arising from mistruths about land ‘taxes’ (more correctly called the economic rent of land).

The Henry Review of Australia’s taxation system certainly did not capture the public’s imagination when it was released in May of 2010. Its recommendation to establish an all-in federal land tax to replace poorly-applied state land taxes was greeted with dismay in some quarters, not the least of them politicians in the major parties—and even from the public, notwithstanding recommendation also to abolish a vast number of less-efficient taxes.

Public distrust of land-based revenues underestimates their advantages and has been carefully founded upon two misrepresentations which would do Joseph Goebbels proud:

* Land-based revenues are unfair, and
* The land tax base is insufficient to raise any worthwhile amount of revenue

Land-based revenues are unfair

The first of these two charges emanates from the property industry and a print media beholden to real estate advertising. Accordingly, it is undeniable that articles warning of the likely outcome of the giant real estate bubble we experienced from the outset of the new century were subordinated to soothing pieces about the benefits of home ownership: also advice to young couples and investors that they might miss out if they didn’t get into the market right now.

The few articles pointing to the existence of a bubble that did make it through were often subject of ‘concern’ by real estate industry leaders. These worthies were not noted for having ever called a real estate bubble before it had burst.

The press and mainstream media in general have accordingly aided and abetted the idea that the right to real estate should come with no greater strings than local council rates.

In the latter connection I’m reminded of my late father-in-law who, more often than not, used to trot down to the municipal offices to complain about his rates. When council justified its valuations, he’d occasionally take the discussion of how he was paying too much up with me. “Did you ever go into the ATO to complain about the far greater amounts of income tax you used to pay?” I once inquired of him. “Don’t be stupid. You can’t do that”, he exploded.

On the other hand, fortunately most of the textbooks in economics do show land-based revenues to be the fairest revenue base. This is because it can be shown they are not arbitrary taxes, they are technically rents in nature and can’t therefore be passed on in prices like other taxes.

John Locke (1632 – 1704) wisely said “It is in vain in a country whose great fund is land to hope to lay the publik charge on anything else; there at last it will terminate.”

Today, we ignore this injunction to our great social and economic distress. The deadweight of taxation cascades everywhere throughout our prices and via an incredibly cumbersome tax administration, sending prices soaring and making manufacturing uncompetitive overseas. It is all this deadweight, not simply our labour costs as claimed render us uncompetitive.

So, the public capture of the economic rent of our land does not act detrimentally on the economy, and economic papers on ATCOR (all taxes come out of rent) and EBOR (excess burdens come out of rent) are unfortunately too few and far between.

In Roosevelt Institute Working Paper No. 6 Principles and Guidelines for Deficit Reduction, Joseph Stiglitz concluded: “One of the general principles of taxation is that one should tax factors that are inelastic in supply, since there are no adverse supply side effects. Land does not disappear when it is taxed. Henry George, a great progressive of the late nineteenth century, argued, partly on this basis, for a land tax. It is ironic that rather than following this dictum, the United States has been doing just the opposite through its preferential treatment of capital gains.

But it is not just land that faces a low elasticity of supply. It is the case for other depletable natural resources. Subsidies might encourage the early discovery of some resource, but it does not increase the supply of the resource; that is largely a matter of nature. That is why it also makes sense, from an efficiency point of view, to tax natural resource rents at as close to 100% as possible.”

Thus endeth rebuttal of the property industry’s great lie.

The land tax base is insufficient to raise any worthwhile amount of revenue

Having demolished the claim of the real estate lobby concerning inefficiency and ineffectiveness of a land tax, neo-classical economics circulates a canard of its very own:-

“The percentage [of property rent in the economy] has dropped to well under one percent today”, New Ideas from Dead Economists: an introduction to modern economic thought, Todd G Buchholz, Plume, 2007, p.86.

“But by 2000 urban land rents represented only four percent of national income”, A Farewell to Alms, Gregory Clark, Princeton University Press, 2007, p.198.

“Rent is one percent of the US income in 2004”, Economics, Paul Krugman and Robin Wells, Worth Publishers, 2006, p.283.

“Rental income was 4.7 billion, or 0.079% of GDP in 1992”, Economics, Third Edition, Karl Case and Ray Fair, Prentice Hall, 1994, p.559.

“Rental income is $7.9 billion of a total GNP of $5,234 billion, or 1.5 percent” Economics: Principles and Policy, Fifth Edition, William J Baumol and Alan S Blinder, Harcourt Brace, 1991, p.137.

“… land rent forms such a small percentage of national income: that 2% is nothing compared to the present tax percentages which is around 30”, Income Distribution, Jan Pen, Pelican, 1974, p.210.

These claims are made to look silly by Mason Gaffney, Professor of Economics at the University of California (Riverside) who actually bothers to do the required research in The Hidden Taxable Capacity of Land” [The International Journal of Social Economics, 36(4)], instead of plucking figures out of the air.

Similarly, in The Taxable Capacity of Australian Land and Resources (Australian Tax Forum, Volume 18 Number 1, 2003), following a painstaking time series analysis, Dr Terry Dwyer announces: “The ‘bottom line’ reinforces the overall conclusion from Table 4 that land-based tax revenues are indeed sufficient to allow the total abolition of company and personal income tax.”

Land rent only four percent of the economy? Less than one percent? Bah, humbug! Try thirty percent plus!

In the face of facts, the evidence that the GFC is the inevitable outcome of a pathological tax system fining labour and business whilst encouraging real estate bubbles becomes compelling.

The diagram below assists to explain the process: effective demand is being choked off by the wedge driven into GDP by increasing shares to taxation and private rent seeking which diminishes the returns to labour and capital.

The analysis is entirely consistent with the conclusions of The Henry Review.

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As the Fairfax papers reported on April 14, the NSW government has rejected yet another recommendation to replace conveyancing stamp duty by a broad-based land tax. That is the effect of the “stamp duty replacement tax” recommended on page 13-4 of the Lambert Report, delivered in September and quietly released in February.

It is often said that replacing stamp duty by land tax would discriminate against recent home buyers (who have recently incurred stamp duty). The remedy suggested by Lambert is to apply the land tax from the next sale of each property, so that current owners would not be affected. As Lambert himself acknowledges, this would cause a hiatus in revenue, because the flow of stamp duty would stop immediately, but the land tax revenue would build up slowly as properties entered the new system.

I was therefore unimpressed to read in the Daily Telegraph that the NSW government might allow first home buyers to pay their stamp duty over three years. That would cause a revenue gap (somewhat like Lambert’s transitional arrangement) without the efficiency gains of replacing stamp duty by land tax!

A more viable transitional arrangement would involve two steps. The first step is to replace the purchaser stamp duty by a vendor duty on the capital gain. This avoids discriminating against more recent buyers, because their capital gains (if any) are smaller. As a political sweetener, this step could be accompanied by the abolition of the existing, narrow-based land tax. The second step is to introduce the broad-based land tax as a pre-payment of the vendor duty. This would not cause any interruption of revenue. The pre-payment could be optional in politically sensitive cases (such as the “family home”), but compulsory in others.

Even the first step by itself would be an improvement on the status quo. It would improve the position of first home buyers relative to repeat buyers, because the former would no longer pay duty up front, while the latter’s capital gains would no longer be untaxed. The duty on the capital gain would not greatly discriminate against more frequent movers, whose capital gains would accumulate in larger numbers of smaller steps. And because each transfer of title would only realize, rather than create, a tax liability, the “lock-in” effect would be smaller than that of a duty on the transfer price.

Nevertheless, the record clearly indicates that governments will not give up the present stamp duty until they have no choice. Accordingly, I point out that the existing stamp duty is highly avoidable.

If you’re a home owner, you don’t have to pay stamp duty just because you move or “downsize”. If you let your old address to tenants, and rent your new address, there’s no change of ownership, so you pay no stamp duty, no conveyancing fees, and no agent’s commission. And if the interest on your old address exceeds the rent, you can start claiming “negative gearing”.

Yes, you might start paying land tax and rental management fees. But that’s all tax-deductible too — unlike the costs of selling your principal residence and buying another.

Yes, if you live away from your property for long enough, you’ll become liable for capital gains tax. But only if you actually make a capital gain! No such safeguard applies to stamp duty, conveyancing fees or agents’ commissions.

If everyone adopts this strategy for avoiding stamp duty, governments will be forced to find an alternative; but early adopters will save a fortune in the mean time.

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19 April 2012

Australia has experienced nine quarters of falling land sales volumes with the last five quarters flatlining forty per cent below long term averages. Current high land prices have no visible means of support and must fall, Prosper warns.

The data was released today by the Housing Industry Association, emphasising the recent shocking five quarter falls to bolster their case for large interest rate cuts, fiscal expansion and weak regulation.

“If the government took the HIA’s advice, it would prop up current prices and enforce the personal nightmare of committing 40 per cent of dual incomes to housing costs to merely get on the first rung of ownership,” Prosper Australia Campaign Manager David Collyer said today.

“We have all privately done our sums. Citizens see buying at current prices as financial suicide and banks will only lend to ideal customers because the prospects for repayment are so poor.

“Anyone who buys on those terms faces a lifetime of poverty or bankruptcy,” Collyer warned. “Debts that big are absolutely crippling.

“Don’t Buy Now!” Collyer concluded.

The HIA release and residential land sales volume data is here.

Media Contact: David Collyer david.collyer@prosper.org.au

About Prosper: Prosper Australia is a tax reform lobby group and think tank that is now 120 years old. It seeks to move the base of government revenues from taxing individuals and enterprise to capturing the economic rents of the natural endowment, notably through Land Value Tax and Mining Tax.

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Last month, I wrote about the staggering $2.4 billion losses by Lloyds Bank on their Australian real estate adventures and asked ‘Was Lloyds Bank the ONLY silly lender in Australia?’

Today, the Bank of Queensland posted their half-year report, showing losses of $91 million after providing $327m for bad and doubtful debts. They attributed this to “troublesome property loans”, saying:

“The Bank underwent a review of its commercial loans portfolio and provisioning approach increasing specific provisions for the period. The additional specific impairment expense that has arisen has been primarily due to the continued decline in commercial property prices in Queensland.

“Collective provisions increased significantly providing greater coverage for potential impairment expenses. This increase included $160 million in overlays created to cover the impact that the decline in property prices may have on loss given default ratios in the collective provisioning model.”

BoQ has $40 billion in assets, overwhelmingly real estate mortgages in Queensland, with similar lending in other states. The provision is for less than 1 per cent of assets and a far cry from the 50 per cent ‘haircut’ Lloyds took.

BoQ is currently raising an extra $450 million in capital to support their balance sheet as its share price languished just above decade lows. The discounted raising dilutes existing shareholders who ought be very angry.

Brisbane residential real estate prices fell a mere 6.9 per cent in the year to December 2011 (BoQ reported to 29 Feb ’12). Commercial land price falls have been much bigger as development projects are deferred indefinitely and the price of vacant land slashed.

Prosper forecasts major price falls beginning this year that dwarf the change so far. If BoQ writes big losses and needs capital due to falls so far, what shape will the bank be in when the big corrections start?

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The following is published from the University of New South Wales’ Australian School of Business website ‘Knowledge’ and Prosper acknowledges authorship.  Audio, PDF, Facebook, LinkedIn and Twitter feeds are available here.

Australia’s residential property market defied global trends by avoiding the collapses suffered by other countries during the global downturn. Insulated by a strong local economy, low unemployment, a growing population and government schemes that propped up the first homebuyers’ market, Australian house prices slipped only 3% in 2008 as the US and UK recorded double-digit slumps.

However, when it comes to looking at where Australian property prices are headed, opinion is diverse, ranging from gloomy pessimism to almost insane optimism. Meanwhile, Australian house prices have been steadily falling.

According to property information firm RP Data-Rismark, seasonally adjusted home prices dropped 4% in 2011 and are forecast to slide further despite two interest rate cuts late last year. Overall, distressed real estate listings for the country rose 30% in 2011.

Since the beginning of this year, auction clearance rates in Sydney have averaged about 55% – notably higher than the rates recorded at the end of 2011, when agents struggled to sell 50% of the properties being put to auction under the hammer – but nowhere near the high 60s and low 70s that were achieved in Sydney during times of past house price growth.

Will this recent downturn in the housing market continue? Or, is Australia effectively in the grip of a housing bubble that may burst at any moment? Bearish property analysts swear house prices need to drop 40% to return to their long-term levels and those of comparable countries. They suggest the property market would have collapsed in 2008 if it were not for first-time buyers being enticed to dive into the market by inflated government grants.

Yet, others dismiss the idea of a bubble as nonsense, claiming prices are more likely to flatline than crash. They see any major slump as unlikely given the strong economy and Australia’s “chronic” housing shortage. According to the National Housing Supply Council (NHSC), the estimated dwelling gap for June 2009 was 178,400 and was expected to increase by 72.6% to 308,000 by 2014.

Anti-bubble believers view softer house prices as an indication that people have simply quit speculating and are becoming more debt-averse.

Philip Soos, a researcher at Deakin University, is in the pro-crash camp. He notes that eight of the nine substantial property price increases over the last 131 years have resulted in a decline. That being the case, he can’t see why the largest increase on record would not precede another drop now. Soos does not buy the argument that Australia is suffering from a “chronic housing shortage”, saying property prices have continually experienced boom-bust cycles regardless of population growth levels. “Housing prices started to rise in 1996 and skyrocketed from 2001 onwards. Yet, 2007 was the first time since 1951 when population growth exceeded dwelling growth, so housing prices should have started to rise from 2007 onwards, not 1996,” Soos points out. Once a bubble bursts, he notes, a huge oversupply of housing is likely to emerge.

Soos argues the rapid rise in residential property prices cannot be explained by economic fundamentals, including the downturn in inflation and interest rates, which began in the late 1990s. “If lower inflation and interest rates were enough to cause a run-up in prices, the 1960s should have prompted an even greater level of household debt. Yet housing prices and rates were the lowest on record. Currently, while nominal rates have fallen by half, the amount of mortgage debt has more than quadrupled, indicating an excessive amount of debt.”

Lax lending standards and the fact that land is relatively untaxed have fuelled the run-up in prices, says Soos. “The obvious indicator of a bubble driven by speculation is a large gap between rent and home sales prices – which is the case almost everywhere in the West where property overvaluation has occurred, including Australia.”

Measure for Measure

Nigel Stapledon, an economist at the Australian School of Business, agrees with Soos on the overuse of the population growth argument, but he does not believe house prices have somehow disentangled from the fundamentals. He has another explanation for why there is such dissent over property.

Since the early 2000s, many economists have been using house price-to-rent ratios to gauge whether or not home prices are inflated or undervalued. The ratio compares house prices with rental indices. For the ratio to work, these indices should capture identical data. But they don’t.

Many house price indices use raw price data whereas the Australian Bureau of Statistics rental index adjusts for quality improvements made over time to a property. A house sales series with no adjustments for alterations and additions, which have boosted the size of dwellings over time, will tend to rise faster than a rent series.

The two indices are measured very differently resulting in a biased measure, says Stapledon. “If you don’t allow for the measurement issue, you get a dramatic upward trajectory in the price-to-rent ratio and people see a bubble,” he says, “Standardise the indices and that upward slope changes dramatically from an upward trend to a flatter trend, in Australia’s case.”

Stapledon has attempted to fix this “apples and oranges” problem by creating an index that uses a rental income series to match the house price series. Both series incorporate quality changes such as additions and alterations, thus removing the bias. While there’s a divergence between rents and prices, Stapledon reports the scenario is not as scary in 2012 as it appeared in 2003 when soaring prices had pushed the price-to-rent ratio into bubble territory and the market was vulnerable to a sharp correction.

A bubble implies prices are out of line with fundamentals. In Stapledon’s view, that initial rise in the price-to-rent ratio from 1996 was a lagged response to the earlier decline in interest rates. Stapledon’s analysis differs from Soos’. Stapledon thinks that after the pain of high interest rates in the 1980s, which soared to more than 17%, it took some time for borrowers to believe that rates would stay down. That’s why there was a reluctance to take on debt

Economists have never been very precise at predicting the timing and magnitude of corrections, notes Stapledon. Through the late 1990s, economists talked about a housing bubble – yet the market rose by 50%. Outstandingly, most US economists did not see their enormous housing bubble until it burst in front of them. But Stapledon insists many analysts in the “bubble” camp have not looked closely enough at the Australian situation. “The reasoning is if the US has a housing bust; then so too should Australia,” he says. “This reasoning fails to appreciate the very powerful influence of the resources boom. Australia is not alone in this. There has been no bust in Canada, which has also experienced a resources boom.”

Not Enough Information?

Soos is concerned there is too little data in the public domain, a view shared by Michael Sherris, a professor of Actuarial Studies at the Australian School of Business and chief investigator in the ARC Centre of Excellence in Population Ageing Research (CEPAR). Furthermore, the publicly available data can be hard to follow.”It is very important that we have better data and that indexes are reliable,” says Sherris.

One problem is that indices for the broader market do not provide information for an individual house relative to others, leaving homeowners without insights on the market value of one of their biggest assets. For example, the sale price of a two-bedroom house with a garage in one area cannot be extrapolated to another house in a different area in a consistent and reliable manner based only on market indices.

“We need better more refined publicly available indices to understand what’s going on in the residential property market allowing for how house prices vary according to their characteristics,” says Sherris.

While privately collected and analysed data might eventually be dispersed to private customers such as banks, the public remains largely unable to access the analytics around individual house price characteristics and risks, which means the available data – regardless of how well it is analysed – is less than helpful.

RP Data-Rismark’s Ben Skilbeck says his firm overcomes the problem by using ‘hedonic’ methodology, which takes into account the characteristics of homes bought and sold. Typically, this includes the number and size of rooms, the number of bathrooms and how far the residence is from a major road and schools, along with special features such as swimming pools and tennis courts.The hedonic model uses such variables to understand their relative value contribution to a property. Once this is understood, changes in the composition of houses selling in one period relative to another are controlled, enabling the underlying market movement to be determined.

The firm tracks the rental market in a similar way. This eliminates the “apples and oranges” problem that exists for many reported rental yield numbers, claims Skilbeck. Median advertised rents are commonly divided by the median house sale prices to quote rental yields, he says, which leads to inappropriate conclusions because the rental houses are often very different to the properties sold.

Spot the Difference

The problem with using a median price to calculate a housing price index is that the composition of houses sold in one quarter may differ to those sold in another, indicates Skilbeck. “Suppose that over a particular period, there were more sales of larger houses in more affluent suburbs. Simply looking at the sale prices would give an inflated view of market movements. Conversely, if in the next period there were more sales of smaller houses in less affluent suburbs, looking at only the sale prices would lead us to believe market returns were lower than reality.”

Skilbeck points to the increased activity in the property market in early 2009 when the federal government doubled the first homeowners’ grant and state governments provided various first home buyers with stamp duty concessions and grants. At the same time, the central bank, the Reserve Bank of Australia, slashed official interest rates by nearly 4% between September 2008 and April 2009 from 7% to 3.75%. The disproportionate number of lower-end properties selling during that period artificially dragged the median house price downwards when in reality the market was responding strongly to the economic stimulus. When the grants were phased out and first homeowner activity decreased dramatically, the median indices showed the market was rising because fewer lower-end first homeowner properties and more higher-end properties were transacting, but the market was actually pulling back. “Our indices showed the true state of the market, whereas the figures from the Australian Bureau of Statistics simply showed a change in the composition of the type of houses being bought and sold,” says Skilbeck.

Trying to gauge the sales price of houses based on bedrooms, swimming pools, views and other commonly valued characteristics is not easy.

Louis Christopher, head of Sydney-based property research and advisory company, SQM Research, warns of inherent weaknesses in a model that tries to measure house price movements by taking into account quality differentials between various homes. “Overall, it is a good theory, but in practice it still has its flaws,” he says. For a hedonic index to work, it needs a vast amount of data on individual properties.” The index does not look at all housing features such as the slope or the shape of the land, renovations or improvements, which are major contributors to value, as Stapledon’s research shows.

Valuing a portfolio of assets, which are all different and most of which do not trade in any period, is a complex problem. “No method can exactly estimate the true value of every property. Even professional valuers can’t do it,” concludes Skilbeck.

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