Securing a loan of the same size at a cheaper rate makes rental yields more attractive to investors, while lower rates increase the borrowing capacity of owner-occupiers to buy a larger home or outperform competitors for the house they want.
Time and time again, the Australian housing market has shown that lower interest rates are fuel for property prices. The current boom of the last six months is a prime example. Population growth has stalled since the COVID-19 pandemic, wages are stagnant, and yet house prices are breaking new records. The main explanation is the fall in the Reserve Bank’s cash rate to 0.1 percent last November.
There are good reasons for setting interest rates that have nothing to do with the housing market. The Reserve Bank cuts interest rates to boost employment and spending and increase inflation, not to boost property prices. It is also happening in a global context of ultra-low interest rates.
Some people argue that lower interest rates make housing more affordable because they make repayments lower. Now there are many home loan rates that start with a 2 and even a 1. However, Brendan Coates, director of the economic policy program at the Grattan Institute think tank, says that people who benefit the most from lower rates they are existing homeowners. As interest rates drop, your repayments get progressively cheaper, while your property values skyrocket.
For prospective buyers who are still saving for a deposit, interest rate cuts are putting home ownership out of reach. “It widens the gap between the homeless and the homeless,” says Coates.
Access to credit is also determined by the Australian Prudential Regulation Authority, which provides banks with a set of rules to follow when granting a loan. APRA has the power to slow the market in the short term, but Coates says the mechanism generally loses effectiveness over time as banks find ways around it and non-bank lenders meet unmet demand.
2. Population growth
The main factor that increases demand in the long term is population growth because it means that more people need a place to live. Last year, the national population grew 0.5 percent, mainly as a result of the natural increase. From the turn of the millennium until the start of the pandemic in March 2020, it grew by 1.5 to 2 percent annually, with Sydney and Melbourne taking a large share of that. Typically, most of the population growth comes from immigration, which stopped last year.
National immigration policy is determined by a large number of economic and social factors, not necessarily related to housing. Immigration has many benefits, from economic growth to greater cultural diversity. But there are tradeoffs too, such as increased demand for homes.
Peter Tulip, chief economist at the Center for Independent Studies, has studied the effect of immigration on house prices. He looked at the period from 2005 to 2018 when immigration accelerated from an annual intake of around 120,000 to almost 190,000 a year. He found that if this had not happened, rents would be 9% lower and this would affect purchase prices.
3. Planning controls
There is always a lag when supply catches up with demand, and planning controls can exacerbate it by limiting supply to meet that demand. In the context of Australian cities, this means restrictions on higher density.
Tulip believes that the main cause of housing unaffordability is that developers are unable to build high-rise apartments in most areas. “The main reason we have these planning restrictions is because local neighbors insist on preserving the character of the neighborhood and these arguments ignore the interest of the people who are not involved in the decision: potential buyers,” says Tulip. “But preserving the character of the neighborhood is actually worth very little to the neighborhood’s amenities.”
Tulip points to apartment developments in areas of Sydney like Forest Lodge near Glebe, Chatswood and Green Square. Despite community opposition, property prices have since risen in those areas, in line with neighboring suburbs where the apartments were not built. Tulip says this indicates that the apartment blocks did not diminish the amenities.
However, concerns about amenities include the issue of green space, something that is even more valuable to apartment dwellers than backyard owners and has come to the fore since the pandemic. Previous analysis by The Herald of the Sun has revealed that the inner city hall areas in Sydney that suffer the highest density are also those with the least amount of open public space per existing resident. Many schools are also straining on the seams with the removable ones that take up a lot of space on the playground.
Hartigan agrees that more density is needed, but says mega-apartment developments could backfire. “In fact, it could exacerbate the problem around NIMBYism because people walk past them and think ‘Oh my God, I don’t want my suburb to turn into that,'” he says. “Do we want to live in a city where we have 20 Hong Kong-style concentrated areas within cities, and then a bunch of local government areas with 1000-meter blocks, or do we want something that’s more balanced?” Hartigan says it would be more equitable if there were medium density in the city rather than high-density areas and low-density areas.
4. Fiscal policy
Australia’s tax policies favor investment in property over investment in other assets. Negative leverage means that an investor can write off investment losses against their income, making it fiscally effective. Technically, it can negatively mesh actions, but it is much more difficult. The reason is that it is the same as generating a business loss: you only pay taxes on the profits. The counterargument is that the losses are deliberate.
Negative leverage works hand in hand with the capital gains tax (CGT). Typically, investors would avoid a loss, but they make an exception because they are speculating on a capital gain a few years later. When they get that capital gain, they have to pay CGT on the increase in value. But for people who have had the asset for 12 months, the tax is cut in half. The rate is the same as the individual’s marginal tax rate, which means you can also schedule the sale for a lower income year.
Self-managed superfunds can also purchase negative property and equipment, although the capital gains tax discount is less.
Many economists believe that fiscal policy should be reformed to be more neutral, to encourage investment in a broader range of assets other than property. However, the impact on house prices would be small. Grattan’s research suggests that if negative leverage were abolished and the tax rebate on capital gains was reduced from 50 to 25 percent, property prices would be 2 percent lower. “Those tax concessions are only worth a few billion dollars a year in the context of the $ 7 trillion housing market,” says Coates.
The problem with policies like first-time homebuyer grants is that they are likely to increase demand and therefore drive prices higher.
5. Old pension
While fiscal policy increases the demand for housing as a financial asset, old-age pension eligibility rules discourage homeowners from selling. The family home is not counted in the age pension assets test, so someone in Dubbo with a $ 300,000 home receives the same treatment as someone in Balmain with a $ 3 million home.
Renters also fall short because they are only allowed an additional $ 214,500 in assets to make up for homelessness, though they can receive rental assistance.
This encourages retirees to stay in their big houses and even to expand or renovate if they need to reduce cash stocks. “A great motivation is passing the inheritance to your children,” says Coates.
That is perfectly rational and individuals are not to blame, but in an ideal world, pension policy would be neutral and would not penalize people for downsizing.
However, most experts believe that it would not have a great effect on house prices because retirees also stay at home for other reasons and not all retirees access the pension.
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