Who is really benefiting from the property cycle, and at what cost?

Take a cursory look through the international press and reports on housing related matters, and it could be merged it into one text as property cycles become increasingly interrelated and investors search for ‘safe havens’ off-shore.

Overwhelmingly, affordability, bubbles, the rise of Asian investors, and fears of a new breed of non-home owning ‘renters’ dominates, and although headline chasing would place any sensationalist report front of line, the reader comments and related dialogue that follow present a familiar picture for the ordinary home buyer – no matter what reforms are taken, it never seems to get any easier. 

You could be forgiven in thinking it’s by some abject force of nature, bustled in at the time of the ‘big bang’ that property (or as I pointed out here, ‘land’) is deemed unaffordable. Outpacing wage growth and inflation through the course of a cycle, subject to the whims of a bank’s propensity to lend - burdening buyers with one of the most stressful experiences they’ll go through in life. 

Or in the bleak words of the eminent poet Leonard Cohen:

“Everybody knows… That’s just the way it goes.”

This is what the real estate and finance industry would have you believe as they navigate through the fluctuations of the property cycle with authoritative analysis, on what and where to buy.  And no doubt, it’s been a prosperous affair.

The number of property investment books written by the ‘I Did It - And You Can Too!’ experts, belies belief. And yet, becoming successful in the game isn’t incredibly hard for anyone with an ounce of locational common sense. The authors are simply singing their own interpretation of an age-old song titled ‘Monopoly’. 

Over the course of a business cycle, which is both lead by, and correlated to the housing cycle, the gains – more correctly termed economic rent or “earnings from land,” alone - by far and away surpass those that can be gleaned from other more productive investments.

This was stressed in a recent submission by Earthshare Australia to the upcoming Senate enquiry into housing affordability:

“Unearned incomes in land increased a whopping $187 billion in the December 2013 quarter alone (ABS 6416). Total yearly dividends (2013), for investors engaged in risk, was recently reported at $84 billion – $103 billion less for an entire year.

(Leading them to question) “Why invest in small business or the ASX when one can earn more for less risk at a lower tax rate as a land speculator?”

These gains occur primarily because we choose to leave the larger proportion of ‘economic rent’ (mistakenly termed, ‘capital growth’ – however in this context, we are talking about the unimproved value of the site) locked in the land, rather than recycled back into community – from where it evolved.

Hence why housing is so expensive – the financial benefit derived from improving the surrounding facilities, is not effectively utilised – and our tax and supply policies do little to assist.

The Henry Tax review was not slow to point this out, when it suggested progressively scrapping a vast array of ‘bad taxes’ (payroll, insurance, vehicle registration, stamp duty, and forth, as well as reducing those that reward speculation) and instead, collecting more of the economic rent of natural resources - significantly land. (Notwithstanding, it was another government review which fell largely on deaf ears.)

Yet, historically, the capture of economic rent (through land tax and to some extent ‘betterment’ taxes) financed some of the most remarkable infrastructure we have. Sydney Harbour Bridge being a case in point.

The tale of a bridge and our accumulated wealth

It was acknowledged at the time, that residents on the north shore would benefit significantly from an increase in their property values as a result of this essential piece of infrastructure.  Therefore, a framework was set in place to capture a proportion of the uplift – approximately one third – to assist with funding. 

This was in no way detrimental to the property owners. 

The increased advantage of economic activity coupled with the rise in prices resulting from the enterprise, more than compensated. A win-win if you like – and readily accepted by the public as fair.

Over time, changes in the way both state and federal government collected tax moved focus away from land values, onto productivity, effectively, placing a fine on labour and doing a good job of keeping us asset rich and income poor.

It’s great for the haves – but not the ‘have-nots’ (our growing pool of tenants.)

Consequently, the wealth locked in our residential land market, through the process of this accrued speculation – sits at post $4 trillion (add the buildings on top, and it’s an estimated $5.02 trillion).

It’s so large a number; it’s almost meaningless in real terms.

In comparison, the UK housing market is assessed to be $5.2 trillion with a population of around 60 million, so the distribution across a population of 23 million, is telling.

It’s this, that enables publications, such as the Global Wealth Report produced annually by Credit Suisse, to assess Australian’s to be the ‘richest in the world’ in median terms. 

In other words – if you stand everyone in a long line, richest to poorest, the middleman has more asset wealth than any other country assessed.

It should therefore come as no surprise that our wealthy know where to bank their dollars - and it’s not down the high street.

As economist Adair Turner and others have pointed out in response to a recent report by Oxfam, which demonstrates how Britain’s five richest families are wealthier than the poorest 20% of the population.  The riches are only in part derived through productive activity – the vast ‘wealth’ however, has been derived through ‘rents’ (unearned gains) in land.

If you thought wars were about religion – think again.

The compounded rent is effectively what we pay for when acquiring real estate – a calculation that takes into account expectations of future growth, minus expenses for the time held – along with a range of other variables such as wages and borrowing rates.

Yet capturing a greater percentage of annual land values, whilst at the same time reducing those on productivity holds much in its favour.

• It reduces the propensity of boom/bust housing cycles.
  
  
• Encourages timely construction and effective utilisation (good for both the economy, employment and consequently, our welfare state).
  
  
• Aids infrastructure financing.
  
  
• Supports decentralisation.
  
  
• Assists in keeping the cost of shelter affordable – levelling to some degree, the playing field between non-owners and owners.
  
  
• And importantly, in regions where it’s been implemented with success - Pittsburgh and Pennsylvania being examples - most owners pay less tax when there’s a shift from productivity onto land, than would be the case otherwise.

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Change ahead?

Of course, to change the mindset of any nation that has been encouraged to use their housing investments as leverage for economic activity, a welfare fund for retirement, collateral for the advancement of business and commerce, and an ATM for family emergencies, is no easy task. 

Not to mention the many vested interests in both government and the property industry, all of which derive their income from the promotion of it.

However, it’s vitally important we do so – because it sits at the very base of everyconversation government is current having regarding the welfare state, cutting pensions, and increasing the working age until retirement.

Even in our technological age of driverless cars, lasers that can change the weather, 3D printers that can produce substitute body parts, and solar farms that can produce enough energy to run a small city, nothing is possible without the land which gives us the food we eat, the water we drink, the air we breathe, and a rich array of commodities to fuel our appetite for ‘growth.’

There is nothing to be gleaned in from the hording of land, and whilst secure private tenure of property is vital in so much as land needs to be cared for, cultivated, and effectively utilised, a proportion of unearned economic gains that come from the locational rent of the unimproved value alone – should not be privatised to the extent that prices escalate through the inducement of speculative gain.

Can supply policy solve it alone?

We talk a lot about supply, but whilst the status quo exists - rising land values being used as the primary driver for economic growth – high prices ensure land will only developed for profit, timed to capture the upward wave of a cycle, rather than developed to meet the immediate needs of a home buyer, which does little to deter the wasteful process of land banking.

It is not insignificant that the burdens to supply policy, which we consistently criticise – the structural impediments to development - were implemented along side a gradual shift of the rental capture of land, onto productivity.

As Bob Day asserts in his submission to the Senate debate on housing affordability:

“The regulatory seeds of the housing affordability crisis were sown in the 1970s. Until then land was abundant and affordable, and the development of new suburbs was largely left to the private sector.”

The 1970s was not only the point at which urban zoning (a process of false scarcity) was imposed by state governments – it also came at a time at which any hope of tax capturing the fair uplift in land values to keep construction timely and offset soaring costs, had been truly eroded.

This, coupled with a shift in infrastructure financing – as private enterprise played an ever-increasing role and projects were no longer provided with capacity ahead of time, but required to prove revenue – ‘user pays’ whilst home owner benefits – was the beginning of the end.  

A Glance Back At Policy

Early settlers had rejected the British system of taxing both land and buildings, in favour of the methods advocated by the classical economist Henry George, who had previously presented his ‘single tax' theory in Australia to thunderous success. 

However, over time, the government’s inept and poor administration in the regularity and standard of valuations, the creeping in of exemptions (including the family home) coupled with lobbying from large landholders - a group which have historically maintained the greatest political clout – significantly eroded the system, and by the 1950s an array of taxes were falling increasingly on productivity, rather than land. 

In 1953 when the Menzies government abolished the Federal Land Tax, rapid post war population growth had firmly laid the foundations for a thirst to profit through capital gain (mounting land values.

The then Labour party – which had historically always rallied in favour of raising revenue from the economic rent of land rather than productivity, were up in arms, prompting Arthur Calwell to speak in opposition of the plan, passionately declaring:

“We have always believed in the land tax…The land belongs to the people, and its use must be safeguarded and protected at all times!” (Hansard, Vol 221, pp 165-170 passim)

However, it was the beginning of the end. Up until 1961 it was an integral part of the Labour platform. By 1963 however, the commitment had been omitted all together, apparently, without conference approval.

When Whitlam came to power in 1972 (see Bob Day’s comment above) he ignored any call to bring in legislation to collect the economic rent of land, instead of levying heavy direct and indirect taxes on income, and in so doing, a politically fabricated boom in land values was underway.

In the decades that followed, the promotion of negative gearing (1985), halving of the capital gains on investors (1999), onerous levies on development and upfront infrastructure costs passed onto buyers - grants, incentives and so forth, had little to do with the delivery of affordable housing, and everything to do with escalating land prices.

It should come as no surprise then, that large landowners and the commission side of the real estate industry, shy away from any changes to the tax system. The smoke screen debates on affordability and scrapping negative gearing are just that.

So what now?

Due to China-led resilience and economic stimulus Australia, although in no way unscathed, avoided the disastrous consequences of 2008, resulting in thousands of foreclosures across the US and Europe, whilst banks were bailed and families continue to be evicted.

Not so the recession that marked the early 1990s.  

Affecting 17 out of 18 comparable OECD countries, high unemployment, a large current account deficit and elevated level of foreign debt left many economists gloomy Australia would ever achieve long lasting economic recovery.

Endless debate was given to the causes and consequence, which left policy makers reassuring the community that lessons’, would be learnt! However, as the then Governor of the RBA, Ian McFarlane, later summed up in his 2006 Boyer lecture:

“Any boom built on rising asset prices financed by increased borrowing has to end.”

And considering the date this lecture was given (2006), the following comment was insightful:

“No-one though has a clear mandate at the moment to deal with the threat of major financial instability associated with an asset price boom and bust.”

It’s unfortunate that “no-one” happens to be our most influential political and economic policy makers – and indeed, we’re not alone. 

After every economic crisis, there is always the promise that events will never happen again – safe guards are put in place and eventually the wreckage is cleared. however happen they do, and reforms that promise otherwise repeatedly fail.

Significantly, globalisation, the interrelating of major economies, is adding to the volatile nature of each economic downturn.  As Wayne Swan asserted in his speech “A Future Of Promise” given at The Sydney institute in 2007:

“It is, truly, the sharpest synchronised global downturn in living memory… And it's being inflicted on good Australians through no fault of their own.”

No cycle is exactly the same, but while history may not exactly mirror the past, patterns do emerge. 

There’s only one reason we have devastating house price booms and busts –  and that is speculation induced, in this case, through the privatisation of unearned gains.  And whilst some continue to reap a windfall from exploiting the process, we really need to pause and ask – Who is it really benefitting?

It’s time for change.