For today?s article, we will continue from our previous 2 articles: Australian property good investment??Part 1: how money printing distort the property market and Australian property good investment? Part 2?Rental & affordability crisis.

These days, we often get to hear about the looming social crisis caused by housing un-affordability and rental crisis. From the news media, we get to see articles like Is the great Australian dream out of reach? and Rents continue to rise, but no relief is in sight. These issues are most likely going to be hot topics in this election year, with politicians and special interest groups arguing, blaming each other and giving their own versions of the causes and solutions to this problem. Make no mistake about this: the root of all these issues are caused by monetary inflation (see How to secretly rob the people with monetary inflation?), which will eventually spill over to price inflation in due time.

No doubt, there are some people who are thinking of ?investing? into property. Is that a good investment decision? Of course, for truly sophisticated property investors with the knowledge, skill and experience, it is possible to profit regardless of the timing and state of the property market. But for the purpose of today?s article, we will talk about property ?investments? from the context of the mum and dads investors.

First, how do property ?investors? profit from their property ?investments?? There are two perceived sources of profit?capital appreciation (i.e. buy low, sell high or buy high, sell higher) and net rental income. Today, we will examine the former.

What drives capital appreciation of property? Traditionally, it is the rising income levels that drive property prices upwards over the years. Naturally, as people?s general income level increases, the prices paid for property will increase as well. Recently, we have another phenomena that drive property prices upwards?the sudden availability of easy credit and low interest rates, which are manifestations of monetary inflation (?printing? of money). The result is a short-term property price bubble, which is currently deflating slowly. Japan, on the other hand, had their property price bubble burst, which led to a long painful recession and continuous deflation of property prices for around 17 years.

In Australia?s case, what are the prospects of capital appreciation? As we said before in Australian property good investment? Part 2?Rental & affordability crisis:

Eventually, the ever increasing amount of debt required to finance a price bubble will result in a debt burden so heavy that no more additional borrowings can be made. As such, the price inflation will sooner or later be halted.

The current housing affordability and rental crisis is a sign that at the current level of income, the strain of debt burden is too heavy to support higher property prices. Until income levels catch up with current property price levels, we will not see income as a driver for property prices. How likely is income going to fulfil this role? Remember, we are currently at the turning point of the business cycle (see Where are we in the business cycle?). Any accelerating economic ?growth? will lead to price inflation (see Pitfalls for businesses in ?accelerating? economy). Given that the Reserve Bank of Australia (RBA)?s mandate is to control price inflation, it will step in to raise interest rates the moment it sees threats of price inflation in the horizon. A rise in income levels without the accompanying real economic growth is highly inflationary in nature.

If current income levels cannot drive property prices upward, then this leaves the availability of credit as the next candidate. In other worse, why not loosen credit standards so that more people can borrow more money? Indeed, this is what happened in the US and the results are ugly (see How did the US sub-prime lenders get into trouble?). Well, if the Australian economy becomes a runaway credit machine running, we can be sure the RBA will be very keen to force feed more bitter medicines into the economy. But what happens if credit standards get tightened instead? When that happens, less people can borrow less money, which means it is harder for property prices to rise further. Anecdotally, our personal experience tells us that credit standards seem to be tightening across all board.

The next thing to consider is price inflation. Suppose headline price inflation is swelling in the absence of wage increases. This means that the debt repayment burden is going to rise, which means that the affordability of property is going to fall. Furthermore, with rising expected price inflation, people are going to perceive that their housing stress is going to increase. At the same time, the RBA may be pressured to raise interest rates (see Price inflation expectation will pressure RBA to raise interest rates). Either way, price inflation is a threat against property prices rising.

Next, there is always the threat of debt-driven asset price deflation caused by an external economic shock. See Can Australia?s deflating property bubble deflate even further?.

Thus, for those who are hoping profit from their property ?investment? via capital appreciation, be prepared to be disappointed.

At this point in time, rental vacancies rate in Australia are at record lows (see Rental vacancies lowest on record). One finance commentator commented that it is so low that it should be considered a ?rental crisis.? He believes that this can only mean one thing?rents and property price are going to increase. As such, some investors are returning to the property market.

For us, we have some reservations on the merits of property as investment. Granted, you may not lose money if you invest in property today, but we doubt it is the best place for wealth. Furthermore, property investments are not as risk free as some may assume, as we said before in Those who have knowledge don?t predict. Those who predict, don?t have knowledge:

To give you an example, we recently heard this assumption, which was manifested in the form of an advice: ?Don?t worry about investing in property. They will never go down in value in the long run.? Try telling that to the Japanese in the early 1990s when their property bubble crashed?those who bought and held out at the top had to wait for decades to recoup their loss.

We will start on a series on the topic of: Are Australian property good investment? Today, we will examine the origins of this rental crisis. Only with a proper understand of it can we then evaluate the merits of property as investments in this current investment climate.

First, what caused the existence of a property bubble (especially in Sydney) in the first place? For the answer to this question, we suggest that you read our earlier article, The Bubble Economy. In short, the property bubble is the result of monetary inflation (aka ?printing? of money) and not due to a sudden and disproportionate increase in ?demand? for housing. To fully understand what monetary inflation is, we recommend that you read this article, Cause of inflation: Shanghai bubble case study. The property bubble in Shanghai is even far worse than Sydney?it defies all rudiments of proportion, common sense and prudence.

Next, how did monetary inflation distorts the property market? As we said before in Wasteful investment not the cause of housing un-affordability,

When money was too cheap [that is a manifestation of monetary inflation], it artificially induced a boom in demand for housing. Builders, upon seeing the rise in price as a result of the artificial boom, rushed to construct more homes than what was really required by the underlying demand. As a result, wasteful investments were made by the housing industry.

How does this work? First, let us examine the concept of inflation from our previous article, Cause of inflation: Shanghai bubble case study:

Consider the case of a fixed money supply. Whenever people increase their demand for some goods and services, money will be allocated toward other goods. Thus, the prices of some goods will increase?i.e., more money will be spent on them?while the prices of other goods will fall?i.e., less money will be spent on them.

Let?s say you are a builder and you see that house prices have been increasing rapidly. What would be your conclusion? You will surely conclude that there is an increase in demand for houses. If the money supply is fixed, then it means that this increase in demand for houses imply a decrease in demand for some other things in the economy. Therefore, the price of a good is a signal to producers that there?s a shortage or glut of that good. In a free market economy, this will divert resources from the production of things in glut to the things in shortage. Now, what happens if the money supply is not fixed i.e. money is printed and fed into the economy? As we discussed before in How to secretly rob the people with monetary inflation?, this implies that there is more money chasing the same amount of goods. The extra newly printed money has to go somewhere and in this case, goes to house price. A question to ask: Are there any changes in the economy that necessitate such an exaggerated increase in demand for houses beyond its fundamentals?

As you can see by now, easy money (i.e. monetary inflation aka ?printing? of money) distort the price signals in the economy and misallocate resources in the economy that would not have happened in a truly free market economy.

However, some may say that the current building bust is due to factors like land scarcity, lagging infrastructure and so on. For their argument, we have a counter-argument. Their argument further validate the Austrian School?s concept of mal-investments (see our article, The first step in an economic slowdown?mal-investment in capital). Capital (which is an Austrian concept that has different meaning) has structure. Ludwig von Mises, said it nicely:

It is customary to describe the boom as overinvestment. However, additional investment is only possible to the extent that there is an additional supply of capital goods available. As, apart from forced saving, the boom itself does not result in a restriction but rather in an increase in consumption, it does not procure more capital goods for new investment. The essence of the credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment. The entrepreneurs employ the available supply of r + p1 + p2 as if they were in a position to employ a supply of r + p1 + p2 + p3 + p4. They embark upon an expansion of investment on a scale for which the capital goods available do not suffice. Their projects are unrealizable on account of the insufficient supply of capital goods. They must fail sooner or later. The unavoidable end of the credit expansion makes the faults committed visible.

The additional investments by builders into building houses can only be completed if you have complementary capital (e.g. land, infrastructure, equipment, labour, etc) already invested. Because monetary inflation distorts the price signals to the builders, they engage in an investment boom that will be doomed to failure because these complementary capitals did not suffice. For example, as you can see, land gets more and more expensive. Infrastructures are non-existent. There are labour shortages. If the price signals to builders were not distorted in the first place, then those booms of building activity would not have gone so fast as to outstrip the shortage of complementary capital.

In the next article of this series, we will examine how this distortion leads to this current rental crisis. Keep in tune!