Australian property good investment? Part 2?Rental & affordability crisis

April 24th, 2007

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Today, continuing from our previous article, Australian property good investment??Part 1: how money printing distort the property market, we will look at how the current rental crisis developed.

Let us assume that the housing property market was initially at a state of equilibrium i.e. demand met supply at a particular price. As it always happen, any injection of excess liquidity (i.e. ?printing? of money, which resulted in an increase in money and credit) will eventually cause a distortion to the economy?inflation of prices. The question is, which asset class (e.g. stocks, bonds) or ?things? (e.g. consumer prices, wages) will bear the brunt of price inflation? As it happened, thanks to the Howard government?s loophole on negative gearing and concessions on capital gains tax, that excess liquidity flowed on to houses, which resulted in a price bubble.

With such artificially induced excess demand for housing, the property market fell into disequilibrium. With such rampant availability of easy credit, the demand increased at a given price. In economic jargon, it means that the demand ?curve? had shifted to the right. The outcome was a ?shortage? of houses, which prompted property developers to increase production to meet the ?demand? shortfall. As we can easily see from hindsight, the economy was not structured to cope with such artificially induced demand. Builders soon faced problems of land scarcity, lagging infrastructure, soaring labour cost and so on. This is what the Austrian School calls mal-investment of capital (our previous article, Australian property good investment??Part 1: how money printing distort the property market will lead you to further explanations on the concept of mal-investment).

As common sense tells us, asset prices cannot rise forever and ever. 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. Next, came RBA?s interest rates rise, which forced many ?investors? into forced liquidation of their property ?investments? because the debt servicing burden of their ?investments? no longer make economic sense. Furthermore, if easy credit boosted demand artificially, what would happen if such easy credit got tightened? Well, easy come, easy goes.

To give you an appreciation how the reality meets this theory of ours, we will relate to you a real story. One of our friends was in the property development businesses during the boom years. Recently, he pulled out of this business as he found it harder and harder to make money as margins were squeezed to the point that his business was no longer profitable. As our above analysis had shown, with falling demand (which was artificially induced in the first place) and rising cost, margins will have to fall.

So, how does all these relate to the housing affordability and rental crisis? The former is easy to understand?easy money caused property prices to be so high that many people were priced out of the market. The latter is what we will concentrate on today. First, we will state the obvious?the current rental crisis tells us that the demand for rental properties is getting tight relative to its supply. From this, we will then look at the supply side followed by the demand side of the problem.

Now, let us look at the supply side of this issue. As we all know, the building industry is in a recession. As a result, from what we can learn from the mainstream media, not enough are being built to supply enough rental properties to a market with growing demand. As expected, the ?solution? that is often mentioned by them is to build more housing. The only way for this to happen is to entice ?investors? back in to the market, in the hope of revitalising the building industry through higher property prices, which will result in a restoration of ?healthy? profit margins. Obviously, guess who will benefit from this ?solution??

Now, let us look at the demand side of this issue. We can see the demand for rental properties in the market as a pool of rent seekers. Every year, there will be some people entering the pool and some leaving the pool. Those entering the pool may include young adults leaving home, people leaving shared accommodation, couples divorcing, newly arrived migrants and so on. Those leaving the pool may include people passing away, couples getting married and people leaving the rental market by buying their own property. Lately, the pool is getting bigger and bigger. Why? We suspect one of the major contributing factors is the housing affordability problem, especially for young people. Because housing is largely unaffordable to a large segment of society, it serves as an impediment for them to leave the rental market through the acquirement of their own property. If they cannot leave the rental pool, it can only lead the pool getting larger as more and more people enters the pool.

In view of all these, we doubt higher property prices and more ‘investments’ are the solutions to the current affordability and rental crisis. It will only exacerbate the problem for Australians in the long run. In the next article, we will evaluate on the merits of property investments. Keep in tune!