The price of anything, whether it is a cake of soap or a jumbo jet, is meant to convey a whole bunch of information to an investor, producer or consumer. Prices send signals up and down the supply chain and these signals determine the ultimate supply and demand of any product or service.
If prices are meant to be the signal that helps smooth the supply and demand of a product or asset, just what is going on with the Australian property market?
Recently released data reveal that new home sales fell for a second straight month in June to a 17-month low. This was followed by news that new home approvals fell by 3.3 percent in June, the third successive monthly drop.
How can this be? We are constantly told that Australia has a chronic housing shortage, yet we are not building anywhere near enough new homes to satisfy this supposed demand.
Shouldn’t high prices be sending a message that more housing is required? It should, but the fact that it isn’t goes to show the completely dysfunctional state of housing in this country.
Here’s the way I look at it. House prices are high not because rents are high and the income returns are healthy. They are high because the vast majority of new credit creation in our economy goes to people buying existing homes. Australian people and its banks are participating in a giant ponzi scheme and they don’t even know it.
High house prices and low rental yields (the reality for most capital city property) are not a signal for investors to come in and construct new homes. It is a deterrent. Who wants to risk building a new house and renting it out for less than the cost of finance, when the capital value is at risk from the ponzi scheme ending?
If yields were more attractive, Australia would solve its so-called housing shortage. But it’s not that easy. You also have layers of government involved, which add to the distortion.
Local and State governments enjoy a healthy slice of the housing pie, which adds to the final cost. The Federal Government uses taxpayer funds to give to first homebuyers whenever the market looks shaky, which ironically adds much more to the cost. The recent phasing out of the latest government handouts is probably a major factor behind the construction slowdown.
All we ever hear month after month is that Australia has a chronic housing shortage and because of this, house prices will remain high. I’m sorry, but if new homes sales are approaching 18 month lows, and construction remains in the doldrums, perhaps its time to think a little differently about the problem. Commentators and bureaucrats need to realise that it’s the huge amount of credit being funnelled into existing housing that is pushing prices up and leading to weaker construction statistics.
I’d be willing to bet a waterfront mansion (if I had one) that if house prices began to fall substantially, yields would increase and so would the incentive to build new houses. For centuries property has been an income-based investment. Only relatively recently has it become the focus for capital gains. Increase the yield to healthy levels and you increase the supply of housing, it’s as simple as that.
So it’s time for the government to get out of the market, stop propping up prices for the sake of political gain and start releasing enough land to satisfy the demand that will flow from weaker prices.
The chances of this happening are virtually zero, but we need to stop kidding ourselves that our housing shortage is keeping prices high. It’s high prices that are leading to the shortage, if indeed there is one.
for The Daily Reckoning Australia