Stamp Duty Dilemma for Aussie States

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There is not a much of a lead to follow after Friday’s slightly downbeat day in New York trading. We’ll just have to make our own way then, won’t we?

Here’s something to think about: farm land. Granted, it has not exactly been a great year for managed investment schemes in the agricultural sector. But it’s not because the underlying assets-food, livestock, forests, fruit-are less valuable than expected. It’s because the structure of the schemes themselves was flawed.

There are two things to like about the idea of investing in farmland right now. First, with Timbercorp and Great Southern both going into administration, this is a hated asset class. You might be able to find some bargains (if you can find a business that makes both sense and money). The second reason is that Jim Rogers and George Soros are talking up farmland too.

The world’s population is expected to go from six billion to nine billion in the next forty years. Frankly, that sounds like way too many new mouths to feed. Arable land isn’t something you can buy down at the corner shops. But it is a fruitful world. And there is much multiplying.

So what’s the investment angle? “Land is scarce and will become scarcer as the world has to double food output to satisfy increased demand by 2050,” says Joachim von Braun in Fortune. He’s the director general at the International Food Policy Research Institute. “With limited land and water resources, this will automatically lead to increased valuations of productive land. And it goes hand in hand with water. Water scarcity will probably increase even more than land.”

Hmm. Well this could be a problem in Australia (the water). And of course, there is always the possibility that there is no way on God’s green earth the world can feed, clothe, fuel, and plasma-TV another three billion people. But it looks like we’re going to try!

By the way, we haven’t paid much attention to “Ute gate.” It looks like it’s just politicians doing what they always do: lying, cheating, and stealing when they think no one’s looking. Business as usual, isn’t it? But indirectly, you can notch another casualty up from the credit crisis.

That’s right. The whole thing started with car dealers struggling to find finance during the credit crunch. The government-in its infinite wisdom and generosity-set up a facility to match dealers with creditors. Strictly a middleman role, of course.

But had it not been for the credit crisis and the difficulty auto dealers are having buying cars on credit to stock the lots, we probably wouldn’t be looking at the possibility of resignations in Parliament today. But the more resignations the better, we say!

Meanwhile, in the housing market, the government is seeking new ways to keep the bubble from deflating. “Stamp duty on housing loans is set to be abolished after the Henry tax review, which is likely to recommend states be given a share of income tax to make up the difference,” reports today’s Australian.

Stamp duty is a cash cow for the States. And boy do they need the cash. The trouble-as they seem to be grokking now-is that if the housing market stops booming, a vital source of State revenue disappears just when the States are facing increasing liabilities AND borrowing costs. According to the Australian, “One of the world’s leading experts on federal taxes, Canada’s Richard Bird, said the states were heading for a financial crisis because they did not have a sufficient tax base to support their burgeoning health and education costs, which were all rising much faster than the consumer price index.”

This is the nexus of the demographic and credit crises. As populations age and get larger, the cost of generously promised government benefits goes up. If the government cuts one tax you can be sure it’s going to raise another. But you wonder if it’s ever occurred to anyone that it’s not a question of getting the right mix of taxes and excise, it’s a question of reducing unrealistic promises the government can’t keep without going deeply into debt or crushing economic growth with higher taxes.

Finally, a third party weighs in on Australia’s banking sector. Dow Jones newswires reported last week that, “Veteran banking analyst Brian Johnson has warned of more bloodletting in Australia’s banking sector. He recommends investors go underweight in banking stocks as loan defaults begin to climb.”

“Mr. Johnson, an analyst at CLSA, says that for the first time in 17 years, Australia is facing a loan loss cycle, where growth in bad debts outpaces growth in lending. In a markedly bearish 200-page report, Mr. Johnson has slapped price targets on the four major banks that are dramatically lower than their current trading levels. ‘Having largely avoided the pitfalls associated with securitization assets that have plagued global institutions, Australian banks are now facing their first loan-loss cycle since 1992,’ said Mr. Johnson.”

There’s nothing new in the analysis. There are still heaps of bad loans in commercial and residential real estate around the globe. Those loans don’t improve if people feel more confident about them. It’s an asset value problem. And it’s a debt problem. The debt households and businesses used to build up their assets now has to be wound down.

So let’s see…it’s still a balance sheet recession…politicians are still liars…you still can’t get something for nothing…and investors looking for bargains now should look at hated assets that are on the right side of long-term trends. Until tomorrow…

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Re Farm Investments: I observed many so called “Pitt Street farmers” when I was a child. The successful ones were always AT the farm when we visited (I usually eavesdropped on the veterinary // genetic // production advice being provided). I knew they were successful because they drove things like V12 Daimler Sovereigns and S Class Mercs . Coming down a peg, other successful farmers I have met just love their work and love to learn. I recall one pig farmer like this who previously flew an ME109 on the Eastern Front. Perhaps he applied the same discipline (and manouverability) to the farm as he did to survive his earlier profession. He was always a few steps ahead of his peers. The common elements here are high involvement and continued learning.

    Where does this leave the arms length investor seeking to preserve wealth in troubled times? Some exposure to large, successful pastoral companies (or the like) probably won’t hurt along with some shares in selected Ag product suppliers. Otherwise there is not enough money in it for the risk : unless of course you are willing to get your hands dirty.

    Stamp Duty: Hooray … but too late! Some local councils are corrupt. Some are just anti development. They all need to be trashed if the supply and demand curves for Aussie housing are ever going to work efficiently.

    Banks: Zero weight is better than underweight me thinks.

    Cheers to all!

    Coffee Addict
    June 22, 2009
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  2. CA: With you on the banks…you’d do well to convince me to buy a single share in the next few years.

    As for stamp duty…of course this is a big deal for the states. Rising real estate prices = higher stamp duty. In some states, they didn’t bother to change the thresholds for FHB stamp duty, even when the cheapest houses threatened to go above the FHB stamp duty threshold. And that was obviously because they were enjoying the money.

    Now my personal theory was that with all Labor state Gov’s and a Liberal Gov before last election, the state Gov’s were a bit harder done by the Liberal Gov when it came to money allocation.
    So if you were a stretched state Gov, wouldn’t you be happy that real estate was providing all this extra cash?

    Now…well, there’s the unwinding. Vic state Gov has declared its intentions by increasing its own FHOG significantly. Although i’m not quite sure how the sums work if the Gov is essentially substituting stamp duty revenue for FHOG subsidies. Doesn’t look like much of a gain there.

    So the next question(s) is: What will fill the gap?
    As Dan said, federal Gov funding. I think the states might get creative and raise all sorts of little land/home taxes.

    Where will the federal Gov get the extra money to pay the states?
    Well, that’s another story…and it’s not pretty

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  3. CA, that German tradition is born of the fact that Germans take everything technical seriously! The weekend garden is also as much a traditional thing as lederhosen and gluhwein and they sometimes combine the 3 even now, you see little family inherited garden plots alongside German railway tracks near most urban centres and when German professionals get a little money they get an adrenaline rush whereby most commercial fields close to cities just beyond the horse riding clubs etc are pitt st types. I also knew a WWII fighter pilot who had the dubious honor of being a decorated interceptor pilot in the ruhr as a kid in the dieing days of the war. He was known as “the fox” who used his Kreis (circle) & sanctum theory of management to run a global business.

    In Australia there was good money in pigs in the 70’s but it went away fast, there were far better tax schemes in the bottom of the harbour years than today and there were poplars for matchsticks on a 30 year cycle that were German emigre friends of mines favourites before Bic came along with their lighter and screwed that one too.

    I am into Ag and am beating consumer staples over the past year by a margin but am getting a little nervous on some of those corporate farming investments (non tax scheme) following the same line of reasoning that you mention in regards to the need for the investor to get down in the muck rather than run it at the whiteboard in front of the bankers.

    Land prices are still up even given the Tipperary debacle. Bankers push money at the sector until those onderlying asset prices head south and they foreclose the very next day on the negative LVR. Corporate entrepeneurial farmers have been the first to fall every time so far but the scaled up technology side applied to consolidated holdings is starting to finally show some promise in cropping. Diversified holdings on different water systems as a hedge I don’t rate highly in tactical terms but we will see. The SOI cycle is headline bad news right now and growing climate is the bottom line for everything. My ag investments were made on the “surely we are finally due for some good years” scientific method (well maybe with a little boost from the charting and ratio mud maps).

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  4. Farming sure has changed over the years, gone are my fathers days where you grew grain delivered it to the silo and the SMA (grain marketing boards) paid you what they wanted in installments over the following 12 months (this was the system until export deregulation in the mid 90’s). Now days to be a successful producer you have to be not only Ag savvy but also market savvy. In my area a number of us use futures, options and local forward contracts to lock in prices for inputs, currency and produce. Like most businesses though its all about critical mass, you must be much larger than the typical farm of 20 years ago. The modern farmer is nothing like the image I’m sure a lot of city people have.

    It may surprise many in the city to learn although some areas of the country have seen a lot less rain over the past few years many of us in better areas have only suffered modest falls in production and our incomes (margins) have actually increased. Perhaps the real estate saying location location is even more relevant to farm land than it is to housing.

    Agree with the comment about the SOI, the IOD also points to a dry year ahead, but touch wood its great here, in fact I haven’t been able to get out and spray because it keeps raining.

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  5. TheGoat, subsoil & sowing window looks good this week in mid west NSW for my connections on family farms. Like you they have been delayed by rain for spraying so much that we were nearly at the point of going back to leavinf it waiting to see what popped up.

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  6. Stamp Duty really is an absurd tax, which stops alot of things from functioning,and land tax is even more absurd…………but Local councils would have to be the absolute most absurd………most large councils are “bloated with fat, and the only service they provide is “safe Jobs” for those within………at the expense of the jobless ratepayer, or lets say soon to be jobless……..

    It does not matter who gets elected to these large councils, they never get better, and just create an economy for themselves.

    Fat local and state goverments employees are feeding themselves from the rest of us, and produce zero.

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  7. Hi Ross, well its raining (showers) in my area again today. My crops have been in since May. I wish we could get a few dry days to knock over some weedy patches. After saying that I’m very reluctant to complain about the rain. Production risk is still the one risk that producers like me can never really fully hedge against. This business isn’t for the faint hearted or those without deep pockets but I suppose when you actually produce something based on the weather it never is.
    Personally I wouldn’t swap it for the city, I spent my high school, uni (I’m an agronomist) and 10 years of my early working career in the city, I enjoyed city living but returned to the family property 10 years ago (my parents retired). Confronted with continue to get bigger or get out I’ve slowly accumulated additional land and we could not be happier with the lifestyle and income it provides. Its certainly not all doom and gloom in ALL rural areas of Australia as the city based media often alludes to. I am sympathetic to those who are suffering but its certainly not all producers. Just like not all producers are uneducated and or poor.

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  8. @TheGoat I have been able to help out sowing and stripping this past 3 years and my luck has been in even if yields have been disappointing. This year we have a couple of issues but if they are syuck this next week I will get up to help out so we cvan interchange between the tractor and ginning around. We bring in an agronomist. So I here you on lifestyle. There is a little vein of connection that needs rubbing and it isn’t to do with the dollar. We have other remote family with a bigger show over Condo way on partialy irrigated land that got caught big time with production risk and my personal belief is that selling forward is a croc. In my mind the buyer certainty on futures needs a countervailing certainty for the grower but production risk knocks it off balance and you need uncertainty maintained on the buyer side. That is why I am also for on farm storage and keeping some uncertainty in what volume is sitting on farm. Without uncertainty Chicago eats you alive, they deliver for the buyer and themselves but not for the grower. You can also get done big time on currency hedges a la the Gibson iron ore contracts.

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  9. Ross I hardly ever sell my actual physical production forward all that does is increase your production risk like your family member found out. Before I go on I better point out that I used to be a grain trader for one of the grain marketing boards, so I suppose I have a bit more of an insiders view of trading compared to most producers. I dont often use futures themselves to hedge, I’m a options person. Options PUT – CALLS give the holder the RIGHT but NOT the obligation to exercise the option (either buy or sell). Meaning if prices move away too far you are not required to settle the trade at a big loss. Instead you let the options expire. Think of options as insurance and the amount you pay for them as an insurance premium, thats all you loose. Some years in the money options has been responsible for lifting my income by >30%. On the downside because you only loose the options premium if you got the call wrong you might reduce your income by 5%, the total cash outlay for the options (before you even take the position you know what your max loss could be).

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  10. TheGoat, I agree in part but it works the same at the bottom line in the markets. 5% has been ++ in my reckoning and must be financed and adding your input costs and looking at cashflow and the outcomes in a bad year … but welcome to farming you will rightly say. One of the most interesting discussion on this shows up within CTX, a different business completely but they don’t hedge their oil price inputs, oil in transit, or their currency because their modelling says over time the net doesn’t work. They did get walloped in 08. My ag positions include ABB, GNC, RIC. ABB and GNC’s risk management on inventories also came up short in calendar 08.

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  11. Oh well, the federal government will get plenty of extra money from other taxes when double digit inflation bites.

    CGT is not calculated on real gains but nominal.
    If an asset, say a bar of gold or a land investment stays at the same real value. But high inflation doubles it’s price in 5 years, the poor owner will be liable for 50% of that notional increase as CGT.

    Even money in the bank earning negative real interest will generate significant tax (at the marginal income rate).

    And income tax rates will bite hard as inflation triggers rapid bracket-creep.

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  12. So why (ever) sell, Richo? Live on the dividends, or the rents. The more I read, the more I’m convinced that a bull with “…a herd of cash cows…*” is a very contented bull… no BS! :)
    * Boholt

    Biker Pete
    June 25, 2009
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  13. If 20%+ inflation is on the cards, Richo’s point about CGT will be crucial to how the markets will operate. Many investors will hold out for dividends as Biker Pete says and SMSF frameworks will be more attractive (indeed the only option) for many traders. Dividend vs. reinvestment policies of companies will also be affected by the tax on infation distortions.

    Coffee Addict
    June 25, 2009
    Reply
  14. It will be interesting times.

    My point about tax on interest will also impact investment decisions, because it applies to dividends. Dividends could become negative in real terms and still attract a hefty tax slug.

    If everyone piles into SMSF and the govt removes some of the tax breaks on super, they will be trapped there.

    I was a child in the 70’s so sisn’t experienced the financial pain of those times but I imagine there will be some parallels – large scale wealth destruction and high taxes by Governments struggling to avoid defaults. Maybe sky high oil prices too. Yippee.

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  15. That is the theory Biker – Accumulate assets that earn income. And where the income will adjust with inflation – So cash is no good. And gold is worse – Unless one is trading it. And if the income adjusts down should deflation happen, who cares – Providing the income remains enough to live on. And don’t sell the assets. That way you avoid paying CGT.

    It is one of the reasons I like/d(?) property as an asset class. It is not a guarantee of course. But my take on Australian history is that the liklihood of a mortgage free property going “bankrupt” is quite low. Certainly lower than the bankruptcy risk that a debt free buy and hold stock holder is exposed to anyway.

    I figure about $1.4M in property is needed at today’s prices in Oz to get an ongoing after tax return of $35K pa. That’s just being realistic – Properties need to be maintained and that’s expensive long term when one starts factoring in roof refurbs and exterior paint and replacement kitchens and bathrooms and hot water systems and stoves and floor coverings and light fittings and driveways and paths and gutters and downpipes and turf and tree trims and door handles and locks and … etc, etc, etc – None of this stuff improves with age.

    Plus one needs their own gunyah/caravan/shack to live in. And a car plus a few doodads can be handy. About $1.8M is needed to be a self funded retiree in Oz at the moment – Without eating the assets. Although $2M would be needed for a bit of breathing space. And $3M would be quite comfortable I think? It’s a pretty big ask.

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  16. CA: Keep an eye on the Ken Henry tax review I think – Waving goodbye to franked dividends for Aussies is a likely tradeoff for bringing more foreign investment money into the country. Plus it is quite possible the corporate tax rate will be lowered. Given that my addictions run to stronger substances than coffee, I’m not clever enough to figure out how that might affect which stocks when. But if you are a trader, I suspect it could all be quite tradeable? I’m half tempted to bear it in mind myself.

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  17. Must be a much bigger tiddler than I thought, Ned! :) Your note: “…. when one starts factoring in roof refurbs and exterior paint and replacement kitchens and bathrooms and hot water systems and stoves and floor coverings and light fittings and driveways and paths and gutters and downpipes and turf and tree trims and door handles and locks and … ” It’s pretty much taken care of with 40-year depreciation schedules. Our tax refund alone is enough to live on, due to these. I guess it is a pretty big ask… but thirty years of buying low and selling high have paid off. And our last seven houses have all been brand new… few issues. Still haven’t found a single established house that’s better value in the last three years… . Yes, we copped some sus tenants a year ago. They made good on around $12K in repairs, so that was OK. If I did it all again, I’d do it quite differently. Our three phases: 1.) Buy properties only the rich can afford to buy from us; 2.) Buy display homes with high, guaranteed long-lease returns; and 3.) Build rentals in beachside locations for $380K-$450K; have all worked well for us, but they’re not quite as productive as Boholt’s strategies. Yes, we’ve had some dynamite returns, but I wish I’d been smart enough to figure out the formulae she has made work, around a decade ago! I know her policy is ‘Never sell!” but she must have been very, very sorely tempted during the last twelve months, with the FHOGs lifting her perfectly-priced acquisitions… .

    Biker Pete
    June 26, 2009
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  18. Yes Biker, it surely sounds like you’ve been considerably more dedicated and consistent regarding putting your financial house in order than a lot. A bloke said to me once that you needed 6 houses to retire in Oz – One to live in and five to earn rent. I think that’s still a pretty reasonable assessment.

    I take your point about the 40 year depreciation schedule on new houses. I can see it being real handy for the first 15 years or so but suspect it would lose a bit of its gloss with inflation? The other big killer with property in Qld at least is land tax if a bloke gets too much of it. The returns just aren’t high enough to bear that extra cost. Although family trusts can be handy in that regard I think. (I’ve got to confirm that.)

    And I am pretty keen to see the outcome of the Ken Henry tax review before making any further investment in Oz – The specifics remain unknow. But unless they fold and say No big changes after all, I can’t see the general outcomes in this sort of environment being pretty for Oz investors (or wage and salary earners or small business) – Just too much debt and government welfare entrenched in the system now for the middle class to not get the pleasure of paying for it.

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  19. I have had the primary sector on my investment radar for a while. There are a lot of middle class mouths to feed in Asia and as they become wealthier they want more than rice, fish and vegetables. Australia seems pretty well placed to meet this demand.

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  20. Greg, not so much on the food side but NAM is worth a squiz, turnover is small and it is a coop so patient accumulation is the way to go. Management & board have steered well thru their market & drought issues.

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  21. Thanks Ross. I just worry about anything to do with cotton, from what I remember cotton is a pretty water thirsty crop and I read a while back that it should have never probably been grown in lot of areas it is now. But I am actually a city boy and know zilch about cotton farming. Any thoughts?

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  22. As the middle class in Asia grows they consume more meat. Diets have changed dramatically in the last 30 years.
    In 1985 the average Chinese consumer ate 22Kgs of meat per year. Today, it’s more than doubled to 55Kgs. That in of itself is impressive, but when you consider that it takes 17Kgs of grain to generate one Kg of beef, you begin to see how grain demand can rise exponentially to population growth with even modest changes to diet, especially meat. Grain production not only feeds us but also the animals we eat who are produced in feedlots.
    Since the ‘60s we’ve added roughly three billion people to the planet. Worldwide arable land per person has essentially halved from 0.42 hectares per person in 1961 to 0.23 hectares per person in 2002.

    This is without further climate change and falling allocations against entitlements to irrigators all further drags on production.

    Stock to usage ratio (for wheat and corn) is currently running at around 17%, which actually sounds good, we have 17% surplus but remember if it was 0 and we have production problems (drought) then some where people will starve or at very least eat grain not meat (cut out the middle man). The current world stock to usage hasn’t been this low since the 70’s. We are blessed never having to worry about feeding our population but make no mistake local end users will still pay the export price for local production, a local abundance doesn’t mean it can’t be expensive.

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  23. Utterly agree, Ned. We signed a new building contract on Monday… and I counselled the missus (dangerous gambit, that!) that we should wait and see what the Ken Henry Report contained before the next one. For once she was stumped (that’s rare) but had misheard me. Thought I was talking about England’s Stuart dynasty. No, KEN, not King, I yelled, before she laid about my ears with her ladle. Then, later in the day, a tiler, seeing me digging water tank overflow trenches asked me “Is it the right time to build?” Basically, I responded as _you_ would: “Wait and see what the Henry Report contains… .” Frankly, I believe _anytime_ is a good time to build, but I have to acknowledge that there are _better_ times to invest in property. A bit like trying to pick the bottom in shares. Being in there for the l-o-n-g term… and being counter-cyclical, I’m prepared to cut back to one new house per year (four a year is starting to knock my frame… the iPod helps… but I get psyched up… forget to eat… and just keep at it ’til the light goes… 24/7. Amazing stuff, Berocca, slipped into ya water bottle!) Besides, I figure we have enough now, anyway. I need more riding time…! :)

    Biker Pete
    June 26, 2009
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  24. Greg, you probably shouldn’t head into the sector unless you get comfortable around the detail. There is cotton and cotton seed. There should be a semi rebound next year in irrigated production and there are dry crops being worked in trial areas that may have some potential further on. We won’t go back to the boom years production wise but on the ginning and marketing side there has been consolidation and Australia has kept its niche customer base especially in Indonesia. NAM has been navigating all the challenges pretty well for mine and they surprised the market on the upside in its most challenging year production input wise.

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  25. Thanks Ross. I will keep having a look at NAM as it does look interesting.

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  26. The stamp duty storey is interesting. Bird also apparently said that “In Australia, it should certainly be feasible to permit states to impose a surcharge on the federal personal income tax base”. Although other parties suggest different ways to make up the revenue shortfall that would result from doing away with stamp duty – Increase land tax; Increase council rates.

    It seems that the argument being put up for public consumption in favour of the change is that stamp duty is seen as contributing to market inefficiencies – It discourages people from selling up and moving to better paid jobs in regions where they’d have to buy again. And discourages (old) people with houses that are bigger than they need from downgrading into smaller properties and freeing up their big houses for growing families who’d love to buy them. The argument sounds very weak to me – Call it for what it is as the author has done; A possible way to shore up both the property market and falling state revenues.

    In fact market efficiencies seem to be pretty unloved all round at the moment. Our lords and masters sure don’t seem keen on them. And not too many market participants probably want them either – Buyers, sellers, middlemen – Everyone is pretty much just looking to be “advantaged” one way or another. Which is why we are seeing such huge forces being brought to bear against market efficiencies right across the globe.

    Property should always be a long term investment if possible I think Biker. 10 years minimum. And yes, preferably never sell. If one has bought it as an investment rather than a convenient shelter until a different one would be more suitable.

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