Deflating Australia’s land bubble

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Great post by Leith van Onselen
Reproduced with kind permission from

Prosper Australia has provided a submission to the Senate Inquiry into Housing Affordability, which is well worth a look. The submission first provides nine metrics illustrating Australia’s residential property bubble, which include the following:

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It took forty years from 1950 to 1990 for housing prices to double, but only fifteen years between 1996 and 2010 to double again. The surge in housing prices is driven by the tremendous growth in household debt, as owner-occupiers and investors take out ever larger mortgages to speculate on housing. The household debt to GDP ratio reached a record high of 98 per cent in 2010, the same year real housing prices peaked. In 2013, the mortgage and personal debt ratios were 86 and 9 per cent, respectively, for a combined household debt ratio of 95 per cent.

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As mortgage debt escalated, investors’ net rental losses increased rapidly from 2001 onwards. In that year, net rental income losses were just over $1 billion, rising to $9.7 billion in 2008 as the cash rate peaked at 7.2 per cent. By 2010, when mortgage debt reached its historical peak relative to GDP, investor losses eased to $5.1 billion as the cash rate fell to a then historic low of 3 per cent in 2009 following the global financial crisis (GFC). The latest data shows income losses rose to $8.2 billion in 2011, the second largest absolute loss on record…

The housing market meets economist Hyman Minsky’s definition of a Ponzi scheme, as gross rental incomes minus expenses are clearly insufficient to meet principal and interest repayments. As 67 per cent of property investors are negatively-geared as of 2011, investment decisions are predicated upon expected rises in land values, not rents. This strategy will inevitably fail, as the escalation in real housing prices can only be sustained by a continual acceleration or exponential rise in mortgage debt.

The price to income (P/I) ratio, otherwise known as the median multiple, is another measure of residential property valuation…

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From the mid-1990s onwards, housing prices outpaced household incomes, and the P/I ratio increased from 4 to 7 nationwide. It is impossible for household incomes to match the rise in housing prices during the boom phase of a property bubble, as wages grow more slowly, usually just above the rate of inflation…

Land is the largest tangible market in Australia… Our housing bubble is actually a residential land bubble, as the total land values to GDP ratio doubled between 1996 and 2010, when it reached a record high of 298 per cent ($4.1 trillion). In real terms, residential land values rose from $895 billion in 1996 to a peak of $3.2 trillion in 2010, a relative increase of 262 per cent. This ratio is closely matched by a similar rise in the value of the residential housing stock. The rise in residential land values, rather than structures, is responsible for almost all of the increase in the value of the housing stock…

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Prosper then places the blame for Australia’s expensive housing on convergence of factors, with Australia’s inefficient tax system front-and-centre:

A convergence of factors are responsible: a large cohort of irrational investors gambling on housing prices, a FIRE sector willing and able to facilitate a credit boom, and low property and land taxes attracting speculators to this asset class…

A positive feedback loop has emerged between housing prices and mortgage debt, with rising prices prompting the take-up of more debt in an upwards spiral…

An inefficient taxation system, comprised of low property and land taxes, allows landowners to expropriate ‘geo-rent’ (economic rent derived from land) by capturing the uplift in land values generated by taxpayer-funded infrastructure and rising economic productivity… Government willingness to tax wages and business ahead of land has elevated its privileged status, resulting in larger capital sums being paid by owner-occupiers and investors.

It also advocates land tax reform, which it claims would significantly improve incomes, affordability, and productivity:

Counter-intuitively, reducing wage and business taxation and increasing land tax would not necessarily lower fundamental land prices, given the offsetting boost to disposable wages, profits and hence rents, but it would certainly lower bubble-inflated land prices. Land tax reform – urged on government by every independent tax review in living memory – would firmly correct the price to rent and income ratios. If Australia wishes to escape or ameliorate the profound financial destruction of a bursting land bubble, the solution lies in this equation…

Prosper also slams housing-related tax expenditures, which undermine the integrity of the tax system:

The generous scope of tax expenditures relating to the housing market has served to further increase prices. Tax expenditures are defined as a deviation from the commonly accepted tax structure, whether it is a tax exemption, concession, deduction, preferential rate, allowance, rebate, offset, credit or deferral. Australia has the highest rate of tax expenditures among our OECD peers, at more than 8 per cent of GDP. Tax expenditures are vulnerable to lobbying, and often compromise the fairness and efficiency of the tax system. Lavish tax expenditures for both owner-occupied and investment property has significantly worsened housing affordability because they allow landowners to capture greater amounts of geo-rent and prioritise unearned wealth and income over what is earned. Existing home owners capture the most benefit, ahead of first home buyers, investors and tenants.

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These tax expenditures provide a strong incentive to speculate on housing prices, and are reinforced by already low property taxes. Investors perceive rental income as secondary to expected rises in capital prices, while first home buyers over-leverage themselves to enter a bubble-inflated market…

Tax expenditures, combined with the ongoing deregulation of the banking and financial system, has transformed the housing market into a casino. Residential property is commonly viewed as a speculative asset to flip, rather than shelter to raise a family in…

Finally, Prosper provides two recommendations to the Senate Inquiry:

Recommendation 1: Reform Land Value Tax. The ideal tool to moderate land bubbles and properly fund infrastructure already exists in the hands of state and territory governments: state land tax (SLT). Unfortunately, this tax has been so riddled with exemptions and concessional treatments it must be considered dormant…

We suggest the current government introduce a nationwide one per cent federal land tax (FLT) – fully rebatable on SLT paid – to oblige the states and territories to use their taxing powers properly. State governments could adjust their tax rules and keep every dollar the FLT raises, to the benefit of all Australians. The Commonwealth Parliament would be entitled to argue this intervention is for sound economic reasons and dissipate the political fallout. Placing state and territory finances on sound bases would vastly improve the federal system mandated by Australia’s Constitution. Transitional arrangements would need to be considered. Rebating all stamp duty paid against a hypothetical past SLT obligation would address concerns of fairness and equity…

Recommendation 2: Macroprudential Regulation. A range of macro-prudential tools are needed to moderate housing price inflation and subdue credit growth in a pro-cyclical financial system, such as those affecting the loan to value, (LVR), debt servicing (DSR) and debt servicing to income (DSTI) ratios.26 Quantitative restrictions should be placed on the share of new mortgages with moderately high LVRs…

To reduce systemic risk, a large rise in capital and liquidity ratios (buffers) is required to ensure banks can withstand a future economic downturn, bank run or large fall in the value of collateral. Research suggests the probability of a banking crisis can be reduced to a 1 in 100 year event by raising core equity (Tier 1) capital ratios to 11 per cent in isolation or raising core equity to 10 per cent with an addition rise in liquid assets of 12.5 per cent (the rise in liquid assets over total assets). For the Big Four banks, this would represent a rise of around 3 per cent in core equity…

The full submission is available here.

17 Replies to “Deflating Australia’s land bubble”

  1. Interesting article but the tax system isn’t the main cause of the situation. I’d like to see some of these charts overlaid with mortgage rates.

    When I applied for a mortgage in the 80’s the LVR was 80% and interest rates were 17.5%. Compare those two numbers with what we have today and that is where the bulk of the price gains have come from.

    The equation is simple, Australians love to own real estate and at the lower to middle end of the market they will frequently pay as much as they can access. As interest rates come down and LVR’s go up the amount people can spend increases dramatically. And to make sure they keep paying more and more all you have to do is restrict supply.

    And at the end of the day that is the real culprit “insufficient supply of housing stock”.

    1. Could it actually be that the ‘real culprit’ is the perceived relative absence in Australia of adequately risk-adjusted comparative return opportunities ? – that is, having assessed alternative longer-term investment opportunities, adjusting for risk, investors apply their funds to property till price equates demand and supply

  2. I am an aged farm owner, with a share-farmer working the land/ My return on a $500,000= property is around $20,000 gross. p.a. (25% share). A 1% land tax would consume $5,000- leaving me with nearly NIL nett in some years. City-based accountants have no concept of the real world.

    1. It is central urban land that is the most valuable on a square metre basis. The farm would probably not be taxed.

      The Henry tax review recommended substituting stamp duty and existing land taxes with a broadbased land tax of “about 1%” and said “In practice this could mean that most land in lower-value use (including most agricultural land) would not face a land tax liability and the tax would apply moderate rates to most other land. Transitional rules will be critical in changing the basis of land taxes, to smooth valuation effects and to allow ample time for those affected to make adjustments to their investments in land.”

      The Henry review cited an OECD report which found that a 1 per cent switch away from income taxes to a land tax would improve long-run economic growth per capita by 2.5 per cent.

  3. If supply was not restricted and more land became available, without an adequate level of land tax the speculative motivation would still attract investors. They would still dominate the market and keep prices speculatively elevated, as most would have capacity to leverage up while FHB’s cannot. Property spruikers would be jubilant as they organised Australian “mum and dad” investors and foreigners to take up most of the new supply. The tendency for the younger generations to become permanent renters would persist.

    Land tax is not incompatible with high land price, just that the price would be a reflection of genuine economic activity, not speculation.

    1. Regarding Land Tax, if the suggestion is that a $500k homeowner should pay $5000 per annum just to limit price rises then I think it would be an extremely hard sell. Land tax might flush out some of the property hoarders but it’s an inefficient way of fixing a relatively simple problem.

      If however there were a constant and sufficient supply of housing stock, not just new land but strata etc in existing suburbs as well, then it would be increasingly unprofitable to invest due to the lack of capital gains.

      Ultimately so long as demand exceeds supply people will bid up prices beyond their true value.

      1. I see land tax as a more equitable replacement for other taxes such as Transfer Duties, not as an additional burden on the taxpayer.

      2. “ColinTwiggs says:
        March 5, 2014 at 4:53 pm EST
        I see land tax as a more equitable replacement for other taxes such as Transfer Duties, not as an additional burden on the taxpayer.”

        Agreed! But if a land tax is to replace Stamp Duty etc then something like 0.1% would be more reasonable.

  4. Housing prices are a function of demand.

    Demand is driven by population growth.

    ‘More people’ require ‘more houses’ to live in. Simple.

    Countries with low population growth have cheaper housing. Australia has high population growth (through immigration), mainly because politicians like the GDP boost that comes with it.

    And no, releasing more land at the city fringes does NOT decrease house prices closer in, where people want to live. Melbourne, for example, has decades of city fringe land already zoned for new housing. That has had absolutely no influence on the price of a house in the 0-15 km range – those houses have increased in price substantially.

    The only way to make more of the good quality middle and inner suburban housing that people really want is to make more cities. Sydney and Melbourne have now grown to the point where fringe housing is no longer desirable. In fact, it’s hideous. So direct the new housing at the next Sydney and the next Melbourne.

    1. I was just scrolling down to the bottom of the article to make a comment saying exactly that Geoff. One look at those graphs recalls instantly the exponential growth shown in population charts (the ‘Population Bubble’?). Where is the graph of the population in this article?

      Sadly the piece is just a rationalisation of conservative ideology regarding taxes (but a pretty one using graphs).

      1. Colin, you must still consider the growth of population, especially somewhere like Sydney where the majority of people settle when they arrive (I did the same myself) and there are limits to how far out of town people can live.

  5. From todays SMH

    I particularly like
    “Meanwhile, in Germany there is little history of persistent house price inflation, most often attributed to constant growth in housing supply and a central bank willing to take action when it believes property prices are rising unsustainably. For what you might pay for a modest flat in Ballarat or Wollongong you can still get a decent-sized family home in Cologne or Hanover.”

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