Saturday, 29 January 2011

The Problems with High House Prices

The average house in Australia is now around $500,000. It wasn't always this expensive. Back in the old days, houses were cheap, but since then an explosion in house prices has occured, driven by increasing willingness and ability by banks to lend money as well as great enthusiasm by bank customers about the wisdom of investing in real estate.

In Australia, investors who borrow money and then lose money if interest repayments are greater than rental income, can use this loss to reduce their taxable income, thereby reducing their tax burden. This tax advantage has increased demand from investors to borrow money to invest in real estate.

This tax advantage will be difficult to do away with as it is political suicide. An attempt by Labor to abolish negative gearing led to so much controversy that politicians nowadays are likely unwilling to try it again. I believe it is best to assume that negative gearing is here to stay and to find ways to deal with it.

The effect of higher house prices can be positive or negative depending on who you ask. For those who own residential real estate, it is brilliant. For those who do not have real estate and want real estate, it is very bad. I am in the bad group in that I do not own residential real estate. However, unlike many young people in my predicament, I do not have a desire to ever buy residential real estate in Australia. The reason why I don't want to buy real estate in Australia is because it is too expensive. The tax advantage has already been capitalized into prices by driving it up. Therefore, if you buy a house you overpay. Many believe paying a lot for a house is harmless but it is extremely harmful. If you borrow more to pay more for a house, you lose money via interest you pay to the bank. If you use cash to pay for a house that you live in, you lose money because of the opportunity cost since you could have used that money to earn interest. If you overpay for an investment home, overprices housing means that you lose money because the interest repayments you make are not compensated for adequated by rental income. Mainly due to tax advantage being capitalized into house prices, rental yields for the average house in Australia is around 4 per cent, and this does not take into consideration the costs of depreciation and repairs.

The bottom line is as follows: if you buy a house, you're being ripped off. The windfall from the housing boom has already been taken by the baby boomers. Generation Y should not try to mimick the baby boomers as the situation back then is nothing like the situation now. Back in the old days, houses were cheap and if you rented your house out you could collect high rents. Nowadays, houses are expensive and if you rent your house out you will not get much back.

Even if you agree that house prices are too high and refuse to buy a house, that does not stop you from being ripped off. High costs of real estate may even extend to commercial and industrial real estate, resulting in the prices of goods rising. This is particularly evident if you traval and notice that everything in Australia is much more expensive than it is in other countries, not just houses. Therefore, if you don't want to be ripped off, the best thing to do is to reduce your spending.

I recommend you keep your spending low, live with your parents (or rent but split the rent with many roommates), and save up money mainly using the highly tax-advantaged superannuation system as well as taking advantage of high private debt levels by investing in bank shares. I am strongly considering moving out of Australia once my savings are high enough. I will get a new job in a new country and live there instead.

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