Beware the mother of all housing booms

Australians are rushing for bricks and mortar as they've always done in times like this. With interest rates low but banks wary, the market is set to blow up.

If we are not very careful Australia is going to have the mother of all dwelling booms. What we are seeing is a three-pronged boost to prices. First is a dramatic push to lift the demand for dwellings by banks offering cut mortgage rates thanks to Reserve Bank Governor Glenn Stevens. But second, and just as importantly, there is reluctance by banks to fund new supply.

In any commodity if you inflate demand and squeeze supply, prices go through the roof.

Thirdly taxpayers will subsidise the boom via a massive increase in the use of negative gearing via both personal and superannuation tax breaks.

Longer term, that will damage the economy and the Reserve Bank will have to take responsibility for pulling the price boom trigger. The market accepts further interest rate cuts but surely the Reserve Bank board members will now have second thoughts about future cuts.

To understand what is now happening, let’s go back to basics.

Where do you put your money? Glenn Stevens has priced bank deposits out of the market for long-term savers who want a fair return. Unless banks are once again prepared to go abroad for their money it means that there will be no abundance of long-term bank deposits, although there will be plenty of short-term money.

The sharemarket has delivered great returns but a large number of people have been burned in the last five years and brokers are no longer excited about value in the market. In this low interest rate environment shares will do well but that is not where the big money is going to go.

Australians are going to rush for bricks and mortar as they always have in situations like this. And when they see the market about to rise they just jump in. In Sydney, real estate agent John McGrath told a mortgage brokers' conference that the city's inner city property demand was “red hot”, although in Melbourne there is a fair amount of supply in the market. Melbourne, along with Brisbane, will quickly follow, although perhaps not with the same intensity.

Most of the demand will be from investors, including those using their self-managed funds, plus the Chinese. First home buyers will obviously contribute at the lower end.

When you see a rush of demand, what you need is supply. Given that the main demand is in inner city areas supply takes a long while to generate. Banks are reluctant to lend to developers – especially given recent failures – and the approval process is very slow.

In addition, the capacity of the building industry has been curbed by the slump and many have been forced out of business. The tax office and the banks played a big role in this.

All the conventional signals told Glenn Stevens he should lower rates. Yet if Tony Abbott wins the election we are going to see a surge in plant investment because the political crisis has held people back. The August rate cut will have had no effect. Because we are dealing with existing properties, an inner city boom does not boost employment until developers can fund and gain approval for new projects. Of course, when it spreads to outer suburban areas then it does boost employment.

At some time (not in the short term) Glenn Stevens will be forced to address the inner city property boom which he triggered in August 2013 – probably by increasing interest rates at an inappropriate time.

Negative gearing may also be curbed.

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