Why government grants to first home buyers are a waste of time.

Imagine if you will, a company that sells gizmos.  They charge $1,000 for each gizmo and sell 50,000 a year.  It is a stable business and each year rolls past with the same price and the same volume.  Now the government decides more people should buy gizmos.  They decide to pay each person who buys a gizmo, $200.  The gizmo company has to make a decision.  Since people only have to find $800 from their own pocket, do they:

  1. produce more gizmos because more people can afford them
  2. or put up the price to $1,200 and sell the same number?

If the company could only increase supply of gizmos by a small margin – perhaps 51,000 in a year.  The obvious thing that will happen is that the price will go up to $1,200 so that $1,000 still comes out of the consumer’s pocket.  The person making the sale is the only winner.  The government is the loser as they have to pay out $200 for no change in the number of gizmos being sold.

Now apply the analogy to the real estate market.  Here the supply of properties available is relatively stable.  There are new houses being built, but the demand far exceeds the supply.  On the other hand, the government has various schemes to help first home buyers.  These range from direct grants, to such recent thought bubbles as allowing buyers to access super, or pay off stamp duty.

banner-first-home-owners-grantIt may seem like a good idea to subsidise first home buyers, but the only people who benefit are sellers.  At an auction, a bidder’s top price is what they can afford to pay, plus the government subsidy.  It is likely the person they are bidding against is in exactly the same position.  The government is boosting the bidding limit equally for both bidders.  In other words, giving first home buyers a financial bonus, only addresses the demand side of the supply/demand equation.

But what else can be done.  Well there are two things.  One addresses the demand side, and one the supply side.

On the demand side, you can reduce the demand for properties.  To do this, you need to take some of the bidders out of the game.  There are two obvious groups to target.

The first is overseas buyers investing in Australia.  Nobody seems to be able to quantify how many of these there are, but companies exist that market Australian residential property overseas, so it can’t be insignificant.  Currently overseas buyers can buy new properties without government approval.  There are reports of new apartment blocks being sold off the plan to foreign investors.  On one hand it is good to build new properties.  On the other, it leaves first home buyers as renters rather than owners of these apartments.  It would be better to only allow investment from overseas in building rather than owning the properties.  Either that, or put further restrictions on foreign ownership as many countries currently do.  Last year I wrote an article to offer an alternative approach.

The second group is investors.  Negative gearing has created an environment where it makes sense to buy a second property to minimise tax.  Surely this approach has reached it’s use by date.  It must be phased out to change the balance between renters and owners.

On the supply side, we could make more land available for building.  The problem is that every new area opened for development needs infrastructure.  Water, sewage, transport, schools, medical facilities, government services, electricity and roads.  There is a massive costs to make a new area ready for people to build.

The people who buy the properties will pay rates and taxes, but it comes nowhere near the money required to initially fund the infrastructure   So who should pay?  If the developers pay for everything including building new schools, medical facilities, buses and trains, the cost gets passed on to the first home buyers.  If the government pays, the costs cannot be contained within current revenue so they either have to boost taxation or borrow money.  In the end, the cost is spread across all taxpayers.

In addition, the initial cost is artificially high.  Instead of a property being the cost of the land, + the cost of building, + the margin of profit for the developer, it now includes the cost of infrastructure.  As the infrastructure will benefit everyone who lives in that home for the next hundred or so years, why should the first owner have to pay all the cost?

Another anomaly, is that a home built on a block of land in an existing area is going to be a significantly cheaper option than one in a new area.  There is no infrastructure cost to pay in an existing area.  Yet these two properties may be within metres of each other.

I don’t have an answer to this conundrum but maybe the money being poured into first home buyers grants would be better spent to provide the infrastructure to new land releases.

So why is it so hard?  To answer this think about the people involved in the market and their vested interest.

This is what happens if real estate prices plateau or even fall.

Current home owners.  The value of their assets falls.  Not happy.

Mortgage payers.  Pay more on a loan than the property is worth.  Not happy.

State governments.  Collect less stamp duty.  Not happy.

Negative gearers.  Loose a tax minimisation facility.  Not happy.

Banks.  Each new home loan is for less money.  Not happy.

Owners of investment properties.  If the number of renters reduces, the rent goes down.  Not happy.

So who wins?  Only first home buyers.  And what proportion of the electorate is happy about this?  Two or three percent?  What would you expect a political party to do?  Maybe I am just an old cynic.

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