Along with four others, I spoke at yesterday’s Central Queensland University conference. My contribution dealt with the incredibly speculative times through which we are living.
HOUSING AND THE 18-YEAR LAND PRICE CYCLE
by Bryan Kavanagh
HOUSE PRICES
The present political discourse is rightly focused on the cost-of-living crisis and escalating house prices. Australia faces an inadequate supply of housing, and many people believe homes to be unaffordable. However, much of the analysis has conflated the issues of supply and affordability, assuming that an increase in supply will automatically make homes more affordable. This assumption is flawed, because more houses are not like a glut of tomatoes on the market which will indeed reduce their prices.
While it is true that construction costs have risen due to COVID-19 supply chain disruptions and labour shortages, and that inflation, government stimulus, and bureaucratic delays have contributed to rising house prices, simply building more homes may not lead to more affordable housing. Here’s why: –
According to the Australian Bureau of Statistics’ “Total Value of Dwellings” report and Table 61 to the national accounts, land now accounts for over 85% of the cost of the average home. This means that even if builders were to construct more homes, they can’t lower the land price component, because they must purchase sites at market value. Therefore, the high cost of land will remain a significant problem.
Real estate valuers know that while supply and demand, population growth, location, zoning, and the characteristics of a site will affect its rent, the price of the land is largely determined by: (1) what banks are willing to lend against it, (2) the mortgage interest rate, and (3) rates and taxes levied on the land. If governments were to capture the full rental value of the site via a land tax, the market value of the land would be zero, as there would be no rent to capitalise into a price.
Recent increases in land tax in Victoria and Queensland have led some landlords to seek investment opportunities elsewhere, with reported declines in land values. So, taxes on land values do influence the land price component.
FORECASTING ECONOMIC TRENDS
Economists have a poor track record when it comes to forecasting recessions. This probably reflects the adage, “The future is unknowable.” However, some real estate professionals—particularly valuers and agents—seem to have a better understanding of real estate market trends, and therefore, possible economic outcomes.
For example, back in July 1987, I published an article in the journal The Valuer which forecast an economic recession in 1991/92. According to Paul Keating, that was the recession “we had to have,” but I believe it could have been avoided had we tweaked land taxes upward—particularly an all-encompassing land tax, not just one on investment properties.
MY FORECASTS
My economic prognostications have been based on trends in the Australian real estate market as a whole. Although there are of course many sub-markets, I employ two national aggregates, namely, total real estate sales–that is, all residential, commercial, industrial, and rural sales–and gross domestic product. The index compares total real estate sales to GDP. My colleague, Dr Gavin Putland, added the year-on-year change in the index, finding that a 25% drop suggested recession within the next two years.
Obviously, I could not foresee the COVID-19 pandemic, but I was able to forecast a recession in 2020, based on the methodology. The sharp decline in the index in 2018 pointed to a likely recession. MacroBusiness published an article on 18 January 2019 quoting me as saying that “turnover and price declines in Sydney and Melbourne during 2018 indicate an economic recession in the 2019-20 financial year.” The recession occurred, exacerbated, of course, by the pandemic. Despite its immediacy, the media ascribed the financial recession entirely to the effects of the pandemic. My chart showed otherwise.
UPDATING THE CHART
We had to establish a new series, to account for data revisions from the Commonwealth Grants Commission and the Australian Bureau of Statistics when updating the analysis to 2023. Although a 25% decline in the index did occur in 2023, it was not accompanied by the general drop in sale prices that would necessarily signal a 2025 recession.
Despite several of my articles being published in The Age and Herald Sun, I’ve found that mentioning an impending recession is considered taboo. Maybe we prioritise maintaining public “confidence”, even at the cost of overlooking the likelihood of economic recession.
LAND PRICE BUBBLES
There have been people historically who understood the risks of inflated land prices. Just before the Great Depression, a young Robert Gordon Menzies, who was to become Australia’s longest-serving prime minister, warned of the dangers of post-WWI inflated land prices. His warnings proved prescient, as the land price bubble burst just before the 1929 stock market collapse.
In more-recent times, the 2008 Global Financial Crisis was another example of a real estate bubble-burst. During the GFC, the housing market collapse in the US was directly linked to inflated land prices, after banks failed risk management by lending against overinflated values. Australia was impacted less, because with Treasury assistance the government acted quickly to pump some $50 billion in public works into the economy. Maybe pink batts were not the best way to do it.
The political environment around real estate remains sensitive. The property industry, financial institutions, and investors are heavily invested in real estate, making it difficult to consider fiscal measures that would reduce land prices. However, history has shown that these bubbles inevitably burst, and the damage they cause is far worse than taking pre-emptive action.
ROCKETING LAND PRICES
Australia’s tax system has played a significant role in inflating land prices excessively. The combination of generous tax policies for property investors—such as negative gearing and the 50 per cent capital gains tax discount—has encouraged land price inflation. Meanwhile, state governments have been slow to use land tax to cool the market. It’s all left to the Reserve Bank of Australia – and RBA cash rate policy hasn’t succeeded,
Since 1971, Australian land prices have increased at an incredible average rate of 12.2% per annum. In 1971, total land values in Australia were only $258 million, but by June 2024, the figure had grown to $9.74 trillion. We may want to ascribe this to population growth, but whereas total land prices represented $2,000 per head for every man woman and child in 1971, they’ve now risen to an astonishing $364,000 per capita. I consider this foreshadows a correction.
AUSTRALIA’S FUTURE TAX SYSTEM
In 2010, the Henry Tax Review recommended an all-in land tax, alongside income tax, the GST and a mining tax, to replace all other state and federal taxes, as a trade-off. If implemented, this could have tempered the growth in land prices. However, after a failed attempt by the Rudd government to introduce the recommended super-profits tax on mining, tax reform has stagnated, and land prices have continued to rise unchecked.
LAND MARKETS WILL HAVE THEIR WAY WITH US
If politicians remain unwilling to address the issue of land price inflation through tax reform, the real estate market will eventually correct itself. Historically, real estate markets follow a regular pattern of boom-bust, with land prices rising to unsustainable levels before the inevitable crash.
Phillip J. Anderson’s The Secret Life of Real Estate and Banking traces this US land price cycle back to 1800. It demonstrated a recurring 18-year cycle. Australia’s property market follows the US cycle quite closely, although it’s rarely discussed publicly, due to political reluctance and vested interests in maintaining status quo.
THE 18-YEAR CYCLE
Let’s take a look at a diagram of the 18-year land price cycle since World War II. It’s based upon the writings of the six people shown at the foot of the chart and isn’t financial advice. The 18-year cycle peaks were in 1954, 1972, 1990, and 2008, with another anticipated in 2026. After each peak, there’s a steep four-year correction, followed by a recovery and a mid-term peak. The mid-term top is usually accompanied by a two-year recession. As we approach the final “Winner’s Curse” phase of the cycle, shown at the top of the chart, whereas many analysts had expected a recession in 2023/24, it has failed to materialise. So, if the 18-year cycle does hold, it may be be a case of “off to the races” next year, with a land price surge that could herald a crash in 2027. I guess we’ll see?
TO CONCLUDE
CEDA, the Committee for Economic Development Australia tells us that productivity is at a 60-year low. GDP grew only 1.5% last financial year, the weakest since 1991/92. With land prices averaging increases of 12.2% per annum since 1971, the tax regime has been directing us into real estate investment by taxing productivity excessively. As we tank towards another real estate bubble burst, maybe it is time for Australians to consider taxing land values more and incomes and purchases less?