By David Bassanese

I am growing sick and tired of the rounding up of the usual suspects to blame for Australia’s alleged house price bubble. To my mind, there are major forces driving the surge in prices in Sydney and parts of Melbourne, but it’s not those that are often cited by the media.

Low interest rates

For starters, there are those that seek to blame low interest rates. If low interest rates were the main factor, Australia would be enjoying broad based house price gains across most states. Yet as the Reserve Bank of Australia regularly notes, the boom is largely confined to New South Wales and patches of Victoria.

According to the RP Data Hedonic Home value index, Sydney prices are up 15% over the 12 months to end-May, while there’re up 9% in Melbourne. Yet in Brisbane and Adelaide the gain has only been around 3% while Perth prices have shown only a 0.7% rise.

Negative gearing

Yet others would blame negative gearing. But negative gearing has been around for decades, and did not seem to prevent Sydney house prices treading water for almost a decade before the last boom began in late 2012. Negative gearing is nothing new, and any considered economic analysis would show it largely works as a rental subsidy – allowing renters to pay less in rent than they would otherwise need.

After all, if homebuyer affordability is the ultimate determinant of house prices – i.e. a house can’t be more expensive than what most people can afford to pay back through a mortgage at current interest rates – then it is rents, not house prices, that are most influenced by negative gearing. Assuming house prices are set by homebuyer affordability, then the level of tax incentives offered to investors then determines the rents they are prepared to accept in the market. Drop negative gearing and investors will demand higher rents to compensate – while house prices will still be largely set by homebuyer affordability.

To the extent investors exit the market and dampen prices, it would momentarily boost homebuyer affordability, until prices return to previous levels given prevailing household incomes and interest rates. Let’s drop the carping about negative gearing.

What’s more, we should not forget that many other countries have different, though still generous, subsidies for property. In the United States, for example, home loan repayments – whether you are an investor or owner occupier – are tax deductible.

The real reasons

So what is responsible for the home price boom? Sydney price performance lagged income growth for a number of years – especially as national economic activity switched to the resource states during the mining boom. So the early stages of the Sydney property upswing were just catch-up caused by improved affordability and the early swing back east of national economic activity as the mining boom started to subside. Of course, Sydney house prices are now at quite high levels relative to household income – suggesting longer-term affordability measures are no longer a driver.

After a few years of strong gains, it is probably true a speculative element has crept into the market – as buyers later to the party mistakenly think past strong gains will continue. It’s the mixture of fear and greed among buyers that drive asset prices cycles, including that of the property market.

But to my mind, two other relatively new elements in the property market deserve special attention.

The role of SMSFs

For starters, in September 2007 an important change was made to the superannuation laws, which allowed self-managed super funds to leverage through borrowing to buy property assets – provide the loans were “non-recourse” in nature. This is a major structural change in the market that has helped account for the influx of investors into the market.

This also begs the question why SMSFs have been most active in New South Wales and Melbourne. One (admittedly partial) explanation is that SMSF assets seem over represented in these states – NSW accounts for 37% of SMSF funds, compared with 32% of the national population. Victoria has 30% of SMSF assets compared with 25% of the population.

Foreign investors

Last but not least – one cannot discount the strong anecdotal information suggesting offshore (mainly Chinese) buyers have become much more active the market in recent years, through legal means or not. Although hard numbers are hard to come buy – because they are not properly recorded – it seems the Foreign Investment Review Board has for too long either been unwilling and incapable of enforcing laws that restricted the purchase of established homes by non-residents.

Loopholes include buying property while being a “temporary” resident and then failing to sell the property when they return home – or buying property indirectly though the use of locally based family or business associates.    

A recent crackdown by the Tax Office – belatedly instigated by Treasurer Joe Hockey - has already uncovered around 190 suspect purchases, which is probably just the tip of the iceberg. On the ABC’s 7.30 Report, property analyst Louis Christopher was quoted as saying “I think the true number is in the thousands”.

Of course, given the many thousands of property transactions that take place each year, it’s hard to believe foreign investor buying is playing a massive role.

But at the margin, it may well be adding to the bidding frenzy at property auctions in our two major cities – especially given these seem to be the two regions most preferred (so far) by foreign buyers.