Should More Houses be Built?

The property market in many cities across the world is facing unprecedented challenges. The prices have risen so high that most of the buyers have been priced out of the market. The sellers have somehow anchored themselves to these irrational prices. The end result is that prices do not seem to be coming down. However, at the same time, there are almost no transactions which are happening in the market at the given prices. This situation is prevalent in many cities across the world. London, Sydney, Auckland, Mumbai, Toronto, and Shenzhen are some prime examples of this property bubble.

The governments in all these cities are under political pressure to lower the rates of these houses. Almost every expert on the subject matter is of the opinion that prices are reflecting supply and demand. Hence, high prices must be reflecting huge demand with very low supply. This is not the case in most cities. Prices have risen much faster than the underlying fundamentals. However, once we believe that the root cause of this price rise is the lack of supply, the most obvious solution is to increase the supply by building more homes.

In this article, we will have a look at why building more homes may not be the best solution.

Property Prices are Based on Future Expectations

Property prices are not commodity prices. Instead, they are asset prices. Hence, they are not dependent upon supply and demand. Instead, property prices are largely driven by the future expectation of value.

If investors believe that prices will rise in the future, they inevitably will. The problem with property prices is that till now the government has encouraged and allowed huge sums of money to make its way to these property markets. As a result, the prices have shot up. Hence it would be safe to say that the price rise is not really because of a shortage of supply. Instead, the speculative behavior of many buyers is to blame.

Easy access to bank credit and private capital being passed on by parents to their children has led to this unprecedented rise in price. Hence building more homes will not solve the problem. A lot of these cities aren’t even facing a problem of shortage of housing, to begin with.

For instance, consider the case of Ireland whose population is about five million. In 2007, the government of Ireland built more than 90,000 homes to ensure that prices remain affordable. However, during the same period, the prices rose by more than 11% proving that increasing supply is unlikely to solve the problem of property prices.

International Money Flows into the Local Property Markets

Most housing price bubbles are happening in developed nations. This is because developed nations are investment destinations for corrupt politicians and bureaucrats from third world countries.

The ill-gotten gains from these countries ultimately find their way to these global cities. These investors are not looking for a return on their investment. Instead, they just need a place to park their funds. As a result, a lot of these houses are uninhabited.

Since these investors do not pay any heed to fundamentals and valuations, they tend to fuel the speculative bubble even further. This is the reason why governments like Germany have levied a tax on people buying second or third homes. Merely building more homes will not solve the problem of land prices. The problem of international money flows and the price inflation it brings along will also have to be negated.

Borrowing Against Land

Another major problem with houses is that banks are willing to lend against them. Many investors have mortgaged their houses and are using the proceeds to further invest in property. Also, it is not uncommon for landlords to take loans based on their rental incomes. Many people have been using their properties as cash machines for the past few years. Thus the idea that houses never fall in value has been firmly embedded in the minds of many investors. This further fuels the speculative bubble.

How The Problem Should Be Solved?

It is now clear that building more houses will not solve the problem. This leaves us wondering about the other steps that can be taken. Some of the other steps are as follows:

  1. The tax system needs to ensure that the speculators are driven out of the market. There must be punitive measures for buying more than one homes. If the rich want to corner the real estate, they must pay the price for it

  2. Foreign investments in the local property markets must be restricted. This can be done by introducing the equivalent of a Tobin tax for properties.

  3. Restrictions must be imposed on banks who lend money against real estate. Laws must be passed to ensure that the proceeds are not going to be used for speculative purposes.

Managing the Downside

The problem with engineering a fall in property prices is that there will be casualties. The people who have currently borrowed huge sums of money to buy real estate at inflated prices will be negatively impacted. Hence, it is the government’s responsibility to ensure that the property prices do not plummet all of a sudden. Instead, the fall must be gradual and should not trigger panic in the investment community.

To sum it up, building more houses will only create more expensive houses. The root cause of the problem is the flow of speculative money in this asset class. Once the flow is stopped or reduced, the prices will automatically rationalize.

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Real Estate