Sunday, May 2, 2010

Unsafe as Houses

I've been reading a bit about the Henry review of Australia's taxation system, and I'm disappointed that it didn't eliminate the tax break on investment property. That would have been a great way to let some air out of our housing bubble, which has been one of the few around the world not to burst. Prices haven't declined much lately and the price to rent ratio is 56% above its long-run average. It's like Australia got the one empty barrel in a game of Russian roulette, but our luck can't hold out forever.

I know quite a few friends who borrowed to buy a second property, then rented it out to pay the mortgage. The tax incentive plays a big part in this - mortgage payments on investment properties are tax deductible. Most of their money is tied up in a leveraged, illiquid investment, with the potential to cause trouble in a severe recession. They could easily lose their tenant, see the property value decline below the mortgage value, and be stuck in a situation where they can't cover the repayments, or get out from under the mortgage by selling.

I think people under 35 are particularly at risk here, because we were children or adolescents during Australia's last major recession in the early 1990s. We just haven't experienced widespread sackings and the chaos that follows. It's quite possible that Australia's boom will last another 5 or 10 years, but that's only going to make the bursting of the bubble more painful when it happens.

While borrowing to buy your own house brings advantages besides just accumulating capital, borrowing to buy additional houses or flats is pure property speculation. It's a pity that our tax system will continue to encourage it.