The property market is a constant focus of the Australian public. Not only does it affect the asset value of many families, but it is also perceived as an important economic driver and indicator. For almost two years now we have been experiencing the slow deflating of the housing bubble, and consequently questions about property prices are on many people’s minds. Potential new entrants, desperate to buy their first home ask themselves when is the right time. Investors on the other hand are wondering just when the prices will stop sliding and start moving back up.
The real estate agents, as an essential part of the market, have an important role to play in forming expectations on both the supply and the demand side of the market. The way they fulfil this role has a strong impact on the market activity and property prices. The problem is that real estate agents are often instrumental in forming expectations in one direction only: property prices are going to rise.
This attitude has likely contributed to the formation of the “property bubble” in the first place. Even though this type of behaviour from the real estate industry might be understandable, it often looks unprofessional and certainly not credible, especially when events that can be expected to reduce property prices are interpreted as “prices are going to rise”.
For example, just hours after the de-facto proclamation of the new Premier of NSW, Morris Iemma, news broke that his first act would be to abolish the 2.25 per cent vendor tax on investment properties, the Real Estate Institute (REI) immediately commented that the move “will create resurgence in the NSW property market but will not lead to a dramatic increase in prices”.
To someone with only elementary knowledge in economics this sends a clear signal that the real estate agents in Sydney wait on any news and opportunity to advocate a rise in prices. Albeit the use of the term “not dramatic” in this statement, still implies that we should be expecting a rise in prices as a result of scrapping a vendor tax. This represents a case of misinforming the market, which in turn creates confusion among market participants.
Basic economic principles, widely observed and verified in the market place, tell us that abolishment of the vendor tax on property should, if anything, result in a decrease in prices rather than an increase. Whenever a sales tax is reduced, the price cannot be expected to rise. A tax in effect represents an increase in the cost of putting the goods (the property) in question on the market. When a tax is scrapped, the cost goes down, effectively expanding the supply of properties. Now that it is cheaper to put the property on the market, more will be offered.
This makes sense and is acknowledged by the commentary involving the REI. The problem is that the REI falsely implies that the tax removal would somehow affect the demand. But, since the tax is on the vendors (it is a vendor tax) the demand is not affected in any way. Since the demand side remains unchanged, but the supply expands as a result of lower cost, a new equilibrium is established at a greater quantity being sold on the market and at a lower price. It is almost trivial to show this in a graph, but here we go for the argument’s sake:
As can be easily seen in the graph, the result of scrapping a tax is a price reduction and not a price increase (not even a “not-dramatic” one).
Another argument put forward by the real estate industry is that many investors have been delaying the sale of their investment property and that as soon as the tax is scrapped they will be offering their properties on the market. This may, according to the REI, result in modest price increases. This is completely contrary to the basic economic principles and to the intuition that most of us have. When something is experiencing increased supply, such as more properties offered for sale on the market as a result of abolished vendor tax, its price will decrease rather than increase. The market will be more active since there will be more transactions executed, but the prices will not go up.
The fact the real estate agents have hurried to put yet another psychological pressure on the property market for a price hike, by using news that most obviously suggests easing of property prices, speaks in itself about the credibility of their comments. Even though we are all aware that it is in real estate agents’ interest to deal in properties with higher prices, thereby earning higher commissions, their profession needs to keep its integrity and be honest and help the property market overcome is current doldrums. They should process information and give predictions based on facts and knowledge available.
The manner in which they currently comment on the various events that can affect property market just creates confusion and uncertainty. So much so that Morris Iemma himself had to ease up the expectations, saying just one day after the original report, that “no firm decision has been made as of yet on the vendor tax”. This has subsequently changed with the actual removal of a tax, no doubt after Mr Iemma had a more profound look at the issue, and became convinced that the decision will not cause another property bubble in NSW.
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