Tuesday, April 04, 2017

On Property

What do you know about Property? Particularly private property?

I suspect the answer to this question, will prove to be: nothing.

The foundation of my suspicion being, that I know nothing. Although this post has been on my 'to write' list for a while, it was as recent as yesterday that I watched developmental psychologist Paul Bloom's talk 'religious thinking isn't special' my relevant takeaway the prevalence of what he called 'double deference'. He defended a Republican Lynn Westmann's inability to name the 10 commandments in a Colbert interview despite sponsoring a bill to have them displayed in the Senate and the House. Just to be clear, he defended the inability to name the 10 commandments while still thinking them important enough to be displayed, rather than the proposal to display them. Simply because it is possible to believe something is important and valuable and true without understanding it at all.

Much like many people who believe that it's important to teach children the theory of Evolution and the Hot Big Bang etc. would quite likely not be able to explain these theories, and many may have a very misguided notion of Evolution, even though they feel it is important. Hence most of us will trust and defer that scientists do science stuff and that what they say is true and correct. And I should say, that if you are ever going to defer to an authority, let it be a scientific authority, because they are actually supposed to base their statements on experiments that are reproducible. Including photographs of the big bang. I feel the scientific community is the most worthy of deference by the lay, unless that scientist is, of course, an economist.

But you have probably done this with property, and sorry in advance if the one thing. The one decision you feel you have got right in life, was buying a property. It doesn't mean you're wrong, I'm just trying to establish whether you know anything about this thing you bought.

So here are my property Millenium Prize Questions, published 17 years late and with no prize money. The questions I can't answer myself. I would love it if you the reader had a go at these, and I'll have a go at them myself below. So in no particular order can you answer:

1. How does property make money?

2. How can 'house prices' increase faster than rents over a sustained period?

3. How can rents appreciate faster than wages over a sustained period?

4. What value does a landlord provide?

5. Why do banks lend money to people to buy property, instead of using those funds to buy property directly?

6. If property prices are to always go up, why does anybody need to get in to the property market?

notes: When I use the word 'how' I'm wanting a description of the mechanism, for example 'How did humans descend from apes?' 'Evolution' demonstrates no knowledge of evolution, this is a deference. Questions 2 + 3 address expectations, so while the answers may be obvious in the short term, I'm looking for a demonstration of knowledge as to how these occur over the long term. When I say 'value' I'm asking not for a description of services a landlord provides, but how these services are beneficial. eg, a cleaning service provides value not through cleaning the house, but by providing a service at a cheaper hourly rate than if I were to allocate the time to doing it myself.

In the time I have allocated to writing this post, both ASIC and the RBA have come out cautioning against a potential property market crisis. I've been a naysayer of property investment for years, as many of my friends disdain me for and may even avoid my company. But a catastrophic property market crash in Australia, while validating, would still be catastrophic. Many people I know and care about would be wiped out financially. Locked down in negative equity for decades.

If I had to describe what most people believe, I have only an impression, and it forms the basis of my suspicion that people can't answer the 6 questions above, as I can't. They simply don't think of them and it hasn't occurred to them. Even though they are aware of terms like cisgendered and have nuanced understandings Sharia law etc.

But I suspect the average property owner thinks houses make money from capital gains, and that landlords provide housing because they are smart and only suckers pay rent. Banks lend money because property must be a sound investment and house prices go up for some grounded reason. It is plain to see that they are.

And that's it. aka - people know nothing, but are literally willing to mortgage their lives at this level of understanding.

This post is effectively done. But my attempted answers are below. They took longer than all my VCE exams combined and they fried my brains in a way that school never has.

[Have a go, I have an economics bachelor degree and I can't answer these questions, but many people who don't have economic or financial qualifications are sufficiently confident to take out loans of hundreds of thousands of dollars to purchase a house that is mortgaged against repayment of the loan + interest.]

When you are ready or resolute that you don't want to attempt to answer these questions, here are my best attempts:

1. There are seemingly obvious answers to this, the number one being rent. Charging people some portion of their income for exclusive or shared use of the space. This just doesn't track with reality. So using my home suburb as an example, the median buying price is $AUD 2.2 million, and the median rent is $710 pw. Plugging these figures into a mortgage calculator with a 3.7%pa interest rate and 25 year loan period resulted in weekly repayments of $2614 pw. Deduct $710 (paid either as rent to the mortgage holder or realised as savings on rent for owner occupier) and the mortgaged party need to find a remaining $1904 pw to service their debt.
Thus rents can't explain how property makes money in isolation, because crucially if you were to do nothing else in my home suburb - the rental income would not pay off the loan. So rent in isolation is a no go. By comparison I understand enough of the share market to know that any company I look up on the exchange should have a price earnings ratio, which is the net profit made by that company divided by the net worth of all common shares issued. So you can get a P/E ratio of 20 for a company, this means for every $20 of shares you own, you get $1 back a year, which in turn means that it would take 20 years for the investment to pay you back, on the 21st year, you start making 'money for nothing' holding everything else constant.
Now this is complicated the only 'earnings' of a property are rent, and this figure is obviously Gross, because there's a bunch of taxes like land rates and maintenance costs and what not. But per year this rent income translates to $37,440 generating a P/E ratio of 58.76. Or it would take 58.76 years for the property to pay for itself, holding everything else constant. My mortgage calculator only offers a 30 year horizon, and I can't find one with a 60 year horizon to bring into line this P/E ratio with the loan repayment frame.
So I don't know enough, let's forget about mortgages and say that our buyer, not me can just buy the property in cash, outright. Then the question is answered, for an initial investment of $2.2 million, the property makes me $710 pw either in the $710 pw I don't have to pay in rent anymore because I live in the house, or from the rental income of putting a tennent in the house, assuming that both these situations can be held constant, then the house will have paid for itself in just under 59 years time.
Again, although ostensibly the question is answered, it still doesn't track with reality. For one thing the easiest way to guarantee income is to live in the house myself and realise them as savings, but that requires me not to move for 6 decades, and in 6 decades I will probably be dead. It also assumes I'm out there working in the real world and earning a lucrative income. If I were just to collect a pension (somehow) it would however ensure that I would get all $400 per week most pensions amount to. But I don't know the law as it regards owning a multi-million dollar property and collecting a pension.
There's a big difference between owning a home, and owning a biscuit factory. A biscuit factory makes money by producing biscuits and selling them, potentially to many many people, this could improve or decline over time but it is risky. A property only makes money by getting tennants, and in the case of owner occupied, as savings on rent paid. It is very limited in its ability to make more or less money. Furthermore, tenancy contracts are usually fixed agreements over a period of time and there's many conditions that need to be met to alter the agreement etc. A biscuit factory can vary it's production figures, prices, distribution channels with a much higher degree of variation. It can even relocate and alter it's shipping contracts etc.
There's one seemingly obvious way property can make money, that I haven't mentioned thus far - Capital Appreciation. and that is because, I don't understand it.
I mean there's a simple term for buying something expecting a return in capital appreciation aka movements in price - that is speculation. But we are talking about people my age and even younger speculating with hundreds of thousands of dollars they don't have. That I don't understand.
When I try to understand it through the framework of a P/E ratio, it looks something like this - You have a high price say $2 million, and low earnings like $500, this could be rational as a gamble if you have some reason to believe at some point in the future, the earnings are going to jump up dramatically, considered in isolation, for me to invest any amount of money, I'd probably want it to pay me back within 20 years, adjusting for inflation (of course) so I might sink 2 million if I had some reason to believe that $500 a week were to jump up to $2000 a week ($100k a year) BUT that would justify the price I paid to a prospective buyer, for them to buy it off me at a higher price - they would have to believe the income was going to increase even more than it had.
Here I would note, that this is about me and other market agents acting on beliefs about the future, and price remains a function of earnings - so I would initially purchase something with a high price and low earnings because that makes it appear overvalued, however I believe it undervalued because of information I presumably have about how the earnings are going to change. I can then sell it when the prices adjust however I would need to believe it to be correctly valued, or overvalued based on my beliefs about future earnings and my buyer (whom I sell to) would need to believe it to be undervalued.
Those are the conditions of rational speculation. I don't understand it though. Further complicating things is Efficient Market Theory, which basically says all information about future changes in earnings should already be factored into the price.
And this is where I begin to stroll into a black hole of my personal understanding. If you were to reverse engineer the 'information' that is fueling the beliefs about future changes in rental income that is driving the high property prices, then any property owner that contributes income above that of the rental income they are earning or saving from their property believes something to be true about those rents increasing in the future.
But this belief must be so widespread that the information it is based on should be just about common knowledge, furthermore these poor P/E ratios have been the case for 10 years plus in Australia so I should have observed by now the massive adjustment in rents and the stabilization of property prices. Being unable myself to explain the current high prices, nor explain why I'd expect future high prices or future rent increases.
I have a basis for capital gains making money off property based on anticipated positive shifts in rent but no evidence to support that. I can explain the basic model whereby somebody holds a property for so long the rental income pays them back, but that is highly conditional on somebody taking little or no mortgage out and needing some reason to buy property rather than shares in more profitable enterprises, like an owner occupier that can hold the property long enough to save enough on rent to wind up with the savings plus the asset for resale... I think, I don't know.

2. My best attempt at answering this is the anticipation model of capital gains, it makes sense to pay a higher price for a property if you think that rents will increase in a disproportionate matter. eg. You might be willing to pay 15% above the real value of the property if you expect rents to increase by 16% - or 15.01% whatever.
That's short term though, how could this happen over the long term. You'd have to be expecting higher and higher rents occurring successively. But that would only explain property prices increasing more or less in line with rents, but with periods where the prices may increase ahead of rents for successive windows. The P/E ratio of property would remain stable over time.
This is what EMT would predict, even with a 'new era story' like the population is increasing faster than the housing supply, or that Chinese/Saudi/Russian etc millionaires are buying up all the properties and other popular stories (rarely verified). This again would suggest that the market would incorporate these factors into property prices.
The only one that potentially gives insight is the foreign investor new era story, typically wealthy people trying to move money offshore by purchasing foreign real estate. Here they are simply looking at property to function as a store of wealth, or bank account. The motivation being to have money in a safe asset that they can convert back into cash should they need it. As such they may buy existing properties and not rent it, restricting the overall rental market. This may in turn cause a rise in rents as the rental supply diminishes. BUT the market has a new piece of information, the potential for those properties to re-enter the rental market and relieve pressure on rents, which means property prices should reflect this potential already.
Furthermore, to the foreign investors, price rises in the assets they hold must reduce liquidity, and they can't be relying on their asset further appreciating by more foreign investment in the market because it becomes tautalogical, or is it a truism.
If you will picture the financial advisor of this Russian Oligarch saying 'you should buy Australian property because you are buying Australian property, and the demand for Australian property is driving up the price, so demand more of it.' It can seem less circular when you take Vladimir Putin and divide him by the millionaire population of China, but even so, what are the Chinese millionaire's being told? The new era story that involves them? Buy it because you are buying it!
I can't explain how property prices are outpacing rents in growth over a sustained period of time. Just to hold steady as an 'investment' that means if your property value has increased 14% for the year, rents need to have increased 14% as well. I just checked and last year rents increased 3.8% in Melbourne (prices rose 13.68%). My brain is not capable of doing the maths, but for these price increases to be rational, and compliant with EMT, for every year property prices increase by 10% more than rents do, the rents need to increase more than 10% the following year. Like those compare the pair Australian Superannuation ads which is to say if you had a period where property prices increased 10% for 5 consecutive years and rents held constant, then the market would 'correct' by having the rents leap up by 61% just to get them in line with where they stood at the beginning of the 5 year period.
Under Australian law there are certain obstacles to that happening, there are limits by which a landlord can increase the rent on an existing lease and limits to how often this can occur. At any given time most of the rental market is not in transition, so you would need a shock to the system - basically all existing tenants deciding to move, break leases and negotiate new ones to have the avenue for such a drastic increase in rent. The other thing being that this would not quite be a musical chairs scenario - all those tenants would be creating a huge upswing in rental supplies. The market would also be anticipating no Government intervention to such a drastic increase in rents.
Given that that makes no sense, I can't really explain how over a sustained period property can appreciate faster than rents do. Particularly if property is being purchased on mortgages meaning that $1900 gap between rental income/savings and mortgage being repaid has to grow by 10% per year, making mortgages less affordable.
I'm even less convinced of my partial answers to question 1 having walked further through this phenomena. I can get an explanation of the short term - a shock in the market. But I can't answer that sustained part. I can't explain how.

3. So last year rents increased by 3.8% which is not insignificant. But wages increased nationally December 2015-2016 by 1.9 pc. So the phenomena does exist, at least in the short term. That it's been happening for a few years is a bet I'd be willing to take, though it may be me using an availability heuristic.
Anyway, if rents increase faster than wages, that means its eating into people's disposable income. eg. rent is $100 and after paying it the tenant has $150 left, if rent increases to $103.80 and wages increase $254.75 , so both landlord and tenant are better off the landlord by $3.80 and the tenant by 95 cents.
If you adjusted for inflation though, The landlord's position has improved so that they are wealthier than they were before (3.8% is greater than inflation 1.5%, which incidentally the RBA is worried is low, hence the cuts to interest rates) and the wages seemingly increased faster than inflation as well but 80% of that wage increase is captured in rent, so the reality for the tenant is that their income increased 0.4% so they are poorer after inflation.
But that helped, wages must be larger than rents, so a lower percentage increase in wages may yield sufficient money to cover a higher percentage increase in rents.
However there's a ceiling as to how much the rents can increase and be absorbed by tenants - I can't do the math in my head, but in the above hypothetical a 4.75% rent increase would be the limit.
It's an aside to this specific question, but such a rent increase ceiling would invalidate the Efficient Market Theory prediction that property prices are factoring in a massive increase in rents UNLESS, it is factoring in an even more massive anticipated increase in incomes.
Blah, where was I, oh yeah, There's a second ceiling though, should the first rental ceiling be exceeded, and here's the simple answer to the question - rent increases can exceed wage increases until they've eaten up the disposable income. How much disposable income is around is ambiguous. I mean if somebody has $150 spending money after paying rent, and utility bills and other overheads break down to $30 a week, we have $120 which is about $8 a day for food or something and lets say a person can meet their nutritional and caloric needs with $4 a day, so you can say half of the food budget is disposable income - the human tendency to consume at the highest possible utility level.
But the $90 is there for the landlords grabs, but no more. Afterwards the average tenants become unable to eat... technically you might be able to grab more, provided the tenants have recourse to charity - eating at homeless shelters etc. This would be called the process of 'externalizing' which is where your business model depends on somebody else picking up the bill, like the Church, the wages of volunteers and the budgets of NGOs. You could see employers feeding their employees to create more disposable income, which provided the business has cash flow to cover it, would be tax deductible, so it would be at the expense of the public in terms of government expenditure on social programs.
So the government or philanthropy could pick up the bill, to maximize a landlords claim to the income of individual tenants.
As it stands, having to get to this 'absolute' ceiling would take time, however even this plan is conditional. It requires almost mass coordination, so that a tenant has no recourse to pursue a cheaper lease or move in with their parents (basically to use market forces to ensure their rents stay low). It also presumes that the erosion of incomes won't reach a threshold where it becomes politically untenable to not regulate further rent increases, popular revolt, cancellation of debts and redistribution etc.
Which needs mentioning because my attempt at establishing a ceiling for disproportionate rent increases may have sounded cruel, brutal, unethical and unjust. However that's not a system redesign, it's basically the negotiation of a contract between two individuals we have now, it just requires a circumstances to be such that tenants have almost no leverage. To be skewered between not eating and living on the streets.  There's some credibility to such a skewer, given that upon living on the streets it is almost virtually impossible to maintain a job, so the tenant would be losing their income anyway - this points to another source of recourse for the tenant though, to sacrifice their job and collect social welfare. I have to confess ignorance as to whether a person with no address can receive welfare, but it should be acknowledged on the landlord's side of the equation that the real limit of disposable income they can eat into is probably at the threshold where holding a job provides no utility over being unemployed. An individual could obtain more leisure time while having equally no disposable income as if they are working and paying higher rents.
There are of course some tenants that have children, who cannot generate an income and thus are already eating into the income generating parent(s) disposable income(s), and such tenants probably cannot entertain the option of going homeless. But this just means there is less disposable income for the landlord to obtain should their tenant have dependents. But landlords may literally have the ability to take food out of babies mouths, by negotiating more favorable lease agreements.
Again, its a complicated and highly speculative exercise to imagine basically how society can absorb higher rents than wage increases over a sustained period of time.
But I'm beginning to get answers that aren't generally discussed. For example, if we assume that the property market is not facilitated by lending, then property prices can appreciate faster than rental income, because you don't need to be repaying the interest and principle over time, so you don't require additional income above and beyond the rent (or your own in savings on rent) and in turn you don't need your income to increase faster than rents do, because you have simply converted an asset into another (cash to property) so your personal income is irrelevant.
This does fit the new era story of Billionaire's arriving from outside the domestic economy and buying property without loans, however this only works for those Billionaires, and not for people who both live and work in the domestic economy.
Those working in the domestic economy need to be anticipating some future significant growth in wages (just as in the previous answer, property prices need to be anticipating some future significant growth in rents) in order to restore what economists call 'equilibrium' and we would subsequently expect that growth in rents would be some function of growth in real wages (adjusted for inflation) provided the market is efficient - in this case you don't have a significant and non-transitional amount of homeless people, and you don't have a significant and non-transitional amount of vacant housing.
Thus 2 and 3 are more or less the same. But you can human centipede them together to create a kind of nested equation - property prices need to be a function of rent - f(rent) if you will, and rent needs to be a function of wages - f(wages) so property prices become a function of a function of wages.
There's a caveat I have to mention as well, all my back of the envelope equations have been dealing with averages, and there's some chance that the variance might be more significant. Such that the median house price does not align with the median rent etc. and that average wages don't align with average rents, or property prices.
Even though it isn't an official question, let's entertain in the spirit of completeness a theory where most property is bought with home loans, and whether they are owner occupied or rented, the debt requires servicing with an income, at risk of defaulting and maintaining the debt while losing the underlying asset, or declaring bankruptcy and losing the underlying asset.
In which case last year property prices increased by 13.68% and wages increase 1.9%. Comparing a $55,000 annual wage and a $500,000 property the absolute amounts = $1,045 increase in income and a $68,400 increase in property price. More than 1 extra year of earnings and a difference of $80 in mortgage repayment per week (using the same assumptions 25 year mortgage, 3.77% interest rate). The wage increase of our property buyer before tax amounts to $20 per week. But they pay tax as well and using a simple tax calculator $340 of that $1,045 wage increase goes to the tax man, if they can't deduct it through negative gearing but worst case is that the effective wage increase our property buyer has to service the higher mortgage with is $13.50. So best case, $60 has to come out of their disposable income a week. I can't make a fair comparison to the increased burden on a tenant without recalculating the orange numbers into apple numbers. $250 income a week is not a 55k annual salary and $100pw rent is probably not proportional to a $500,000 property. But hopefully your intuitions are strong enough that it is going to be about a tenth of the sacrifice of disposable income for the tenant or thereabouts, aka a landlord is subsidizing your living arrangement in pursuit of the long term claim to the underlying asset.
Of course these changes only effect buyers, if the buyer bought the property for $500k two years ago, and it's valued at $568,400 one year ago, that doesn't effect their mortgage repayments unless they refinance and up their loan (effectively buying the property from themselves) which they have no incentive to do so, unless they need emergency surgery or to buy a boat or some shit. But it does mean that they can increase the rent by 3.8% (unless an owner occupier, in which case they would have to increase their savings) and their wages increase by 1.9% and thus they have more disposable income after deducting their mortgage repayments. They would probably be better off though just selling the house and realizing the capital gains, provided they don't then buy another property.
My brain is broken again, so I'm happy to throw in the towel on this one, and say I can't explain how rents can increase faster than wages for a sustained period.
Which is to say, I can but to borrow Nassim-Nicholas Taleb's terminology my explanation would 'fragilize' the economy if not almost all social contracts and almost inevitably shatter it.

4. Again there's a seemingly obvious answer, which is that a Landlord 'provides housing' however in contemporary society this isn't true, and probably hasn't been true historically. Developers and construction companies provide housing by erecting shelters. Architects too by a degree of separation. Hence 'providing housing' is a misnomer, the landlord by definition is leasing out their superfluous housing. Like if it was raining and I had two umbrellas, I can use one for myself and could sell the other when it is raining (a demand spike) or rent it during the rain.
But I am not creating an umbrella for other people's use.
A landlord simply owns a house, is that of any value? There are more concrete services a landlord provides, for example they have to take responsibility and upkeep of the property and fittings. They also absorb the 'risks of ownership' which may be the exorbitant mortgage repayments, a landlord may be subsidizing the shelter of their tenants.
On the question of maintenance though, before I tumble down a rabbit hole, is similar to an insurance scheme. Say you get a dental extra on your health insurance, resulting in an extra $1000 a year in premiums. Then you go to the dentist and have your cavities filled and discover that your $300 bill is now reduced to $230 thanks to your insurance. Is this of any value?
No, you paid $1000 to save $70. Suggesting you didn't do your research properly.
Now in my own experience and from anecdotal testimony, the maintenance services provided by a landlord are often neither timely or to a quality standard. Furthermore there's a compliance cost too, of putting in the maintenance request and then following up and then coordinating the repairs or maintenance.
Thus the question of value is how is paying rent for upkeep and maintenance services more valuable than not? Or, if you think as rent like a maintenance insurance - where if you need a plumber, electrician etc. you pay monthly premiums of hundreds of dollars and in turn get a free visit from a tradesman once or twice a year.
Let's keep in mind that a modest rent in my hometown of $160pw is $8320 per year, with a bond lumped on at the front end ($793). Yes you can get the bond back, but how many electricians and plumbers and how many fittings would you need replacing in 12 months to fork over $8320 to a middleman.
Of course, we aren't factoring in the savings of whatever it would cost to live in a hotel for a year, but that is because a landlord just buys a house. A house (or room + communal space) that is surplus to their own needs for shelter. Hence why doesn't a landlord simply sell the house to the people that want and/or need to live there? They in turn can then sell the house to whoever needs to live their after them.
This turns out to be a good question, if we go back to the hypothetical mortgage repayment of $2614 weekly mortgage repayments vs the $710 rent paid to the landlord.
Here the value kind of becomes obvious, the Landlord is paying an extra $1900 of their own income per week for the privilege of letting you live in the house that they do the upkeep and maintenance for. They only retain the rights to the asset if they manage to pay off their loan.
A landlord pays most of the rent to the bank subsidizing the cost of shelter for the tenants. This only works taking a very narrow view, and in this regard I guess when the costs of ownership are higher than the rents collected a landlord does 'provide housing'. by taking on the financial burden that the tenant my be unable or unwilling to.
That is an answer, however it doesn't work the moment you plug it into a larger context. Without which we aren't talking value so much as pure altruism.
Simplify. Let's consider 1 house 1 bank 2 bidders same salary, and to boot both bidders know that whoever loses the auction has to become tenant in the house living with and paying rent to the other as landlord. Neither party has recourse to live somewhere else, find temporary shelter, live rough etc. Now you could play out the auction in a state of ignorance, where neither party knows they have the exact same limit as the other, and do not know the other will have to rent, in which case the auction will play out like an 'eenie meenie' rhyme where whoever bids at their max limit will by default win the auction because both have the same. The loser of the auction then approaches the other about renting.
If we throw up some numbers, let's say the two bidders earn $11,001 dollars a year after taxes and expenses, they both can secure a 10 year loan for $200,000 at 10% fixed rate interest, for a mortgage of $220k, with annual payments of $22,000.
In which case, should the bidders pay top dollar for the property, the landlord can charge the other tenant $11,001 in rent (the max the other can afford) as they have no recourse. They then pay $10,999 of their own income to service the mortgage and per year the winner of the bid is $2 better off than the loser. The real winner of course, being the bank.
If the two people cooperated and agreed to bid the minimum reserve and have the tenant contribute slightly less than half of the mortgage repayments, you could have a system where both prosper at the expense of the bank (albeit the bank is already getting a 10% return) but relatively speaking both parties win.
But really, the Landlord does no favors to anyone by owning shelter that somebody else needs. They simply entitle themselves to rents. Sure the world is crazy at the moment when people are willing to pay far more for the entitlement to the economics rent than the economic rent will actually provide them.
What I can't wrap my head around though is whether the gap between rent and mortgage repayments is purely inflated by having a completely superfluous agent - here called a landlord - thrown into the mix. Simply put, if we didn't have a pool of competing investors buying up the rights to rent existing property to people who actually need it, would anybody pay for the service of having a landlord? Somebody they need to ask permission to make modifications and carry out non-urgent repairs. Somebody they pay a constant retainer for services that require no individual expertise or qualifications?
I can think of one very bounded circumstance where a Landlord provides value - for transitional life-cycles. Eg. Imagine somebody has to obtain tertiary education in a locale for a short period 3-5 years, that is not near their home or where their future jobs will be. In such a case, it may be worth paying rent to somebody willing to take on the upkeep of a property over the long term that you only require for a short time. The same may be said for temporary work environments.
There is however a conceivable alternative - which is to say, imagine a world where property prices are very cheap and property turnover is highly liquid. There is adequate housing near educational institutions so you simply buy the house for roughly the equivalent of a years rent, then sell it at the end of your degree for roughly the same price.
That would be called an efficient market, where the assets are owned by the people who need to use them and transferred easily when circumstances change, buyers match sellers etc.
There's no real value I can think of that landlords provide. I can imagine a world without them that would probably be much improved. There is a fake value that landlords provide and that is when it costs more to own a house than to rent one. - $2500 mortgage against $700 rent, but this value is artificial and I don't believe the enthusiasm for home ownership that I witness has any basis in altruism. I suspect that for some reason the landlord believes that there is somebody eager to pay an even higher mortgage that will compensate them for their losses through capital gains on the asset pricing. Why they believe this is the subject of questions 1, 2 & 3.

5. So in my above answer I talked about a 1 bank 2 bidders 1 house scenario. That kind of is the answer to this question, but think about it some more. Because if you believe there is an answer to question 1, that houses somehow 'make money' and that there is a good answer to question 4 that landlords contribute a valuable service that tenants willingly would pay for rather than simply own the housing the need and take on that service themselves, why wouldn't a bank just buy the property hold them as assets, and employ people to fulfill the valuable functions of being a landlord.
In a scenario where two people approach a bank and say they need a loan to buy a house they have to live in, and that they both can afford 11,001 in rent a year, but they could buy the house and rent out a room to someone else and blah blah blah. The bank could just buy the house for the cheapest possible price (given that it can deny the two bidders a loan) and that way would only have to make a minimal investment of it's cash reserves and could charge both parties the max rent.
So why would a bank choose to lend $200,000 to one or the other parties? To get the 10% interest? If the monopoly is sound though, the bank can use the market mechanisms to extract the lost interest payments via rent. They can only rationally loan what the tenant can afford to repay, so the only difference is in what they pay for the asset?
A bank would do this in such a scenario. Why wouldn't it do this in real world, messier scenarios?
I feel this is a really good question. If the answers to 1, 2, 3 and 4 are so plainly obvious to most people and I am particularly stupid. Why do banks lend money to plebs to buy homes off each other when they could use those funds to buy the property themselves?
Consider how safe the banks are though, under a mortgage arrangement. If you fail to make your payments as and when they are due you retain the debt, the bank can then repossess and sell the house and if that doesn't cover the amount owing you, or your guarantor still owe it plus all the legal and sale costs with interest.
Thus I imagine the reason why the banks are willing to lend money to people is because the underlying business model of home-ownership is unsound. Rents can't increase faster than wages, and house prices can't increase faster than rents over the long haul. So the banks don't buy, they lend. They lend money to people who sacrifice ever growing amounts of their disposable income, and live under ever increasing austerity to service the loans that grow faster proportionately.
The banks are confident to do this, because they are confident that encouraged by the increasing prices, more people will apply for even greater loan amounts. Hence the interest rates can shrink as house prices grow. The prices are sustained by people's income, salaries for doing things that are valued by the productive sector of the economy, then channeled into speculation - betting on price increases to make money through 'flipping'.
Consider that Melbourne house prices grew by 14% yet you can obtain a loan for 3.77% why are the banks willing to accept 10% less return per annum on money they already have?
The answer must be, though it would be very complicated to figure out, that that 14% can only be achieved by lending money to the buyers.
If there were only 4 buyers in Australia (the big 4 banks) or even only a couple of thousand, if buyers were institutional I doubt you would have $2.2 million price tags on properties that can only charge $710 per week rent. Assuming the house can be sold for $2.2 million after one year that nets a return on investment of 1.68%. This would not cover the interest paid on the savings the banks hold.
The banks would have an obligation to their shareholders (and creditors) to invest in asset classes that yield a higher return and that are considered lower risk, like companies that make things that can be sold. Industries that manufacture things that are useful (possibly the construction industry) or to buy properties at much lower prices than the current market.
Because you don't invest to break even, and an institution like a bank needs to beat the rates they are offering on cash deposited with them, while also providing for the liquidity gap (a property loan lasts for 25 years, whereas a person may draw on their cash deposits the next day - thus you need to reserve some cash to service withdrawels, you can't tie it all up in long term investments).
So instead, the bank loans money to people to buy at prices that transfer their income to the bank in greater amounts than if the bank was to buy at prices and charge market rents.
If the property market worked like that, property prices would move in line with rents. This doesn't happen. But if property was what you believe it to be - the bank would not lend money to consumers to buy the assets, they would just buy them themselves.

6. A banks willingness to loan is based on confidence. The worst thing that can happen to the bank is for the asset to plunge into what is known as 'negative equity' - where the asset price is not sufficient to repay the debt owed. The debtor has little to no recourse but to default or declare bankruptcy.
If house prices are always going up, though, the bank has nothing to fear.
Therefore, it doesn't matter if the price of houses just went up by 14%, because we can expect them to be worth even more in the future. Therefore, the bank should always be willing to lend me as much money as necessary at any given time to purchase a property knowing that the price will continue to increase in which case, any chance of default can be written off by future growth in prices.
Under the circumstances that property prices always go up, there can be no such thing as responsible lending. If the bank is as confident as the consumer, there is no need for me to furnish it with a deposit, provide my bonafides, or work in a secure profession on a long term contract.
Should I lose my job etc. it doesn't matter, just sell the house, pay off the debt and eat the profits.
Sounds magical right? Because it is.
This doesn't happen, because there are no apparent answers to questions 2 & 3. But it is kind of the inverse of Keynes expectations theory. If people expect prices of goods to fall further, why would they buy today anything they can put off until tomorrow? This was a question that couldn't be answered by classical economists during the great depression, and similarly when you change it from goods to assets, I can't answer the question as to why there is any rational urgency to buy in to the property market if it is just going to continue to rise indefinitely.
A being of pure reason would say, as Benjamin Graham, student of Keynes and teacher of Warren Buffet pointed out - if an asset is always going to rise in price then it's value is infinite and it is effectively priceless. Vis a vis, any price of something that always increases in price is a good price. Even a bargain price. So why buy today? If you can afford your rent or whatever current living arrangement you have. Then just chill. It doesn't matter if you buy today or tomorrow, or the next day. Time period n+1 will make you money. So there's no need to put a foot on the ladder of an escalator that does the climbing for you and continuously. The very fact there is any liquidity in the property market at all suggests that property prices can go down.
Perhaps the real question is, how devastating is the difference between something that always goes up and almost always goes up?

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