June 2002

Last month’s discussion on mortgage interest rates brought forth the typical plethora of emails expressing every emotion from extreme agreement to radical disagreement. Such comments are always welcome, as my intent is not to inspire agreement but to stimulate thinking.

From Australia came the following question, “Why did you not mention the effect of the government’s First Home Owner’s Grant?”

The reason is, nearly everyone in Australia has probably heard of the First Home Owner’s Grant and since this newsletter is syndicated in or sent electronically to no fewer than 38 countries, this information would not apply to people in 37 of those 38 countries.

Having said that, the First Home Owner’s Grant is an interesting exercise showing how the government attempts to encourage a specific behavior, although good-intentioned, often has the inverse effect of that intended.

To combat a sluggish real estate market, Australia’s government instigated a scheme whereby first time home buyers could receive a $7,000 tax free grant toward the purchase of a property.

As an election policy, no doubt you can see the potential of this bribe. “Vote for me and I will give you free ice-cream.” So long as the number of people you are buying ice-cream for (your potential supporters) exceeds the number of people that must end up paying for the ice-cream (your potential detractors), you have a winning election formula.

Needless to say, the scheme was very popular. Under what other circumstances will the government give you $7,000 with no strings attached?

However, that’s not the end of the story. Suddenly, real estate was in the headlines. People who thought they couldn’t afford a property were considering buying. With interest rates at historical lows and a $7,000 grant in hand, the public went on a buying spree. Prices started to move, the building industry was humming and everyone was happy.

So far so good! The government was no doubt applauding itself on its foresight. They even modified the scheme to offer additional grants (see http://www.firsthome.gov.au).

However, as with any government expenditure, there has to be a day of reckoning! Firstly, millions of dollars in $7,000 lump sums had to come from somewhere, and that somewhere was the tax-payer’s pocket. Money was being siphoned away from the productive and given to those who had not yet managed to save enough to buy a property.

Secondly, artificial demand had been created. This distorted the natural forces of supply and demand, sending Australia toward an inevitable period of over-supply.

Finally, a perception has been created that such a grant is normal, belonging to the masses as of right. Once eliminated (as it will be!), there will be negative sentiment towards the government.

Combining the over-supply factor along with the many people who will have over-extended themselves, you begin to see that there will be many builders, contractors, carpenters, laborers, plumbers, electricians, landscape gardeners, interior decorators and the like, who will not have as much work as they have enjoyed in the past. And remember, the grant was partially introduced to stimulate work in the real estate sector!

As I have written on numerous previous occasions, most government policies have the opposite effect of what was originally intended. Cities and countries that impose rent rise restrictions, limiting any increase in rent to the CPI index, (to protect innocent tenants from the ravaging claws of rapacious landlords) usually end up with higher rents hurting the very body of people they were intended to protect. Similarly, forcing schools to accept students from within their geographic school zone may be efficient from a commuting standpoint, but inevitably will effect real estate values within certain zones, as well as scholastic achievement, depending upon how desirable a school is.

It is not that the government policies are ill-intentioned. On the contrary, I think most politicians have an earnest, somewhat naïve view on what can be achieved through financial manipulation.

Why not eliminate poverty in a nation by giving every citizen 10 million dollars? The obvious answer is that the money would have to come from somewhere. The cost to the nation would be indescribably large in terms of inflation, devaluation of the currency, interest rates and so on.

If everyone sees that handing out lumps sums of 10 million dollars is ridiculous, why is it so difficult to grasp that handing out lumps of 1 million dollars, $100,000 or even $7,000 will have a similar downside effect?

There are two noteworthy differences between property investors such as ourselves and the politicians we are writing about.

Firstly, we can talk about politicians and criticize the incumbents, but if the economy goes sour, we don’t cop any of the flack. That makes it easy for us to talk! We should recognize that it’s the politicians who really do stand in the heat.

Secondly, when we do talk about what is best for the economy, we can do so devoid of any desire – or need – to make sure we still have a job after the next elections. In other words, how do politicians resolve the very real dilemma, that although handing out free ice-cream may be devastating for the economy and health of a country, it may also do wonders for their re-election campaign? The temptation must be there to buy votes, “Vote for me and we will give you more benefits, lower rents and higher subsidies.”

I would like to return to the original email quoted at the beginning of this newsletter and include the text of the entire paragraph…

“Why did you not mention the effect of the government’s First Home Owner’s Grant in Australia? That might have shed some light on the market in Australia where gearing is high and a lot of us are waiting for interest rates to rise so all of the people who took out loans on the back of a $7,000 grant from the government realize they cannot afford their new home.”

You see, whether or not the Home Owner’s Grant was put in place purely for altruistic reasons or as part of a re-election campaign, what matters most is how you position yourself in the face of known facts. The views expressed in the email above show good, lateral thinking. Always think outside the box. Even when your competitors get grants or perhaps because your competitors get grants, there will be opportunities for you to do extremely well.

Successful investing!

Dolf de Roos