We hear a lot about the free market, especially from those on the right side of politics.
Shrink the government, reduce rules and regulations, and just let the market set prices.
So how does the market set prices? What sets the price of a new laptop or television?
Well there are the production costs. The cost of the components and the labour to produce it. Then the business needs to set a margin above the production costs, for the business to sell at a profit.
But the business can’t just pick any high margin to sell at, because there are other makers of laptops and televisions. They’re subject to the laws of competition.
This is why laptops just keep getting better and cheaper. They’re subject to the laws of competition. That’s the free market, the so called ‘invisible hand’ at work.
Now to housing — but before we get started, we need to recognise, there are two components to housing.
It’s important to understand this.
There’s the improved value, basically the value of the house itself, and there’s the unimproved value, basically the value of the land on which the house sits.
Some people suggest you can’t separate the two values, or that it’s a difficult process to do so.
Well, I get a rates bill every year, and the two values are separated on my rates bill. My local council can seemingly to do the impossible.
Insurance companies can do it. For example, should your house burn down, the insurance company will replace the house value only.
The fact is you can easily separate the values. It’s done all the time.
Two Components of the Housing Market
If you can think of housing as having two components, it becomes easier to get an understanding of housing issues.
Land around all the infrastructure and services we enjoy is fixed in supply. It’s not subject to the laws of competition, like the laptop.
Therefore it just gets bid up to whatever the economy can afford. If the economy is booming and unemployment low, house prices get bid up to the red line.
And unlike the laptop example, land has no production value. It only has an exchange value.
So while the free market may operate in the land market, it works a little differently.
Land around the services we all enjoy will always sell at the red line. Housing has never has been affordable.
So building cheaper houses won’t make housing cheaper; it will only mean people can then afford to pay a little more for the land component.
When you look at housing from this perspective, you’ll see nearly all the government schemes designed to make housing more affordable will actually send house prices higher.
It’s not the house itself that rises in price. A house is a money drain; it requires constant money to upkeep. But it’s the land underneath that keeps rising in price.
But what can government do to lower land price?
Well you could look to our founding fathers of Federation. In 1901 they somehow found a way.
You see, they had a problem. They were to build a new capital city, somewhere between Melbourne and Sydney.
And the problem was this. What would be the first thing that would happen once the location of the new capital city became known?
They realised the first thing people (especially insiders) would do, is buy up all the land in and around the location of our new capital city.
The sheep paddocks could be bought for a song, and insiders could sit back and watch it rise in value over time.
So our founding fathers of federation found a way to take the speculative component out of land price.
And the bonus was that the funds raised by doing that would help fund the building of the new capital.
But their vision of 1901 never really came to fruition. Over time the vision was lost and badly implemented. Parliament House itself didn’t open until 1927. The span of time saw their original vision lost.
But the clues are there for anyone who wants to follow it through.
While land has a price, we must get the boom and bust of a real estate cycle. It really is that simple.
This cycle simply repeats in a set time frame and the sequence. It allows you to see the big picture of what is coming next for the economy. It’s profitable knowledge to have.
At Cycles, Trends and Forecasts we condensed that knowledge into our real estate clock. You can see that clock and find out where the economy is headed next by going here.
Lead Researcher, Cycles, Trends & Forecasts
From the Port Phillip Publishing Library
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