1.      Executive Summary

The purpose of this report is to evaluate the property market in Sydney. To accomplish this, the report will investigate the cause of the risein property prices, identify main stakeholders, as well as identify key economic concepts. The report will recommend alternative solutions to curb theissue. Information in the report has been gatheredfrom various sources, includingthe Sydney Morning Herald.The findings show that the increase in the property prices can be attributed to low-interest rates, Speculative behavior by investors, and increase in population growth.The report recommends that the RBAincreases banks discount rates, thegovernmentapply price control policies,and, or provide lost-cost affordable housing. The report also recommends that the government reduces the prices of factor inputs such as taxes, levies and charges.

2.      Introduction

The prices of properties in Sydney have unpredictablyincreased.This has resulted in negative impacts on the socioeconomic well-being of people, as well as on the economy. Housing is very valuable to many households. In evaluating socioeconomic well-being and living standards of people, Stafford & Black(2013) state that governmentconsider home ownership a key element. It not only provides independence, but also privacy and security.This report describes the main issues associated with an increase in the price of property in Sydney, identifying the stakeholders and how they are impacted. Additionally, the report will discuss associated economic concepts and recommend alternative solutions to the problem of high property market prices.

3.      Description of the Main Issue

Housing is a critical factor that affects the social wellbeing of most people.It provides good economic and social environmentsvital for wealthand political stability.It is not simply shelter, but an essential partof Sydney’s economic infrastructure. While home ownership is a goal for most households, increasingly it is becoming unaffordable. The increase inthe property pricesin Sydney hasincreased the price paid by first time home owners. Prices have soured16.2% in 2015, with the median cost of new land lots rising by more than $100,000(Duke, 2015). This has madeSydney the most expensive city to purchase new land in Australia (Duke, 2016). This has resulted in first time home buyers fleeing the market, while investors are flooding, in anticipation ofhigher returns. However,Wade(2015) warns that the highprices and overvaluation of may result in a bubble burst. This is especially likelyifnominal property prices drop and is coupledwitha drop in theproperty’s real prices, which according to The Economist Magazine, can result in more adverseeffects on the general economy, than when a stock market collapses.

4.      Description of the Impact on Stakeholders

4.1 Government

The increase in property prices denies citizens access to affordable housing. However, it has positive impacts on the macroeconomic front. According toMuth & Goodman(2013),increases in aggregate prices in the property market tend tohave a positive impact onreal GDP.The authors add that in developed economies, the real estate industry is a valuable investment asset.As such, when prices in the propertyincrease above the cost of construction, it spurs growth in the building industry. This boosts the government’s efforts to reduce unemployment by creating employment opportunities and boosts the demand in property-related sectors.

4.2 Investors

A rise in prices in property market raises the expectations of investors on the returns on their investments.Investors are also encouraged to further invest in the industry as the cost of debt capital is comparatively low,relative to the anticipated rate of returnon investment in the property. This has the spiral effect of encouraging more and more investors to invest in the property market. However, asWade(2015) states, if there occurs a bubble burst and the properties reflect their real price, they will loosea lot of their investments.

4.3 Home Owners and First Time Buyers

First time home buyers and home owners will be affected increase in the price of properties in different ways.For homeowners, price increase will give them feelingsof being wealthier, as such, and according to the permanent income hypothesis of the life cycle model (Altman, 2015), theywill increase consumption.However, First-Time homeowners will decrease their private consumption and increase savings. This is because they will need higher initial house deposits as well as higher mortgage payments.The aggregate wealth effect of the change in consumption and savings to the macroeconomy will depend on their respective marginal propensities.

4.4 The Financial Industry

Australia’s financial system was deregulated in the 1980s’, removing government controls over the financial market. An increase in prices in the property market will give banks confidence in the property market,this will make them loosen financing conditions for investors in the property market. This will increase housing demand and prices in the property market. However, it will negatively affect financial institutions if the property market bubble bursts asWade(2015) warns leaving banks with many non-performing loans and high loan defaults rates.

5.      Economic Concepts Relevant to the Case

5.1 Government Intervention

In any economy, it is the role of the government to safeguard the interests of the public where market forces of demand and supply favor one economic agent or there ismarket failure. When the prevailing price is not reflective of the value of a basic good, the government is tasked with intervening through policies such as fiscal policy or price control policy (Muth & Goodman, 2013). The increase in the prices of properties may denote an artificial equilibrium position where in real terms is a disequilibrium position. Therefore, it would be prudent to intervene to ensure that equilibrium is restored,safeguarding economic agents from exploitation.Stafford & Black(2013) suggests that to address an issue of disequilibrium, a government can intervene by employing price control policies, or using fiscal tools such as taxes, levies and charges.

Price ceiling involves the government setting a maximum price (P^c) on the price of goods and services which is below the equilibrium price (P^e). This government intervention ensures that when market the market equilibrium price is exploitative to the consumer, the consumer is cushioned against the exploitative prices.

5.2 Investment Demand

Investor confidence in the housing market in Australia has been high since the mid-1990s, resultingin increased investment in the sector. Accordingly, investor-landlords became important drivers of therise in property prices in Australia. According to ex-ReserveBank of Australia governor, Ian Macfarlane, beginning early 2001, investors had powered the persistent inflation in the housing market, sustained by generous tax benefits. Institution reforms, tax benefits, growing Rental income, socio-demographic factors, and development of the capital markets and economy have further increased investment demand in the Sydney property market.

5.3 Monetary Policy

For any given pricelevel, low-interest rates indicate even lower mortgage payments. This allows borrowing at any given repayment-income ratio. This triggers increase in demand in the property market and a rise in housing prices.Contrariwise, an increase in the bank interest rates, the cost of capital goes up, discouraging borrowing. This eases property demand, allowing prices to remain stable. In Australia, interest rates have remained low over the years to promote aggregate demand and reduce unemployment, but have contributed to increasesin property prices.

5.4 Macroeconomic Climate

The economic environment in Australia has been favorable and stable. Key macroeconomic indicators such as inflation, CPI, unemployment,GDP have been well under control. Themedian income has alsorisen. Therefore, outlooks among house owner and investors have been positive. These macroeconomic indicators have resulted in a rise in the demand and price of property.

5.5 Fiscal Policy

All the levels of governments in Australia impose some form of tax, levies or charge on the use and development of urban land. Most of the time,these costs add to the final price of property and passedto the buyer. In Sydney, these costs include stamp duty on the sale and transfer of land, developer levies, land tax, and GST. These costs contribute to the high property prices.

5.6 Excess Demandand Supply Shortage

Demand for housing is a major determinant of the housing price. Migrants and population growth results in an increase in the number of householdsin demand ofhousing resulting in excess demand for housingand a shortage in supply. This leads to an increase in property prices.

From Graph 1, excess demand causes the demand curve to shift outwards and to the right from D to D₂this causes the market equilibrium to shift from E to E₂ while the equilibrium property price increases from P₁ to P₂. From Graph 2, a shortage of property supply causes the supply to shift to the left causing the market equilibrium to change from E to E_2, this results in an increase in equilibrium price from P₁ to P₂. Therefore, in both cases, excess demand or supply shortage results in an increase in property prices.

6.      Recommendations for Alternate Responses to the Issue

6.1 Setting High-Interest Rates

The Reserve Bank of Australiacanapply monetary policy to address the imbalances in the property market. According toSterne & Mahadeva(2012), monetary policy tools are effective in influencing the amount of liquidity in the economy. RBA can undertake contractionary monetary policies using Cash Reserve Ratio, Statutory Liquidity Ratio, and Open Market Operations, but mostly the Discount Rate. RBA can increase the interest rates, raising the cost of capital. This will discourage borrowing, and reduce demand for property, and subsequentlyproperties prices.

6.2 Price Control

According toStafford & Black(2013)price ceilings are a common instrument of competition policy usually employed to protect economic agents fromexploitation. In this case, governmentscan put a price ceiling on the property market. This will prevent investors from pricing properties above their real value.While such a policy may have the negative effect of reducing the number of investors, it will protect first time home owners from exploitation making housing affordable. However, it is upon the government to assess whether the negative effects are large enough to be worrisome, or whether the social good achieved makes it worthwhile.

6.3 Government Low-cost Housing Schemes

Housing affordability can be improved by not only targeting the supply side but the demand side as well. Towards this, the government can increase the supply of low-cost housing. Additionally, the rate at which new land and housingare brought to the market can be increased to ensure that the increase in demand is matched proportionately by availability of property. This will stabilize the property market. Alternatively, governments can increase their allocation of stamp duty concessions, Federal Government First Home Owners’ Grant, or cash assistance.

6.4 Reducing the Prices of Factor Inputs

The government can reduce the prices of interposing factors that contribute to the final price of property prices. It can ease housing affordability by reducing taxes, levies andcharges.

7.      Conclusion

This report has presented the main issue associated with the continual unanticipated increase in price in the property market in Sydney. It has identified the stakeholder and how they are affected by the high prices of property in Sydney. Also, the report has discussed key economic concepts and conceptions related to the property market and concluded by recommending alternate probable solution to the identified problem.

References

Altman, M. (2015). Handbook of Contemporary Behavioral Economics: Foundations and Developments. New York, NY: Routledge.

Duke, J. (2015). Sydney property prices up 16 per cent over the financial year. Retrieved from Domain: http://www.domain.com.au/news/sydney-property-prices-up-16-per-cent-over-the-financial-year-20150701-gi2462/

Duke, J. (2016, March 8). First-home buyers dreams dashed as Sydney land prices jump $100,000 in a year: UDIA. Retrieved from Domain: http://www.domain.com.au/news/firsthome-buyers-dreams-dashed-as-sydney-land-prices-jump-100000-in-a-year-udia-20160307-gncrgf/

Muth, R., & Goodman, A. (2013). The Economics of Housing Markets. Oxon, OX: Taylor & Francis.

Stafford, D., & Black, J. (2013). Housing Policy and Finance. New York, NY: Routledge.

Sterne, G., & Mahadeva, L. (2012). Monetary Policy Frameworks in a Global Context. New York, NY: Routledge.

Wade, M. (2015, February 14). What goes up… Rate cut reignites housing market, but economists warn of bubble. Retrieved from Sydney Morning Herald: http://www.smh.com.au/nsw/what-goes-up-rate-cut-reignites-housing-market-but-economists-warn-of-bubble-20150213-13dxas.html

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