The house and land value trap

By Leith van Onselen

Last month, I wrote an article in MacroInvestor entitled Beware the house and land value trap, which examined the pitfalls of buying new house and land packages on the fringes of Australia’s capital cities.

The article was particularly critical of measures adopted by Australia’s property developers aimed at reinvigorating new home sales by offering generous incentives to new buyers, such as giving away new cars, offering large cash-backs, free landscaping, or paying a buyer’s energy bills for three years when they buy a new house and land package (see below examples).

By offering such giveaways, developers are effectively offering buyers of house and land packages big discounts without reducing the face value of house and land contracts.

However, such incentives are also precluding the new home market from functioning properly.

A buyer of land that comes with an incentive, such as a new car, pays stamp duty on the higher contract price, resulting in more stamp duty being payable than if the price had been lowered by the amount of the incentive. Moreover, when the buyer seeks finance, the bank is more likely to value the property at a lower level than the contracted price, thereby reducing the amount that the bank will lend and effectively increasing the borrower’s required deposit.

Indeed, earlier this year it was reported that bank valuations on new house and land packages were coming in -15% below developers’ sale price valuations, meaning that new home buyers were being forced to contribute 15% more funds (on top of any housing deposit) in order to cover the valuation shortfall, or forfeit the sale.

With new home sales continuing to struggle, there are now growing calls for the industry to abandon incentives in favour of transparent land price deductions. From Chris Vedelago at the Age:

DEVELOPERS are being urged to end discounts and giveaways for new home purchases as concerns mount that the incentives are distorting the market and making it tougher for first home buyers to get financing.

The call comes as research shows the typical block of land now includes nearly $13,000 worth of developer incentives, pushing the median price below $200,000 for the first time since the first home grant-fuelled boom of 2010.

But some industry players warn that what began as a temporary measure to boost demand during the property slump is causing a growing number of buyers problems as valuations fail to stack up.

”The rebating has caused an enormous amount of confusion for buyers and valuers about what the purchase price of the land is exactly – does it include or exclude the rebate?” said Sam Tamblyn, managing director of valuation firm Urban Property Australia.

”Valuers are taking it to be the net price [without the rebate]. That’s causing problems for purchasers with their loan-to-value ratios and deals are falling over.”

With financial institutions reportedly reluctant to lend on the face value of the contracts, first home buyers are being forced to provide additional equity to cover the discount. Those who can’t make up the difference are defaulting on the contracts…

Australand general manager Rob Pradolin said incentives had become so pervasive it was time developers recognised that prices had effectively come down and adjusted accordingly.

”I’m calling on the industry to recognise where prices are, set them at that level without incentives and start selling value again,” he said.

”It means customers will pay less stamp duty – making it even more affordable – and there’ll be no surprises when buyers go to the bank.”

Australia’s property development industry appears to be caught in a pincer. If they don’t abandon incentives in favour of transparent land price deductions, financing of new house and land packages will remain problematic and sales will likely continue to struggle. At the same time, reducing the listed price by the same value as the bonuses and incentives being offered could lower their collateral value, potentially triggering the banks to call in more equity from bank-financed developers to bring their loans back to agreed conditions and/or loan terms. Straight price cuts are also more likely to aggrieve recent purchasers that paid higher prices.

Ultimately, the core problem with the new house and land market in Australia is that prices remain above what many buyers can afford or are willing to pay. And until prices deflate, the rate of home sales and construction activity is unlikely to rebound materially, leaving Australia’s property developers holding large land banks that they cannot offload.

Twitter: Leith van Onselen. Leith is the Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.

48 Responses to “ “The house and land value trap”

  1. Neznam says:

    Is the median price in the graph for Melbourne/Victoria only as that was the impression I got from the Age article ?

    The next stage may be to offer stamp duty incentives so that the cost is lowered but the price remains the same.

    • The Patrician says:

      +1 on the poor labelling of the graph.

      I’m not convinced they haven’t got the line labelling ass-about. Mind you it is so ambiguous, it’s hard to tell.

    • raveswei says:

      Government is actually doing the same thing with FHBG and reduced stamp duty. I see FHBG same way as giving away a car, or cash-back.

      With all the other incentives (CGT, NG, RA, …) government is just precluding market from functioning properly. Without these interventions there will be no major macroeconomic issues related to housing market.

  2. The Patrician says:

    Sweet music.

    A functioning price mechanism.

    One day there is a floor…the next there isn’t

    Is it too much to wish for?

  3. thomickers says:

    *Pop!*

  4. Peter Fraser says:

    The giveaways are completely counterproductive at the low end. Builders have always advertised small incentives such as a kitchen appliance upgrade that is really priced in anyway, but for base level homes giving away cars doesn’t help when it comes to considering finance.

    At the high end it might appeal to some to get a seemingly free car, but if the buyer of the land and home package doesn’t have plenty of equity in the build, then problems are quickly encountered.

    If you are an FTB looking to buy a house and land package, avoid the gimmicky sales pitches. Look at what the land and construction cost will be in total, and if that isn’t equivalent to the sale prices of similar homes in the area that are only one year old, then the property just won’t value up and you might get stuck with a block of land that you have to meet payments on whilst you also pay rent. That can be a real drag on finances if you’re trying to save a deposit for the construction.

    My persoanl opinion is that FTB’s with limited deposits should stay away from house and land packages in the current market, that avenue should be for the upgraders with some capital, but with the current incentives to build a new house, I’m sure a lot will be drawn into this avenue.

    • The Patrician says:

      Is there much of a market in 1yr old homes?

      • Peter Fraser says:

        A valuer has to give the bank a realistic estimation of what might be a recoverable value if the loan went pear shaped. When he values the end product, he will look at what near new homes are selling for in the area – the best comparison available.
        If those homes are of a comparative size and value, and they selling below the total land and build price, then the valuer will bring in a valuation that is lower. What else can they do, they are paid to rate an asset that the bank will be relying on as security for their loan.
        Their job is easy in a rising market, but it’s quite difficult in a falling market.

      • Bubbley says:

        Sage advice Peter, thank you.

    • dumb_non_economist says:

      Wouldn’t the contract fall over if the buyer didn’t get finance for house + land? I can understand if a buyer was buying just a block and intends to build as my sister was caught out recently having made an offer for a block while chasing H + L finance, there was trouble getting a fixed price contract on the build and without my sisters knowledge the broker told the bank to disregard the house component and to issue approval for finance on the land only, which they duly did! When she confronted the broker the response was if you can’t get finance for both, you can just sell it!

      • Peter Fraser says:

        Well that really sums up the problem. I can’t comment on your sisters case because I don’t know the details, and nor do I want to.
        People seem to misunderstand what they are doing – they think that they are getting a “one package” deal but it’s actually two contracts. One contract to buy the land and one with a builder who is a completely separate entity.

        The crux of the problem is that a valuer simply cannot arrive at a valuation for both the land and the end construction value without a full set of plans and specification with a list of all inclusions (ovens, hotplates, light fittings, floor coverings etc)

        To provide that is a significant cost for the builder, so they won’t until you sign the building contract and pay a deposit to cover their cost, and that is when you are really past the point of no return.

        People naturally spend a lot of time over the selection of their house, colours, fittings, alterations etc, but that time can cost them dearly – they can end up with the land as your sister did, and then not be able to build because the value of the land has dropped, and they can’t cover the LVR shortfall.

        I had a recent discussion with a valuer for a construction, I think it was at Point Cook. She kept saying that the contract price was about right, but she wouldn’t value the house at the contract price because almost new homes in the area were being discounted quite a bit to sell.

        It’s a problem in this market that may cause the RBA’s plans to come unstuck if they don’t counter it. I’m sure that it can be overcome, but until they do get it right there will be some tears amongst FTB’s. An FTB might only be $5000 short, but that’s a lot of money if they don’t have it, and to not proceed means walking away from the 5% deposit that they have already paid on the building contract. Any additional borrowings won’t impress the bank who may withdraw their approval, especially if it affects their ability to service the debt.

        Catch 22.

      • The Patrician says:

        “She kept saying that the contract price was about right, but she wouldn’t value the house at the contract price because almost new homes in the area were being discounted quite a bit to sell.”

        Doesn’t that mean that the contract price is NOT “about right”

      • Peter Fraser says:

        Possibly but not necessarily. It might cost that much to build with a fair margin for the builder, but the resale prices might not support it. The valuers job is to protect the banks asset position, house by house.

        When demand for new builds falls away, contractors, sub-contractors, building material suppliers, everyone has to start shaving their prices. In the early stages there is little that an individual builder can do until it is forced on the industry as a whole.

        The same applies to land subdivisions. If the owners of large subdivisions go into liquidation, those blocks will probably be bought for much lower prices as an “in line” transaction where all of the subdivision will be purchased as a whole.
        Those blocks will then be marketed for lower prices, but that scenario will only occur if the market collapses. In the right circumstances the market for subdivided vacant land can collapse almost overnight – or it may never happen. Vacant land has no income, it’s a cost to hold.

        I’m not trying to sound bearish, it’s just what can happen in the right circumstances. If the RBA are trying to drive construction I can’t see that happening, but one day it will and you will recognise it.

      • Gen Y Ranter says:

        To me this means the land portion of the home is overvalued,simple as that.

      • The Patrician says:

        The true value of a property is not what it cost to build but the highest bidding purchaser is willing to pay. That may be above the land + build cost or below.

        Construction will be stimulated when prices adjust down to meet demand and people start buying again.

      • Barell77 says:

        “I had a recent discussion with a valuer for a construction, I think it was at Point Cook. She kept saying that the contract price was about right, but she wouldn’t value the house at the contract price because almost new homes in the area were being discounted quite a bit to sell.”

        I think what the valuer might have been trying to say is that the building contract price is reflective of what they would expect a house of that size/quality to cost ie $1,200/m² when compared to other building contracts they have seen in the area.

        However when the valuer is completing their analysis of the comparable sales for the valuation ‘upon completion’ the valuer is comparing the proposed build to already completed homes that have sold (ideally through a local agent and not developer house and land packages). If the sales of similar homes are only reflecting a rate of $1,000/m² then this is what the valuer would adopt, not the cost rate of $1,200/m². Remember cost does not always equal value.

      • Peter Fraser says:

        Absolutely correct – costs do not equal value. Many renovators have found that out to their peril.

        When owners spend $100,000 on a high spec kitchen, it only adds about $20,000 in value.

        Alternatively some people can spend a minimum and add a lot of value – it just depends.

        A coat of paint and mow the lawn is always a good value add, but any structural work is money lost usually.

      • Mik says:

        Makes our house and land we bought at $25/m2 a bargain. (yes twenty five) and only a 50 min drive to CDB in rush hour traffic.

  5. tsport100 says:

    “remain above what many buyers can afford or are willing to pay” HUH?

    That can’t be true as sales home-and-land sales are bouncing along the bottom!

    Even with stamp duty concessions ONLY on these new home FHBer deals, there’s no interest!

    Isn’t the margin call scenario the REAL truth here??

  6. persnickety says:

    Huh, and here I thought you might talk about the value differential between the easy commute and the hard commute.
    One of the biggest factors keeping me out of those estates is the potential commute time. My time is valable (to me) and time spent on the commute is in many ways a cost that buyers forget.
    Conservatively, a commute from the outer suburbs as opposed to my current location is an extra 45 minutes each way. that’s an hour and haf of my time. On a conservative basis living in such an area over a 15 year eriod would cost me about 160k over all. Throw in my husband and we are looking at $325k. And that doesn’t take into account increased travel costs. In order to justify buying, the house and land would need to be over 400k cheaper – just to cover the commute difference. A free car doesn’t exactly cover that.
    While I can’t be the only one thinking this, I do seem to be in a minority. I wish I wasn’t, maybe some of the FHB grant money would go towards better transport options and some incentives to put alternative CBDs around our cities, not concentrate everything in place.

    • Exactly. Land prices on the fringe are above what many buyers can afford or are willing to pay. If a typical fringe block fell from $200k to $75 to $100k, then the value proposition (including commute costs, etc) would stack-up for a lot more buyers.

    • thomickers says:

      I know someone in Sydney who’s commute to the CBD is 2 hours each way (2 months/yr in the car)

    • aj. says:

      P people just don’t seem to think about it rationally. Its actually worse than you present: If most people sleep for 7, eat/shower etc for 3 and (conservatively) work for 9 then you are already at 19 hours. That leaves 5 hrs for personal time.

      People adding another 1.5hrs commute are taking away 30% of their available time. Nutbags!

      • It’s wrong to assume that the majority of people living in these estates commute to the CBD for work. Many would likely be tradies or other professions that live relatively close to where they work and many would not catch public transport even if it was available.

        The majority of the population does not work in the CBD or surrounding inner-city suburbs.

      • persnickety says:

        I would be interested to see the numbers on this (although i doubt that they are collected). Most of the people I know (through work and external social ties) who are out in the outer burbs do work in inner suburbs. But then i live and work in those inner suburbs, so my range of knowledge is limited.

        Then if you do have a job close to your suburb and want to change there are issues. This is where the poorly thought out transport issue comes up. Many of the great global cities have what i think of as spiderweb transport- concentric rings with lots of linking lines- so going two or three suburbs over is as easy as heading into central districts. Australia mostly has the all lines lead to central nodes approach. This ties us so firmly to the one central business district and limits a lot of efficient urban development.

        An ex-coworker of mine lived in one of those outer burbs because it was “cheap”. She did work in the city, and sent her son to a private school in the inner suburbs. She spent a lot of time complaining about her commute, and her sons 2 hour bus trips home, because there was no direct line. Then again she also thought that investing in Detroit real estate (with 0 knowledge of the market, just because it was cheap) was a good idea.

      • [email protected] says:

        There most certainly is data that illustrates where people live and work, and even how they travel to and from work. It is called Journey to Work data. For NSW, the Bureau of Transport Statistics provides excellent interactive features to access this data http://www.bts.nsw.gov.au/Statistics/jtw/default.aspx#top . Admittedly, it will be based on 2006 census. I imagine 2011 Census JTW data will be released sometime next year.

      • Explorer says:

        About 10 years ago, only 10% of people who lived in the Sutherland shire in southern Sydney worked in that shire.

        The secret is to move the jobs to the middle and outer burbs.

        But surely people who are buying houses take these things into account, although pre 2009 the growth in property values was such the trick was to buy and spend as much as you could afford.

        Travelling extra to get a cheaper property is like working a second job to get a better property in some ways.

      • richierm says:

        Don’t forget road Tolls!! A mate of mine lives out near Cambelltown and commutes to Sydney. I saw an article about the NSW government looking at charging tolls based on length of travel, not just point based tolls….for some people this would dramatically change their cost per week and surely this would affect their house value in some way also?

        Considering the various Government’s need to raise more $$, these types of additional costs would have to factor in people’s purchase ability and therefore the value of some of the homes in the fringes!

      • Bubbley says:

        So the poor get pinged again.

        Doesn’t seem fair does it.

      • Mik says:

        depends doesnt it, we move 50 minutes away (it could even take that to get to the city from Point Cook sometimes) but then again we only work 2 days a week and we moved from the burbs for the lifestyle.

    • JC says:

      Good point. Personally i live 9km (direct line) from the CBD here in Perth and i couldn’t imagine living much further away as my commute (just west of CBD) is already annoying. I leave early (7:15-7:20am) and it only takes 15-25 minutes to get to work.

      I feel sorry for people who live in McMansions in suburbs like Iluka (beachside) 32km north of the CBD, who have to commute that far to get to work. That would be exhausting. If someone offered me residence in a Palace that far away i’d say no thanks.

      Imagine working a 10 hour day, then tacking on 2+ hours for the commute. You wouldn’t have the time or inclination to cook a decent meal or do any exercise, or have any time to yourself.

    • The Claw says:

      Huh, and here I thought you might talk about the value differential between the easy commute and the hard commute.
      Even the dumbest real estate agent knows that property is all about location location location.
      Yet shortage-deniers like to disregard this simple fact. When an immigrant buys a decent house near work for $800k and leaves 2 or 3 distant houses available to me for $600k – this does not solve my problem.
      Travel costs real money in fares, fuel, parking etc. This cannot be disregarded to prove some kind of oversupply.

      • Rusty Penny says:

        and leaves 2 or 3 distant houses available to me

        Erhh, if there was a shortage, there’d be no houses available to you.

        That’s the definition of shortage.

        Now the pricing mechanism may be broken, but thats not due to a shortage.

      • “Now the pricing mechanism may be broken, but thats not due to a shortage.”

        No, it’s due to policies that pump demand and restrict land supply, creating a nasty feedback loop of panic buying and speculation.

      • dillegance due says:

        Sorry Leith.
        Even after feeling the intense heat of PF’s fine intellect about this issue yesterday, I remain unconvinced.
        House prices not crashing or slowly melting or going sideways does not necessarily equal housing shortage.

      • The Patrician says:

        +1 As far a I can tell the price mechanism is broken primarily by the ability of developers to hold new land/dwellings at a effective floor price until the demand comes back to meet them. This is achieved through a combination of factors including, but not limited to, an accomodative tax structure, collusive price setting amongst the big developers and the banks and a highly developed RBA/govt/media lobbying mechanism that is able to stimulate demand when required.

      • Mav says:

        TP. You forgot overseas investors who, according to HRH Triguboff, form 90% of his buyers. Admittedly, this figure may be lower for house/land packages.

        But the impact is that the local supply/demand to price linkage breaks down and things go crazy for a while.

      • The Patrician says:

        Mav,
        Not forgotten. You can include the overseas investors as part of the demand pool I referred to, that can be stimulated by various means when required.

    • Alex Heyworth says:

      What you may be forgetting is that a lot of people never commute to the CBD – in fact some never commute at all.

      Around 90 per cent of commuter trips these days are not to the CBD.

      A house on the fringe makes a lot of sense if you are a tradie. Your work is right next door.

      • avexdevil says:

        in addition to an already sluggish economy, you’ll be experiencing even slower growth in property value. It’s the notion of living in the vicinity of the CBD; irrelevant if you were fhob looking for a roof over your head, a whole different story if you were looking to ride the low interest rate wave of what many claim to be ‘the best time to buy’.

      • persnickety says:

        A lot of commuter trips may not be to the CBD, but they will usually be by car because there is no public transport.

        While tradies may need to commute by car because they need the tools of the trade, the majority of workers are not tradies.

        One of my issues (and I am in Brisbane) is that most suburbs are a lot of housing, a little bit of commercial and a little retail. there may be more industry, or a few more commercial enterprises, but there isn’t much. External activity centers are very concentrated- big shopping centres- one on each side of the city and the general CBD. This places significant upward pressure on the housing areas close in.
        I have spent too much time in larger cities (Paris, Tokyo, London) where there may be a central business area, but there are mini business areas all over the city, and recreational areas- so one can live, work and play in a single suburb. Brisbane- not so much.
        When you get on a morning train here, it gets fuller heading in to the city, disgorges 95% of the passengers in the city and remains empty on the outbound run. Board a train in Tokyo and the passengers will ebb and flow- so that while many may get off at one station, nearly as many get on.

    • Explorer says:

      But if you pay more to be closer to the city/employer to benefit from the reduced commute and have to borrow the extra you then have to pay interest on the extra borrowed and that also mounts up to a lot of money over 25 years.

      With little to no growth in prices maybe the best strategy is to live simpler, borrow less and pay off faster to reduce non-deductible interest expenses.

      • Rusty Penny says:

        Or emmigrate…. that’s a pretty cheap alternatives.

        A skilled tax payer is a valuable commodity… Australia isn’t necessarily the most deserving of them.

  7. Neznam says:

    There might be some land going cheaper if building companies continue to go bust.
    http://www.smh.com.au/business/another-nsw-home-builder-collapses-20121114-29bbo.html

    • Mav says:

      Oh dear, one more building company for the RBA to rescue.

      One building company goes bust EVERY week like clockwork and RBA still proposes to have a construction boom replacing a mining boom?

  8. Junkyard says:

    Sounds like Australand is a lot less leveraged that it’s competitors ;)