Empty homes: The economic reasons behind investors keeping properties vacant - Dr Cameron Murray


30/04/2017

Research by Cameron Murray on Catherine Cashmore's Speculative Vacancies report - interesting content for investors. 

Empty homes: The economic reasons behind investors keeping properties vacant
CAMERON MURRAY APR 4, 2017

Prosper Australia has for years been conducting research into how many of Australia’s 9.8 million homes are left vacant. Its major finding is that of the 1.7 million homes in greater Melbourne alone, about 82,000 are vacant, or 4.8 per cent. That research has been cited by a recent United Nations study on the pernicious effects of the financialisation of the housing sector, and has likely been a key reason for the adoption of a vacant housing tax, and probably in Canada as well.

It is timely, therefore, to consider some of the economic and practical realities of vacant housing.

Why keep property vacant?
 
What gets lost in the hype is this important question. Very few people understand the economic rationality behind leaving homes vacant, as the common sense view is that a vacant home is always costly since it is forgoing rental income for its owner.

Very few people understand the economic rationality behind leaving homes vacant. It often makes money for the owner. Photo: iStock

The answer is “options”. What I mean here are real options. That is, keeping the home vacant keeps open the valuable option of selling the property vacant and earning a higher price.

Say you have a property that could sell for $500,000 if there is a sitting tenant in place, or $520,000 if it is vacant (a 4 per cent price boost from vacancy). This means that the option to sell vacant is worth $20,000.

If you are considering selling in the near future because you want to time your exit from the market, then you may want to forgo rent in order to keep your option of selling vacant open. If the annual rent is $19,000, it might be worthwhile to forgo a whole year’s rent because it is less than the value of the option of selling vacant.

It’s difficult to know how many apartments are kept vacant because many are billed for utilities as a collective. Photo: Glenn Hunt

Quite clearly, if you are making this decision, you aren’t in the housing market to be a long-term supplier of rental housing, but to time your exit and cashing your capital gains.

This is why financialisation of housing, which encourages speculative buying and selling (getting most of your return from capital growth), rather than long-term investing (get most of your return from rental income), makes housing markets fail in their primary social function of supplying secure housing.

Related: Apartment glut could mean cheaper rents for tenants
Related: Nearly 20 per cent of investor-owned homes empty
Related: Top tips to make sure your investment isn’t empty
The same logic is at play with vacant land. Given that there is always a positive return to be had from developing land, the very existence of vacant land should be a puzzle. But it is, again, a real options problem.

Vacancies may sort themselves out when the market turns down. Photo: Louie Douvis

If I have a vacant site that I can economically build a five-storey building on today, doing so removes my option of making even larger profits from building a 10-storey building in a few years’ time when price make a larger building more profitable. This happens in the absence of any zoning controls, because as prices rise, a larger scale of development becomes more profitable.

So vacant land is only vacant because the landowner is waiting for their development options to increase in value.

But this can be stopped. In my example, if there was a zoning limit of five storeys, there would be no future option of building a 10-storey building, only a five-storey one at a later date. This makes the value of waiting less, and encourages faster supply.

A tax on vacant housing can act as a dampener on speculation. Photo: Penny Stephens

This is not just my opinion. Here’s an excerpt from a 1985 article by Sheridan Titman who asked this exact question and published his results in a little journal called the American Economic Review, in an article titled Land Prices under Uncertainty.

“It is shown that the initiation of height restrictions, perhaps for the purpose of limiting growth in an area, may lead to an increase in building activity in the area because of the consequent decrease in uncertainty regarding the optimal height of the buildings, and thus has the immediate affect of increase in the number of building units in an area.”

A ballpark estimate
The next question is to ask how many homes may be vacant primarily because of this speculative motive. Prosper uses water meter data to asses whether a property has been vacant. By looking at properties that have used no water over a 12 month period (25,000 dwellings), and those that used less than 50L per day over a 12 month period (82,000 dwellings), they make a judgment that these extremely-low-water-use homes are vacant.

Many investors would just keep the taps running if water use was used as a proper determinant in whether an apartment was vacant.

To answer how many vacant dwellings there are nationwide we can make a ballpark estimate by scaling up the results of Prosper’s research to other capital cities based purely on the relative size of the dwelling stocks. This method relies on the assumption that if it is logical for owners in Melbourne to keep that share of dwellings vacant, it is equally logical for owners in other states.

The reason to do this, rather than simply recreate the research using water meter data, is that in Queensland and NSW, apartments are not all individually metered for water, but metered only once for the whole apartment building. So their approach fails to catch vacant apartments when adopted to other areas. Using electricity usage data, or data from other utilities such as internet and gas, can also be troublesome, both in obtaining reliable data from utility companies, and making judgments about what constitutes vacancy.

When scaling up Prosper’s results from Melbourne, we can be conservative, and instead of taking the 4.8 per cent number as the share of vacant dwellings, take a clean 4 per cent. We can also make some other (somewhat) justifiable downwards adjustments for other states where the value of the “vacancy option” is lower because prices have been more stable. The table below shows this calculation.

Adjustments for national estimate of vacant homes

As a ballpark, about 300,000 our of 9.8 million dwellings are likely to be sitting vacant each year, or about 3% of them. For the last five years the country has built about 153,000 net new dwellings each year, so these vacant homes represent about two years of new supply at our recent historically high rates of dwelling construction.

So what?
What’s the big deal then? Two things. First, if you think that the supply side of the housing market is a major determinant of prices, having two years of new supply already built but sitting vacant is bad. Second, even if you don’t think this much supply has any significant effect on prices or rents (which I don’t, probably about 1 to 2 per cent at most) then the main rationale for concern is on economic efficiency grounds. These vacancies are a symptom of bad housing policy.

When the housing market turns downwards, much of this vacancy will solve itself as owners look to buckle down to ride out the downturn and generate the rental incomes instead of capital gains.

The historical data from Prosper’s Speculative vacancies report confirm this pattern. After the financial crisis, the speculative vacancy measure fell from 7 per cent to 4.4 per cent in the following four years, but since 2013 has begun to rise again as property prices started once again began to increase rapidly.

When the next downturn comes, those who are unwilling to accept the price they can get from their option to sell will probably take the option of renting instead, bringing a massive dose of new supply into rental markets.

In this context, a tax on vacant housing can act as a dampener on speculation, as it makes more costly the speculative option of keeping property vacant. In practice, Canada’s vacant home tax will rely on declarations by owners and spot checks to ensure compliance. This is really the only way. Relying on water data would simply encourage owners to leave taps on to avoid the tax.

But in many ways, speculative vacancies are a symptom of a poorly regulated housing market that is attracting speculative buying (undesirable) rather than long-term investing (desirable). We can use some of the underlying causes in a much broader way, such as by restricting speculative lending into the housing market in the first place, like by banning interest-only loans. With stable prices, only investor buyers looking to earn an income from renting will be likely to invest.

Dr Cameron Murray is an economist who specialises in property markets and environmental economics. He teaches at the University of Queensland, blogs at fresheconomicthinking.com and tweets at Rumplestatskin.

 


Return

Our Services

Buyer Advocacy

Buyer Advocacy

Whether you want us to bid at auction, or provide a comprehensive buyer advocacy service to search, asses and negotiate your ideal investment property or home, we tailor a plan ideally suited to your individual needs.

Read More
Development

Development

We have the expertise to assist with any type of development you are considering - large, or small - from concept to completion.

Read More

What our Clients are Saying

Catherine worked tirelessly in finding me a great property at a good price. She did things that I wouldn't have done (hours and hours of legwork) and more importantly, couldn't have done (organising the purchase before anyone else had even put in an offer). When I was ready to give up, Catherine kept working. I'm certain that I never would have been able to buy the same property within 10k of what we eventually settled at.... David
The expertise you bring are excellent and helped us understand the process and what to do and what not to do. You discussed at the beginning that by using you it will save us money and in our instance and the current environment of Melbourne’s market I believe you saved us $100,000 or enabled us to get into a suburb which going to auction would have gone way over our limit. You worked tirelessly to help us purchase a home.... Karen
“You impressed us from the start, especially compared with the other buyers agencies we approached…” - Raj

More Testimonials

Why use Cashmore & Co?

Our advocates and researchers are international experts on market and real estate cycles. 

With decades of experience working in the Australian real estate market Catherine Cashmore and her associates have lectured widely on the real estate cycle and the economics of investment.

Cashmore & Co use their expertise to assist investors, home buyers and developers.  They simplify the buying process saving buyers thousands in negotiation, as well as preventing costly mistakes.

Cashmore & Co's services and expertise will not only assist you to increase your wealth, but also educate you to become a better investor.

Please click here to see the range of services we offer. 

Or contact us for more information. 

About Catherine

Catherine Cashmore

Director

Herald Sun Pic .jpg

Catherine Cashmore has been working in the Australian real estate market for over 14 years. As a buyer advocate, she has assisted hundreds of Australian home buyers and investors to secure quality real estate for the best possible price. Originally from the UK, and having lived in the US, Catherine is a seasoned traveller who has extensive experience across a range of international real estate markets for those interested in property investment overseas.. 

As President of Australia's oldest economics organisation, Prosper Australia, Catherine is a regular and highly respected media commentator and often called upon to give guest lectures to university students (including RMIT and Sydney University) on how tax policy affects real estate, the design of cities and the economy.

She is editor of Port Philip Publishing’s 'Cycles, Trends, & Forecasts' – a publication that teaches real estate investors about the land cycle and its effects on the economy. She is author of ‘Speculative Vacancies’, the only study in the world that analyses long term vacant housing based on water usage data (Melbourne focused). As such Catherine has an in depth knowledge of the Australian real estate market, few can rival.

You can contact Catherine directly on 0458 143 089 or at cc@cashmoreco.com.au

 

 

Meet the Team

Please contact us for more information
or call us on +61 458 143 089

Contact us for More Information

Contact Us