The Australian government has announced increased scrutiny around foreign investment in the country’s property market to provide “a level playing field” for homebuyers and to make sure foreign purchases serve the country’s national interests.
The recent reform not only introduces new rules, but also seeks stronger enforcement of new and existing ones amid widespread evidence of abuse of current regulations, and growing public concern that wealthy foreign investors, mostly from Asia are pushing up prices, worsening affordability for Australian families, especially in capital cities.
New rules and tougher enforcement
There have long existed such foreign investment policies and regulations to restrict foreign purchase of existing residential property.However, in the lower penalties and poor enforcement environment, foreign investors could avoid being caught or circumvent restrictions with the help of experienced agents and accountants, or even pay the required low fines to keep the property.
Now it is all different – who will enforce, how will enforce and what will be enforced.
First of all, the responsibility to enforce new and existing rules in the area of residential real estate is switched to the Australian Taxation Office (ATO) from the Foreign Investment Review Board. ATO already has a register of taxpayers and is better resourced to use its data-matching systems to identify possible breaches and wrongdoers.
Secondly, penalties are stricter and heavier to make it “worth” for the government to pursue those foreign investors who breach the rules. In simple English, if the fine is $1, it is not worth for the government to spend $10 to catch the wrongdoer to enforce the required fine.
Under the new arrangements, those breaching foreign investment laws will face three-year jail terms in aggravated cases, or fines of as much as $127,500 for individuals and $637,500 for companies.
Third parties, such as developers, real estate agents, lawyers, accountants etc. who assist foreign buyers in illegal purchases will, for the first time, be subject to civil and criminal penalties, including hefty fines of $42,500 for individuals and $212,500 for companies.
Temporary residents who break the rules will face fines of about 25% of the transaction.
The wrongdoers will be issued disinvestment orders, complemented by civil pecuniary penalties and infringement notices for less serious breaches. In this way, illicit buyers will be prevented from making a profit on the forced sale of a property and will be fined 10% of the transaction value.
Foreign investors will continue to be allowed to buy new residential properties since the government well understands the importance of overseas investment in increasing housing stock, and eventually leading to more availability in the secondary market.
However, the government thinks stricter rules alone don’t create “a level playing field” because there are costs to assess and approve foreign investment applications.
So, screening foreign investment applications will no longer be funded by Australian taxpayers, instead there will be an application fee for a foreign investor to enter the market. A $5,000 application fee is payable by a foreigner buyer for residential properties worth below $1 million. The fee will increase to 10,000 for properties valued over $1 million, and a further $10,000 fee will be charged per additional $1 million in property value (the total fee will be capped at $100,000). Higher fees will apply to business, agriculture and commercial real estate applications, as well as acquisitions if the property is in strategically sensitive sectors such as telecommunications, transport, defence etc.
As changes affecting other sectors is not in the scope of this article, if interested, more detailed information can be found at the bottom of the announcement
Moratorium
The Government will introduce legislation into Parliament in the Spring Sittings and the changes will be enforced from 1 December 2015.
As Treasurer Joe Hockey announced, a moratorium will be in effect until then to encourage rule breakers to turn themselves in. So, the government wants the overseas investors to sell their illegally obtained properties by November 30 to avoid prosecution.
This delay allows the government not to scare away foreign investors for what government turned a blind eye and didn’t enforce. It allows investors to sell and invest in new developments here in Australia without losing much. Just like hey investors, let's start again … from scratch.
Housing affordability
Australian families have among the highest home loan debts in the world - 194% of annual earnings - at its highest point since 1960, according to data from Barclays.
Kieran Davies, chief economist at Barclays PLC in Sydney, was quoted by The Wall Street Journal as saying the current trend will put homeowners and lenders at a more vulnerable position, especially in the case of a predicted rise in unemployment.
Now that the Reserve Bank of Australia keeps interest rates low (to stimulate economic growth ), debt levels are expected to increase further as people borrow more and more to invest in residential estate.
In parallel, risks of home loan defaults in big cities such as Sydney and Melbourne are high and still growing as climbing property prices are combined with larger loans and worsening affordability.
According to Moody’s Australian Housing Affordability Measure, which gauges the share of income needed, on average, to make monthly mortgage loan repayments, affordability has worsened in both Sydney and Melbourne over the past year against the backdrop of soaring home prices and relatively flat household incomes.
Housing affordability remained steady year-on-year nationally as at March 31, 2015 with households spending 27% of their income to repay their mortgages, slightly below the 10-year average.
In Sydney, families spent 35.1% of the income on home loan repayments during this period, higher than the 10-year average and up from 32.8% in 2014.
Housing affordability improved in Perth and Brisbane while Adelaide kept it steady.
Affordability is a complex phenomenon, which is not significantly changed by price crash, supply, demand etc.
For example, there has been plenty of talk in the media about the bubble and price crash when the bubble bursts. However, price crash is not as good as it sounds.
In the study involving the implication of house price crashes on the GDP in a number of countries since 1973, Moody’s found that in nominal terms price crashes in real estate markets tend to be smaller than commodity and equity price downturns, although they usually last longer.
With inflation adjustment, the average fall in home prices in real terms during a crash is around 26% (16% in nominal terms) and a downturn can last around 4 years, the Financial Times reported on the findings of the study. This may affect GDP significantly. The study estimates that GDP decreases by 4% per 10% fall in real home price levels in advanced economies such as Australia.
As the Reserve Bank’s head of financial stability, Luci Ellis, said housing price crashes do not eventually improve affordability because the capacity to pay also decreases.
The main reason why Australian property has long been a popular choice for foreign investors is that prices are rising and attractive, especially now due to low Australian dollar. If the market drops in the eye of overseas investors, they will lose their appetite, reducing the demand for new developments, which is currently powered by the influx of foreign money.
According to the recent data from the Foreign Investment Review Board, China has overtaken the United States in foreign investment approvals in Australia last year. Foreign investment has been integral to Australia’s economy and even to the property market and the need grows higher amid the fading mining boom. Therefore, the government wouldn’t want to see a drop in foreign investment, but wants to benefit from it most.
Instead of reducing property prices, the government’s recent move regarding foreign investors is aimed at preventing unnecessary pressure and providing sound competition in the secondary market.
In fact, it would be naïve to expect a significant improvement in housing affordability any time soon solely due to this measure given the scale of possible wrongdoings.
There is no reliable data on the scale of illegal purchases by overseas investors obviously because such activities were “underground”.
Unless the scale is extremely large (which would result in a short-term price fall due to an oversupply when investors rush to sell by December)– which is unlikely, especially in low to medium price ranges, the changes may have almost no noticable effect. At the same time, legal foreign investment in existing homes is likely to be too small as well to affect the overall market trends (temporary residents have been the only group allowed to legally purchase existing homes as their principal place of residence but they must sell it when their visa expires).
The other side of the issue is that most of such illegal purchases are likely to involve luxury homes which are sold at premium prices anyway. Why would a foreign investor hire expensive lawyers, accountants to buy an established dwelling in low to medium price range, instead of purchasing a new home hassle free at a similar price? For example, earlier this year Treasurer ordered a Chinese owner to sell a $39 million harbourside mansion in Sydney. More than 100 cases of this kind are still being investigated by the government as Joe Hockey told Reuters.
There is no reliable indicator or research to blame foreign investment as the main force behind soaring prices, but nobody doubts benefits of it in stimulatinng the construction of new homes (a foreign investor can not move the immovable property overseas - it will become second-hand when investor sells it, which can not be bought by another foreign investor). Whether foreign investment comes from illegal sources, involve money laundering etc. is a different issue.
However, tougher enforcement will help prevent further expansion of abuse of regulations and deviation of foreign investment from the primary market, and will lead to better reporting, stricter government control, and increased public confidence in the process. As to application fees, they are too small to scare overseas investors away from lucrative Australian market.
