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The Biggest Infrastructure Spend in History


Catherine Cashmore
Catherine Cashmore

Catherine Cashmore - Editor of Fat Tail Media's 'Cycles, Trends & Forecasts', Director of Cashmore & Co Real Estate, President of Prosper Australia

The virus may have triggered this downturn.

But it's the fragility of Australia's economic makeup that has our governments panicking.

We have a houses and holes economy.

Australia's economic complexity is dismal.

We're down at number 93 on the list - just above Pakistan.

About 70% of the products we sell to foreign buyers, on a net basis, are minerals and energy.

The rest of our wealth is mostly tied up in a $6.9 trillion housing market. One that breathes by way of population growth (mainly from immigration) and high levels of private debt.

That also means we have a lot of winners, and many more losers.

And now, in response to the COVID panic, Governments around the world are gearing up to spend trillions of dollars on infrastructure.

This is going to be the biggest global build-out of physical assets in human history.

Think roads, bridges, airports, seaports, energy facilities, 5G towers, schools, hospitals, rail and ... even hyperloops.

You name it, they have been planned... and funded.
This will fuel a global land price boom.

It also requires an almost un-suppliable amount of building materials, skills, and new technology. This is highly likely to further heighten global trade disputes.

It will also kick us into a very strong second half of the real estate cycle - which I expect to peak in 2026. (You can read more on my reasoning for that in "Cycles, Trends, & Forecasts' over at Fat Tail Media's website)

But let me set the stage.

Here comes the Great Depression playbook

It was only a few months ago in October 2019, the new Treasury Secretary Steven Kennedy warned against a mega infrastructure spend as a way to boost economic growth.

However, blowing an infrastructure bubble -inevitably blowing a land market bubble - is a well-worn strategy.

It was how the US got out of the Great Depression.

In 1933, British economist JM Keynes wrote an open letter to US President Franklin D. Roosevelt supporting an expansive public-works program that government borrowing could finance.

He got what he wanted. 40,000 new and 85,000 improved buildings, as well as thousands of new roads and bridges were constructed America wide. Most are still in use today.

You may not know of that impact on land values this had due to the depth of the downturn. Everybody knows how bad the Great Depression was.

But renown US economist Robert Shiller discovered a substantial recovery in US home prices prior to WWII. As well as increases in the cost of building materials.

Those who study the 'Law of Rent' are not surprised. This is exactly as we would expect.

We saw the spirit of Keynes resurrected again in the 2008 financial crisis.

Headlines around the world called for infrastructure initiatives - "The Revenge of Keynes," (Le Monde) "The undeniable shift to Keynes," (Financial Times), "What Would Keynes Have Done?" (The New York Times).

It was Keynes's moment again after decades of neglect.

The Obama administration spent $150 billion on infrastructure. China pledged $585 billion, India $500 billion and the European Union, $252 billion; Japan, $129 billion; Canada, $12 billion; Australia, $4.7 billion; Singapore, $13.8 billion; Germany, $42 billion; the list goes on.

That took the world out of the 2008 disaster. And here we go again...

But this is going to be much bigger.

Therefore, despite lockdowns, the one industry that has been encouraged to continue (globally) - and the first to resume, has been the construction sector.

As Australia's Infrastructure Minister Michael McCormack said on April 21, 2020:

"I want to see bulldozers on the ground, I want to see heavy vehicles pushing dirt, and more workers in hi-vis on site...

"We've already got $100 billion and that's a record amount of money that we're rolling out, so to bring some of that money forward is important. I like what I've received."

Governments are targeting a 'U' shape, or better still, a 'V' shaped recovery.

Consider that before Covid-19 Australia's federal government already had a record AU$100 billion spend allocated to infrastructure.

So too did the private sector - owners of toll roads and airports.

The Melbourne Airport owner, the major asset belonging to Australia Pacific Airports Corp. (APAC), was planning capital works worth some $2.5 billion.

Transurban, Australia's largest toll road operator, was looking at capital contributions of $3.5 billion over the next four years across its portfolio of roads in Australia and the U.S.

By 2022, transport projects alone were set to hit $22 billion.

And now we can add to this the 'COVID Panic' infrastructure spending plans that includes a further $2.7 billion in Victoria, $40 billion in NSW, $350 million SA, $49.5 billion in QL and $140 million in WA... to name but a few.

Plus, the $1.8 billion in federal funds to go to local councils to accelerate infrastructure projects "that support jobs" - and feed into land prices!
Oh... and not to forget, the property industry wants a $50,000 first home buyer grant directed to new buildings.

And with the "extra" $60 billion discovered from the JobKeeper program recently, they just might get it...

The only glitch to all this might be the physical inputs!

Before COVID hit, building material and labour costs were rising and we had significant shortages.

In fact, it's one major reason why Victorian Premier Daniel Andrews refused $4bn of federal funding for the controversial East West link.

He said at the time...

"We are pretty well at full-tilt with sand, gravel and concrete...

"The notion we can just throw another major project into the middle of the biggest infrastructure agenda the nation's ever seen and not shelve or hold up the projects we're committed to, it doesn't make sense."

It's also why Andrew's wants to sign up to China's 'One Belt One Road' (OBOR). Controversial as it is, he needs access to both trade and skills.

The current spending plans are more than double the spike in the infrastructure construction boom that began in 2013.

Why do we care?

It was around that time that Sydney's $2 billion CBD and South East Light Rail network commenced.

It's due for completion this year.

So, no surprise then that house prices around the new network surged 21 per cent in the past 3 years.

To put that in context - prices increased despite declines in most other suburbs due to worst downturn in 30 years (resulting from the Royal Commission into the banking sector).

 

Source: Robert Shiller

The Law of Economic Absorption and ATCOR

UK economist Fred Harrison (2005) coins the effect of infrastructure spending on the housing market the "Law of Economic Absorption."

US veteran economist Mason Gaffney, takes it one step further with the acronym ATCOR - "All Taxes Come Out of Rent."

The term "rent" refers to "economic rent" - the earnings from owning land.

Both central to the land theory of the 19th Century economist Henry George.

The Law of Economic Absorption and ATCOR may sound a bit complicated, so let me try and put it in simple terms.

It will help you understand how the economy works and why we have a property cycle at all.

Why Progress always comes with Poverty

Despite great technological advances, it is always the owners of the locations that capture the most wealth.

This includes access to the electromagnetic sphere for telecommunication etc. Noting that "Land" in economics refers to all-natural elements - minerals included.

Well-facilitated land is always short in supply, and high in demand.

Therefore, as society gets richer, the land market is bid up in price.

This is why Henry George's magnus opus was called "Progress and Poverty - (An Inquiry into the Cause of Industrial Depressions and of Increase of Want with Increase of Wealth)" Published 1879.

No matter how much progress we have - whilst the owners of land are allowed to reap the gains, poverty will always exist.

In the housing market, labour taxation takes some of those riches before they reach the land market - reducing a buyer's budget.

Therefore, it follows that the removal of labour taxes (and note - 90% of current taxation falls on labour) naturally washes up into higher prices for real estate.

If we were to capture this rise with a land tax, then in theory, it would leave the resulting rise in the economic rent of land 'just' enough to replace the forgone revenue.

To put it plainly. Get rid of labour taxes and land prices rise.

But equally, if we get rid of taxes on buildings, land prices rise.

Removal of Stamp Duty (as the Property Council desires) and land prices rise.

You get the idea.

In other words - All Taxes Come Out of (land) Rent - ATCOR

The only way to counter this, is with a broad-based land tax that takes the gains before they are pocketed. Something the FIRE (Finance, Insurance, and Real Estate) sectors will never permit.

They would rather a labour tax.

Your labour tax bill is the biggest bill you pay in your lifetime.

However, there is a way to get all those taxes gifted back to you. And anyone well invested in real estate knows it.
A chap in the UK called Don Riley documented how he did this in his book "Taken for A Ride - Trains, Taxpayers and the Treasury" (2001)

Don worked in the computer industry for 40 years. He duly paid his taxes to Her Majesty's Treasury throughout that period.

However, when the millennium came, as he puts it, "a miracle happened."

The Government returned every penny he had ever paid in taxes. And more.

How?

Britain's taxpayers generously funded an extension to the Jubilee Line (JLE) on London's Underground rail network.

Two of the stations were located close to Don's office properties.

That raised the value of his properties significantly.

In fact, the £3.5bn invested in the JLE by taxpayers caused the price of houses near the line to soar by an estimated £14bn upon opening.

Don's calculation showed the rise in value for his two properties gifted back all the tax payments he had made over that entire 40-year period.

Land takes the gains - never forget it. It creates a nation of winners and losers.

And whilst the system exists you have two options - be a renter, or a rentier.

The biggest gains come from these two

We could take these gains via a process called "Value Capture," and use them to fund the infrastructure.

It would prevent 'white elephant' projects being funded where there is little cost/benefit analysis.

As it is, the greatest gains come from land close to New transport links.

These links need to make a significant difference to our lives that is short on time.

Time matters more than distance.

If a rail line is being upgraded, but capacity doesn't equate to a significant difference to the commute - you will see little difference in property values.

Also note that by the time the construction/upgrade has finished, most of the initial gains are already priced in.

If the transport links do give home buyers a significant time saving, then the area will fall under consistent demand and continue to perform strongly.

But...

If you're chasing a windfall, you need to get in early.

Take the Gold Coast light rail scheme as a recent example.

It was an investment of $1.5 billion for 13km of rail and more than $40 million a year in subsidies.

A study by the University of Sydney showed that properties within 800m of the station, went up by more than 30% in response.

Unsurprisingly, the increases were highest on blocks. between 100m and 400m of the stations.

In fact, land within 400m of the stations increased in value by 7% more, than land between 400m and 2km.

Collectively, the absolute change in land value for the plots within 400m was a whopping $300 million.

This is the once-off unearned gain to the owners of just 1,324 plots of land.

However, note, once it opened, there were only modest increases.

That is in part, because line had replaced an existing bus route.

Patronage on the trains remained low for some time - leading many to question if the project was worthwhile.

As mentioned, far bigger uplifts have been observed when the transport link is new.

That was the case with South Morang railway station in Melbourne. Connecting the area via a new fast route directly to the CBD.

Property prices had increased by over 50 per cent upon opening.

However, note from the graph below, that the gains were largely realised prior to construction.

New schools also produce strong increases in land values.

The Victorian government has announced 10 new schools as part of the COVID buildout.
We already know what this will do to property values.

When Kororoit Creek Primary School in Melbourne's north-west was announced and constructed nearby property prices went up 37 per cent after the announcement and 68 per cent on opening.

Another free windfall to the owners of land.

The process isn't a fair one. But, I doubt Australia's property owners will ever vote for it to change.

That being the case, there's little stop the cycle playing out over the next few years as forecast.

Between 2012 and 2017, Sydney's dwelling prices rose by 75 per cent and in Melbourne, 58 per cent.

But with immigration hampered for a while, other states may take the baton as we head out of the COVID panic, and into 2021.

Source: EY - Value Capture, options, challenges, and opportunities for Victoria


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