In recent years, the popularity of socialism has grown, especially among young adults. What will the impact be on real estate investment if socialism is fully implemented?
What is Socialism?
Socialism is defined as a populist economic and political system based on public ownership (also known as collective or common ownership) of the means of production. Those means include the machinery, tools, and factories used to produce goods that aim to directly satisfy human needs.
Socialists contend that shared ownership of resources and central planning provide a more equal distribution of goods and services and a more equitable society. The objective is not only equality of opportunity, but equality of outcome. This often involves taking from the rich and giving to the less fortunate.
In a previous post, I discussed the implications of a wealth tax, which is one of the tenets of socialism.
How is Socialism Implemented?
Socialism begins with the implementation by the government of rules and regulations that attempt to equally distribute products and services to everyone in society. This requires the utilization of massive bureaucracies to formulate and enforce these rules and regulations.
Needless to say, there is a significant cost associated with setting up and maintaining these bureaucracies. It is no surprise that taxes rise significantly under this system of government.
This post is not written to argue the merits or demerits of socialism but to analyze the effects of socialist principles on the real estate market and real estate investors.
Impact of Socialism on the Real Estate Market
As already mentioned, taxes will rise under a socialist regime. All taxes will be increased including income taxes and property taxes, leaving the consumer with much less disposable income.
We already see this in Europe where consumers pay an average of 60% of their income in taxes of one shape or another.
When consumers have less disposable income, they have less ability to pay rent or purchase a home. The government then implements rent controls to prevent the cost of rental housing to rise above the ability of the average consumer to pay.
Quality of Housing
As rents are more controlled, the landlord does not have the income to make improvements or required maintenance. The landlord is also prevented from increasing rents to cover those costs. Over the long term, the quality of housing declines.
In order to ensure that everyone has access to equal housing, new construction is scrutinized for location, square footage, and minimum quality of finish. Regulations are often determined by committees or commissions who can only agree on the lowest common denominator.
Permits are issued when all requirements of the government have been satisfied. The process can be costly and time-consuming which just adds to the cost of new housing.
Again, if we look at many European countries and look at the housing that was built in the 1960s when socialism was at its peak, you cannot help but notice how uniform and bland it is. There are little or no architectural distinctions as they just add to the cost of construction.
Because of the additional costs of taxes and regulation, and the inability of consumers to pay, new rental housing may not be economically viable for developers. Consequently, less rental housing will be built which will reduce supply while demand remains unchanged or even increases over time.
In response, the government undertakes the construction of housing using more tax dollars to cover the cost. It is common knowledge that anything the government undertakes is inefficient and more expensive than when it is done by the private sector. The government has zero profit incentive to produce anything efficiently.
Despite the government’s best efforts, the supply of housing lags behind the demand. The difference between supply and demand only grows larger.
Along with rent controls, the government might implement regulations that make it extremely difficult, if not impossible, to evict tenants for non-payment of rent, or for any other reason.
These regulations provide a further disincentive for private developers to build rental housing. In most jurisdictions where these regulations have been implemented, virtually no rental housing is built by the private sector.
Developers will shift their efforts to the construction of single-family homes and condominiums. They can be built and sold to consumers without any risk of loss of income due to rent controls or eviction regulations.
In some countries, the government has resorted to confiscating property for public use. However, in the USA, there is little likelihood of this occurring. As long as the Fifth Amendment of the Constitution is in effect, the government is required by law to make “just compensation” if private property is taken for public use. “Just compensation” usually means the fair market value of the property.
The implementation of these regulations leads to an overall shortage of housing. The laws of economics cannot be ignored. The shortage will lead to market-wide price increases, to the point where the majority can no longer afford it.
From a broader perspective, under a socialist government, there is never enough tax revenue to pay for all the programs that attempt to equally distribute goods and services to everyone. This usually leads to budget deficits, more government borrowing, and/or more money printing which have inflationary effects that ripple through the entire economy.
The Bottom Line
The ideals that socialist politicians espouse look very attractive on paper. However, when you look beyond the headlines, they never offer a detailed plan on how their programs will be paid for.
The common reply is, the rich will pay more but even if 100% of the income of the rich is taxed, the tax revenue is insufficient to cover the cost of the programs they propose. Conversely, if the rich are taxed excessively, they will leave and take their wealth with them, resulting in even less tax revenue. Be careful what you wish for.
The benefits of socialism as it pertains to the real estate market are short-lived. Over the long term, the result is higher costs, lower quality, and a shortage of housing. As such, the standard of living declines for the majority, and the cost of living at that lower standard is higher.
It would be erroneous to conclude that real estate investment in a socialist environment is not viable. However, it would be correct to say that it is less profitable and will take considerable more time, effort, and resources to make that profit. The rules will change and real estate investors will have to adapt accordingly As with any game, you need to know the rules before you can play to win.