Tuesday, August 23, 2011

Negative gearing is not your friend

On this day 38 years ago, a gunman walked into the Kreditbanken branch at Norrmalmstorg Square in Stockholm, Sweden, to hold up the bank. Police were called, the gunman took hostages, and a six-day siege ensued. When the police finally took the bank and the gunman and his associate, there was observed amongst the hostages a feeling of solidarity with their captors. A criminologist dubbed this feeling 'Stockholm syndrome.'


In the Brown Couch's never-ending quest for elaborate extended metaphors by which to describe the Australian housing system, Stockholm syndrome sounds like an appropriate diagnosis for our relationship with negative gearing – that is, Australia's almost unique tax arrangement that allows landlords to deduct interest payments from not just their rental income or capital gains, but from all their income, thus reducing the amount of tax they pay.

Talking with tenants, we occasionally hear them mutter ruefully about how their negatively geared landlords are making out like bandits, but then say, 'oh well, I wouldn't be able to afford to live here if it wasn't for negative gearing.'

Our political leaders feel captured too, repeatedly refusing to countenance any changes to negative gearing and, furthermore, positively supporting it. Politicians of otherwise such divergent points of view as John Howard and Tanya Plibersek have defended negative gearing, claiming that if it were ever changed, rents would go up.

That's the claim: that negative gearing makes renting cheaper than it would be otherwise.

We need an intervention. Negative gearing does not make renting cheaper. On the contrary, negative gearing pushes rents up. Tenants, policy makers: negative gearing is not your friend.

First, let's be clear: landlords set the rent at what they can get. If you really think that because of negative gearing, a landlord will accept less, try this experiment: pay your rent $50 short, and tell your landlord that you're helping him reduce his tax. Observe his angry reaction. Note his insistence that you must pay the going rate and if you don't, he'll find another tenant who will. Try another experiment: offer to pay more rent. See if your landlord doesn't take you up on it.

The committed negative gearist who finds themselves faced with the prospect of actually making money – that is, their revenues are greater than their costs – is not going to cut their revenues just to keep posting a loss. They are going to refinance, take on more debt, and buy another property.

But, we hear you say, negative gearing works to reduce rents by expanding the supply of rental housing.

Well, it certainly has expanded the supply of landlords. The popularity of negative gearing saw the number of Australian landlords grow by almost 50 per cent over the last decade-and-a-half, and the proportion of them posting a net loss grew similarly.


(ATO TaxStats, various years)

But look what they've spent their (borrowed) money on: established dwellings, not new construction.


(RBA, Table D06)

So they've expanded the supply of rental housing, but only by turning dwellings that might otherwise be owner-occupied into rental. In other words, along with any expansion in the supply of rental housing goes an expansion in the supply of renters.

This is reflected in the declining rates of home-ownership amongst younger households (25-44 year-olds) – and, for that matter, middle-aged households (44-65 year-olds).


(Source: Flood and Green (2010) 'Australia's Changing Patterns of Home Ownership' AHURI Research and Policy Bulletin no 133. Click here for more.)

These households are in the prime income-earning years of their lives, and many would be owner-occupiers if they weren't priced out by big-spending negatively geared landlords. Instead they are renting – alongside the low income households who have always rented. AHURI researcher Maryann Wulff and her colleagues have charted over the period 1996-2006 the rise in the number of renters who are in the higher segments of the income scale:



(Wulff, et al (2009) 'Australia's private rental market: changes (2001-2006)', AHURI positioning paper. Click here for more.)


Wulff et al explain: 'overall, the number of private renter households in the lowest seven income categories (Y1-Y7) stayed relatively stable over the three census years [ie 1996, 2001 and 2006]. The growth in private renter households occurred in the top five income segments.'

Now, these higher-income renters can afford to pay more than their lower-income competitors, so their presence in the market helps push up rents. They also out-compete the lower-income households in terms of risk and general attractiveness to landlords, so if they want to save a bit of money and live in a relatively cheap rental dwelling, they very often can – which means a lower-income household, who really needs the lower rent dwelling, will have to look at renting another, more expensive dwelling.

We can put some number on this problem, thanks to the National Housing Supply Council. As of 2007-08 (the latest figures), Australia has 814 000 low-income households (that is, in the bottom 40 per cent by income) who are renting in the private market... and the private rental market has 1 410 000 dwellings that would be affordable for these households. That's apparently more than enough affordable rental dwellings... except that fully 1 089 000 of those relatively cheap dwellings are occupied by households above the 40 per cent line. That leaves 493 000 low-income households paying a higher rent.

And it is not just a problem of how the relatively low-rent properties are shared around, because the number of low-rent properties is declining, too – thanks to negative gearing. As a strategy, negative gearing depends on the prospect of capital gains: the negatively geared landlord makes a profit only if the (lightly taxed) capital gain at the end of their speculative adventure is more than the total income lost to interest etc along the way. So negatively geared landlords will go for properties where there's strong expectations of capital gain... and pass on properties that are not so blessed. The latter properties, as economists Woods, Ong and Stewart point out (in a paper for the Henry Review), are the relatively low-value, low-rent properties that low-income renters seek out. Over time, as properties are bought and sold, these sorts of properties drop out of the rental sector, and as they become scarcer, they become less cheap.

We can put numbers on this too, again courtesy of the National Housing Supply Council. Between 1996 and 2006, Australia's private rental stock grew by 234 000 dwellings. All of this growth was in dwellings that rent for more than $200 per week – and mostly more than $300 per week. Over that period, we lost 125 000 dwellings in the $232 or less price range (and all those dollar amounts are 2006 dollars, so we're comparing apples with apples). The Council provides a graph to illustrate the changing shape of the rental market, under the influence of negative gearing. Notice the bulge in properties around $200 flatten down and push up further along the scale of rents at $300 per week, $400 per week....





To recap:
  • negative gearing does not cause an individual landlord to charge less rent;
  • negative gearing does not create net additional rental housing;
  • negative gearing has contributed to more higher-income households renting, which both pushes rents up, and pushes lower-income households out of lower rent properties;
  • negative gearing has contributed to low-value proprties dropping out of the rental market, which pushes up the rent for those that remain in rental; so therefore
  • negative gearing is not your friend.

18 comments:

  1. spot on Chris well written

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  2. investors are low life scum

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  3. govt enables tax evasion

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  4. Firstly we have to acknowledge that negative gearing has a psychological effect. Well this may be illusory in the long run, but it must have an impact on people's willingness to buy property that is loss-making and thus pushes up the price point at which demand for property will fall, thus raising the price (assuming that finance is available to those wanting to buy loss-making property). This will of course be a factor with slick salesmen and offplan apartments, but I'd argue it is a factor across the entire market, as it will also affect the mindset of slightly less gullible "investors".

    Secondly, even if the net result over a 5-10 year period is the same, the short term result is much better if NG can be written off against other sources of income. This means that from day one, there is an advantage gained from buying loss-making property (or at least the disadvantage is significantly reduced in a way that makes the investor feel more positive about the deal). It's not just a potential advantage miles down the line, but an advantage NOW. Again this is an inducement to people to buy loss-making property, and it pushes up the equilibrium price by increasing demand at the point where yields no longer cover interest.

    Thirdly, it feeds into the tendency of property investors to maximise their borrowing against a property - if you have equity in a property it incentivises people to borrow to the max, and then reinvest in more property. Again, maybe this is just psychological, but economics is all about psychology. Overall, the difference between Australia and most countries is pretty clear if you read property sites like AustralianPropertyForum.com . In Australia it is seen as pretty normal to buy property that makes a loss, which inevitably pushes up the equilibrium price. In the UK for example, the bottom line tends to be a property that about breaks even.

    There's a good discussion on Negative Gearing here.....

    Negative Gearing Debate

    Paul Collins

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  5. Great article enjoyed it a lot.

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  6. Negative Gearing Scenario using a string of ‘investors’ over a 104 year time frame:

    Investment Property – No1. Dumbville Ave, Ponziville, Australia.

    Now assume 26 landlords A, B, C, . . & Z each born 4 years apart negatively gear the purchase of ‘The Dumbville’ in sequence.

    ‘Investor’ A buys ‘The Dumbville’, holds for 4 years then sells to ‘investor’ B who repeats the process and sells to C, and so on up until the property is held and sold by each of the 26 investors.
    After 100 years ‘investor’ Z comes along and buys ‘The Dumbville’ as a negatively geared ‘investment’.

    Under the current tax system, ‘The Dumbville’ is deemed a business even though there is no intention to produce a positive return on money invested and there has never been a positive rental return after more than 100 years.

    Tax system is transparently rigged to encourage speculation, allows 'investors' to outbid genuine home buyers.
    The place is a joke.

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  7. Negatively geared investors are profoundly exposed to the end of The Great Australian Land Bubble. See my May 28 post at Prosper: http://www.prosper.org.au/2011/05/25/australia%E2%80%99s-fatal-flaw-negative-gearing/

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  8. Good analysis BrownCouch.
    NG is justified for new dwelling construction only - and then only for the reason that the developer did not have a revenue stream during the period of the build.
    Only that portion of the interest bill incurred during the construction phase should be allowed to be offset against other income.
    Allowing NG to be claimed for 2nd hand homes is purely inflationary and has not added 1 property to the equation.
    All NG (in the case of 2nd hand dwellings) has done is enable speculators to go into more debt than would otherwise be the case.
    Banks love it (larger loans & therefore interest repayments), govts love it (higher Stamp Duties) and RE agents love it (higher commissions).
    The Aussie potential home-buyer has been offered up to the banks on a plate because govt is negligent in addressing this speculative & inflationary element of the tax system.

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  9. As the boomers (the largest voting bloc) all retire, they will not need NG and what the boomers want, the boomers get. They will want govt dollars diverted into health and pension, so NG is dead in the water within 5 years.

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  10. Without negative gearing there would be not enough housing for tenants. Are you telling me this government builds enough housing for those in need. Get real.

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  11. ....ok so we get rid of negative gearing - the alternative is? ....there will be more of this - housing shortages:

    http://www.theaustralian.com.au/national-affairs/housing-shortage-blowout-to-hurt-economy/story-fn59niix-1226228023321

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  12. @Anon

    See the second graph (RBA Table D06).

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  13. Also, have a look at this post from a few years back:

    http://tunswblog.blogspot.com.au/2009/04/state-of-supply-part-2-rental-market.html

    If anything has changed since 2009, it doesn't seem to have been for the better:

    http://www.sbs.com.au/news/video/2228579585/Rental-crisis-hits-Australia

    Cheers,
    N.C.

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  14. For a more detailed report on the supply of affordable housing:

    http://www.abc.net.au/news/2012-04-30/rentals-too-pricey-for-low-income-tenants/3979600?section=business

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  15. A fatal flaw in your argument with offering to pay less rent if that if you offer to pay $50 less, he's not $0 less out of pocket, he's out by whatever his tax rate is. So if he's paying 29c to the dollar, he's out $35.50. He only saves $14.50 in tax. So he's still most certainly out of pocket on what you're not paying him.

    Don't get me wrong - I agree negative gearing is BS, but your argument is flawed.

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    Replies
    1. Hi tjsr

      I think you've misunderstood point I was making... which was precisely that a negatively geared landlord will not stomach a sub-market rent just so they can show a loss to the tax office.

      Delete

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