Boy am I getting sick of writing these negative gearing pieces. But with the Federal Election this weekend, I’ve got strength for at least one more. So here goes.
University of New South Wales’ Nigel Stapledon has penned a curious piece in The Conversation trying to explain why he believes that rents would rise under Labor’s changes to negative gearing and the capital gains tax (CGT) discount.
Below are the money extracts:
In the current housing tax debate a number of studies have come out arguing that while prices will fall (by varying amounts) rents will not be affected. That rents will be unaffected is surprising and (in my view) wrong…
If the increase in user cost of capital (on investors who are ‘geared’ by borrowing money to invest) with the Labor proposal is higher (roughly double), on what basis could rents not rise? It is not evident to me.
The key component of the user cost of capital, and the one which varies the most over time, is interest rates. When interest rates rise or fall, we expect prices to fall, or rise. But interest rates also change rents, since rent = user cost × value of house.
And what we also see is that a rise in interest rates causes the rent-price ratio (that is, the ratio of home prices to annual rent, also referred to as the rental yield) to rise, while a drop in interest rates will see it fall…
So, while the assumption of most commentators is that price movements do the work in changing rent-price ratios, and that is so over the short term, over a longer time span, rents do some of the adjustment.
Changes in interest rates are uncontroversial. But the same principles apply to changes in tax if they change the cost of capital, which is why the Henry Review expected rents to rise.
In the case of the Labor’s negative gearing changes, the waters are muddied for some by its proposed exemption on new housing. A couple of points here. Firstly, ABS figures (see Table 8 from ABS5671.0 – Lending Finance, Australia) are quoted to suggest that investors’ purchases are 93% established housing, and only 7% new housing. This significantly understates the role of investors.
The NAB residential property survey has domestic investor purchases of new housing at about 20-30% – that is, domestic investors are already a significant component of the new market (adding to supply!).
Secondly, Henry also expected a change in the mix of landlords to consolidate from one with a large number of small landlords, to one with a smaller number of large landlords. More marginal investors – middle income/low wealth investors – will be the first to vacate the field as their entry point is typically cheaper, old stock not premium new stock.
High income/low wealth investors will have the option of new dwellings. High income/high wealth individuals will benefit from the higher rents and lower prices on established dwellings.
That is, the ownership of the dwelling stock (and tax benefit!) will shift to the top end of income earners. But it is not clear that the special treatment of new housing will add materially, if at all, to supply of new dwellings.
In short, the law of unintended consequences will apply. Logic says that rents will rise, and with the 30% renting in the private market skewed to low income earners, that means housing affordability will have declined for these people.
Let me say at the outset that anybody who thinks that “rent = user cost × value of house” is clearly living on another planet. But hey, I’ll indulge in this formula for a moment.
Sure, Labor’s policy by making the tax system less advantageous to property investors overall would certainly increase the “user cost” part of the equation. But it would also put downward pressure on house values, other things equal, so it does not necessarily follow that rents would rise. It’s no different to when mortgage rates rise/fall. They don’t automatically result is higher/lower rents because the “value of house” also adjusts.
Stapledon also fails to mention that under Labor’s proposal, existing investors would be grandfathered. Therefore, their costs will not rise upon implementation of Labor’s reform. Investors in newly constructed dwellings would also continue to receive negative gearing benefits. The only group that would be adversely affected are new investors into existing dwellings. It is true that they would require higher rental yields to be enticed into investing. But the yield may rise by either prices falling (likely), rents rising (unlikely), some combination of the two (unlikely) , or by a downward effect on rents and an even bigger downward effect of prices (also likely).
This whole line of argument by Stapledon about “rent = user cost × value of house” is weird because in the comments to his article he admits the true driver of rents, at least in the shorter-term, is supply and demand:
“Jeremy, I completely agree with you that supply and demand will dictate what happens to rents in the short run and in particular markets. That was very much the story in the 1985-87 period”.
No landlord lowers their rent just because they can negatively gear. They charge whatever the market will bear based on supply and demand.
Stapledon’s argument that “more marginal investors – middle income/low wealth investors – will be the first to vacate the field as their entry point is typically cheaper, old stock not premium new stock” is also irrelevant. Even if this was the case, how would this impact rents one iota? In such a situation, the rental stock would reduce, whereas the owner-occupied stock would increase, leaving the rental supply-demand equation unchanged. There would, therefore, be no change to net rental supply and no change to rents.
The only way that rents would rise over the longer-term is if Labor’s policy led to less construction, other things equal. But it is hard to see how this would occur under a policy that specifically targets negative gearing towards new builds. If anything, construction and net rental supply would rise under Labor’s policy, lowering rents in the longer-term (other things equal).
Stapledon’s last sentence should really read as follows: “Logic says that rents will rise fall, and with the 30% renting in the private market skewed to low income earners, that means housing affordability will have declined improved for these people”.
