My cousin, Peter van Onselen, writes for the Australian. In my opinion, he is one of the more insightful and balanced commentators on their roster (of course I am biased). Today he published an article explaining the political sensitivities and difficulties of reforming Australia’s housing policy, in particular our overly generous taxation concessions (such as negative gearing) as well as freeing-up the supply-side of the housing market in order to speed-up land release.
Whilst I agree with the crux of the article, I strongly disagree with the following part:
…Or what if the government moved to restrict the number of investment properties people could negative gear their incomes against? That might be a way to take some of the upward pressure on prices out of the equation, but it would leave existing investors upset, and there is an argument that it could constrict what is already a tight rental market.
Fewer people investing in property means fewer rental properties available. When supply is already a problem, people in lower socio-economic circumstances don’t need that. [my emphasis]
Negative gearing is an issue dear to this blogger’s heart. In fact, my June article, Negative Gearing Exposed, is possibly my best piece of work and has also been my most popular article to date. Hell, it’s even been cited in Wikipedia!
Given the “negative gearing assists the rental market” claim seems to be getting air-play once more, it’s time for a refresher on why negative gearing is a costly policy mistake that does little to improve the availability or affordability of rental accommodation.
One expensive policy:
Negative Gearing Exposed provides the background and history of negative gearing in Australia. In a nutshell, negative gearing was abolished by the Hawke/Keating Government in July 1985 as part of a broader tax reform package. But after intense lobbying by the property industry, which claimed that the changes to negative gearing had caused investment in rental accommodation to dry up and rents to rise, Treasurer Keating restored the old rules in September 1987, thereby once again permitting the deduction of interest and other rental property costs from other income sources.
The reintroduction of negative gearing in 1987, in concert with the halving of the Capital Gains Tax (CGT) rate in 1999, led to a surge of property investment in Australia. The below three charts come from Morgan Stanley. The first chart shows the number of taxpayers claiming rental income to the Australian Taxation Office (ATO) skyrocketed from 608,000 taxpayers in 1988/89 to 1,765,000 taxpayers in 2007/08 – 13% of the total.
With house prices booming and rents remaining flat, the proportion of taxpayers where rental income does not cover costs increased from around 50% in 1993/94 to 70% in 2007/08:
And the cost to the Australian taxpayer is immense, with the aggregate level of net rental losses ballooning from +$219m in 1999/00 to -$8,600m, meaning that average Australians are massively subsidising property investors:
This increase in property investment in Australia was also assisted by a significant increase in credit provision to property investors. From the mid-1990s, investors were permitted to purchase an investment property via accessing equity in their own home, without having to contribute any cash up front. Lending criteria on investment loans were also relaxed and became much the same as loans to owner occupiers, as did the interest rate charged. Lenders also began competing aggressively for investment loans and offered products specifically designed to attract investors, such as the split-purpose and interest only loan.
This increase in credit provision for property investment is evidenced by borrowings for investment properties growing at a faster rate (17% per year) than borrowings for owner occupied properties (12% per year) since 1990. Accordingly, investment loans share of total housing lending has grown from around 14% in 1990 to around 30% currently (see RBA Statistical Table D2 for data).
Impact on rental market:
Despite the massive surge of property investors and the huge subsidies provided by Australian taxpayers, negative gearing has done little to:
increase the availability of rental accommodation; or
reduce its cost.
On the first point, the below chart plots the percentage of investor mortgages going to existing dwellings versus new construction.
As you can see, the share of investment in new construction has fallen for the past 25 years, from around 60% in the mid-1980s to around 7% currently. So despite the favourable tax treatment provided to property investors in Australia, for every 14 investment homes purchased in September 2010, only one was a new dwelling that actually added to housing supply and rental availability.
The data on new home construction by investors is even more damning. As shown below, there was a surge in investor loans for second-hand properties from around 2000 onwards, coincident with the reduction in CGT. By contrast, loans for new construction have remained relatively flat for the past 25 years. As a comparison, the ratio of investor lending for existing dwellings to new dwellings was around 2:3 in 1985; 7:1 in 2000; and 13:1 currently.
The key point to take away is that negative gearing has not improved the availability of rental accommodation. Why? Because investors that buy existing homes do not increase rental availability since they do not add to overall housing supply and merely turn homes for sale into homes to let. They also do not address the shortage of rental accommodation, because the reduction in the supply of homes for sale throws potential owner-occupants onto the rental market.
On the second point – the impact on rents – consider the below chart showing real (inflation-adjusted) rents for the Australian mainland capital cities. The first vertical dotted black line shows the beginning of the ban on negative gearing (July 1985), whereas the second vertical dotted black line shows its reintroduction in September 1987.
Now if it is true that the abolition of negative gearing by the Hawke/Keating Government in July 1985 caused investment in rental accommodation to dry up and rents to rise, you would expect rents to have risen significantly in each capital city, since negative gearing affects all rental markets equally.
But this is clearly not the case. Rather, between July 1985 and September 1987, rents rose in both Sydney and Perth, were flat in Melbourne and Adelaide, and fell in Brisbane. Based on this analysis, the claim that negative gearing reduces rents is false.
My conclusion is supported by Saul Eslake, former Chief Economist at the ANZ, using different rental data. According to Mr Eslake:
It’s true, according to Real Estate Institute data, that rents went up in Sydney and Perth. But the same data doesn’t show any discernable increase in the other State capitals. I would say that, if negative gearing had been responsible for a surge in rents, then you should have observed it everywhere, not just two capitals.
Based on the above evidence, there is clearly little merit in Australia’s tax concessions for property investment. Negative gearing and the CGT concession do not provided any incentive to invest in new housing because they are available for both existing homes as well as new ones. And since these concessions do not increase housing supply, they also do not put downward pressure on rents.
Rather, the increase of investment in existing dwellings has merely added to housing demand, reduced housing affordability, and displaced potential owner-occupiers, forcing them onto the rental market. While the cost to taxpayers is immense, the costs to younger Australians, in particular, from reduced housing affordability and increased debt levels is even greater.
I only wish our mainstream commentators would acknowledge these facts instead of perpetuating the myth that negative gearing is good for the rental market. Nothing could be further from the truth.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
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