Labor to cap private rents?

There a few versions of a story floating around today about the Labor government considering price caps on private rents:

The Real Estate Institute of Australia has slammed the Labor government’s proposal to cap rents in Australia

REIA president Pamela Bennett said capping rents would be “disastrous” for rental affordability and the property market.

Earlier this week, the Labor government said it would look at monitoring the rent costs in the private rental market and examine mechanisms to maintain affordability such as the introduction of rent capping legislation.

“To cap rents in the private rental market would be counterproductive to the objectives of improving affordability. It would reduce the supply of rental housing which would be detrimental to rental affordability,” Ms Bennett said.

“If the proposal was implemented, the impact could be similar to the outcome of the Hawke government’s decision in 1985 to deny investors tax deductibility of interest payments. The market response led to an undersupply of rental property and escalating rents, before the decision was reversed in less than two years.

“The proportion of income required to meet rent payments is currently 24.8 per cent while the proportion of income required to meet loan repayments is 34.6 per cent.

“Rental affordability has been relatively stable, at around 25.0 per cent of family income, for the past three years with some slightly improvement in affordability in recent times.

“The proposal is not sustainable and when it is reversed, rents will soar. This is an extremely important issue and one that should not be taken lightly.”

It’s not a comfortable feeling agreeing with the spruikers at the REIA, and the stuff in there about the 1985 removal of negative gearing causing a rise in rents  has been comprehensively debunked, but the rent capping idea is a questionable solution.

Europe has some major markets with rental controls and none sounds overly encouraging. From a report by the Royal Institute of Chartered Surveyors, first Sweden:

Social housing is predominantly owned by municipal housing companies (MHC), which are non-profit housing organisations owned by local authorities. Anybody can apply to live in a social rented dwelling, because traditionally the means-tested criteria that are common elsewhere in the EU do not apply.

The legally determined system of rent setting in both the private and social sectors requires that there are local negotiations between tenant organisations and MHCs for social housing and with private landlord organisations for the private sector. As rents have to be comparable across both sectors, and private tenants can appeal to a rent tribunal if they are not, the overall costs of local MHCs essentially set the average rent level. Rents are largely historic-cost based, dependent on outstanding debts, management and maintenance costs, and they consequently reflect the age composition of the social housing stock rather than prevailing market rent levels. One unfortunate side-effect is to limit the incentives MHCs have to be efficient, because they always know that rents will be set to cover their costs. Negotiations then determine rents for the different dwelling types and locations. There has been some change in recent years, because any subsidy element (as defined through a court ruling rather than in economic terms) in public housing cannot be used in the comparison between public and private sector rents. However, as many

MHC-owned dwellings are no longer in receipt of subsidies, the impact of the change is fairly limited in many localities. Obviously, prevailing rental values are reflected in the capital values of residential investments, so that the returns are sufficient to attract investors. The SFI/IPD Sweden residential index had average returns in 2009 of 5.2% evenly split between income and capital growth.

The regulated rent setting process means that rents in attractive urban locations are often well below market clearing levels. Existing tenants can enjoy substantial windfalls by sub-letting or by requiring undercover (‘key’ or ‘furniture’ money) payments from new tenants before agreeing to vacate the property.

The cost-based rents of the social sector are low because the stock was mainly built before the mid-1970s and most of the debt on it is now paid off. Such rent levels do not encourage efficient use of the stock. Existing tenants have limited incentive to economise on housing consumption or to move to cheaper locations. Because the criteria for entry to the tenure has been very broad in the past, people from a wide variety of social strata and income levels can end up with substantial implicit gains, whose social benefit is questionable. Queues to enter social housing are long in areas of high demand. The general allocation process has detrimental effects on labour mobility

There has been a gradual tendency for rents in nominal terms to rise, because costs are increasing. However, there are variations across regions, with Stockholm having the greatest divergence of actual from potential market rents and the rents on social housing in some of the depressed regions of the country probably being higher than open market levels. As rents have not risen to reflect prevailing market shortages in an era when house prices are rising, investment in new rental housing is, outside of the luxury sector, generally unprofitable and so does not occur.

And, The Netherlands:

With the exception of the small up-market sector, which represents 5% of all rental dwellings, rents are controlled, with the same legislation applying to both the private and social sectors. Security of tenure is guaranteed – temporary contracts are forbidden – and tenancies can be passed onto spouses, children and others. Rents bear little relation to market levelsbut rather to a points system related to amenities and to service charges. If landlords do not keep up repairs, tenants can apply for rent reductions, and rents can only be raised annually by a maximum amount decreed by the government. From 2009, tenants were also able to request ‘reasonable’ improvements to their dwellings which landlords are obliged to carry out. Despite the long boom in house prices, real rent increases have been limited and over the past decade have actually fallen somewhat in real terms.

While the freezing of real rent levels over the past decade has undoubtedly been popular with many of the 40% of Dutch households that are directly affected by them, rent controls and low rent policies distort the operation of the housing market with long-term adverse consequences. Households are encouraged to consume excessive amounts of housing, leading to greater shortages than there need be. Those that can afford to become home owners are discouraged from purchasing. Housing providers have less income for investment and less free stock to allocate to younger households and those in greatest need. Existing tenants are favoured over new households and movers, leading to regressive distribution effects and enhanced social segregation.

Households are induced to behave in ways that conform to social housing’s access rules, which often work against labour market and other welfare policies. Informal and illegal rental markets are encouraged. General mobility is reduced. Another implication is that demand shocks result in queues and intense pressures on households to become owner occupiers because that is effectively the only free market housing option in most localities. Price volatility in the owner occupied sector is exacerbated as a result. In summary, such rent control policies lead to general welfare losses rather than gains.

Given Australia already has a choked supply process, bogged down in regulation, and over-inflated prices with investors now counting exclusively on rents for a return, price controls would probably cause a run on the market.

RICS 2011 European Housing Review – Full Report

Comments

  1. In both of the examples above it is an extraneous influence that is the problem. In Sweden it is the effect of the MHC, whereas for Holland it is the tenure rules which cause the issues. In neither case is it price control which caused the problem.

  2. Since when did Australian governments look at what happened in Europe when similar policies to the ones they propose here were debated or put in place..

  3. General Disarray

    Someone has crunched the numbers and found that key swing seats have a lot of renters – it’s the only thing that explains this.

    • Agreed, it’s populist pandering.

      We’ve got the worst of it up here in QLD. Paul Lucas MP is investigating state funded legal action to stop Westfield Carindale charging for parking if people stay more than three hours.

      This is a government that has a great reputation for supporting local business ha ha har…

      • That should’ve read “state funded legal advice” as he was encouraging the Council to amend it’s local planning laws to stop them charging. Just making it clear.

  4. Lol they always claim that rents will rise, but they always forget to mention that the sell off, from investment properties will mean cheaper properties for renters who were previously priced out of the market.

    Sure not everyone wants to buy but I can tell you the majority would love to buy over renting.

    • Maybe the government dont want to look at the tax breaks and this gives them an out. Another words “what are you crying about mr investor, we didnt remove the NG” or it could be to stop the speculators in the mining towns from charging 2-3,000 a week rent.

  5. Hugh PavletichMEMBER

    INDUSTRY ASSN’S NEED TO WAKE UP

    This is an inevitable part of the whole sorry process unfortunately.

    Its well past time the industry associations starteed to talk with clarity about the supply impediments to getting affordable housing in place.

    The worst offenders have been the Housing Insdustry Association of Australia (HIA) and I gave them a blast many years ago on this issue of “clarity” Refer “The Need for Clarity” within the Highlighted Articles Section on my website http://www.PerformanceUrbanPlanning.org .

    All the industry associations, such as the HIA, UDIA, PC and MBA were “playing games”, encouraging the Government to throw taxpayer money at these problems – adding fuel to the bubble fire.

    Lets hope the halfwitted Rent Control suggestion, finally wakes up these industry associations – so that they focus on the REAL PROBLEM – the lack of affordable supply.

    Hugh Pavletich
    http://www.PerformanceUrbanPlanning.org

  6. Some context… this so-called ‘government proposal’ is an item in the draft platform currently before the ALP conference.

    I agree that as on its own, such a measure would be, well, odd. But it may have a place in a wider suite of reforms – say as a temporary measure to guard against exploitative rent increases as reforms to negative gearing are phased in?

  7. I’m sure I read somewhere that one of the effects of rent controls in New York has been to reduce the supply of new housing. They also have a similar problem of lack of mobility, with the system ecouraging rent control tenants to stay put come hell or high water. Last thing we need here is further supply disincentives…

    Get some competition into the market by fixing the supply side, and rents will take care of themselves.

      • I should put in the caveat that I’m talking about the majority of renters who have jobs and are functional etc.

        The poor and many disabled people will never likely be well catered for by the private rental market, and that is where I think the true role for government is, that is to provide housing for this section of society. But even here, I think the housing needs to be directly provided (built), rather than more cash subsidies introduced which will only inflate the price for everyone else if it doesn’t bring additional stock into being.

        • invest-magicMEMBER

          I disagree that the private sector can’t look after the less needy.

          The notion of Govts looking after needy has only been around for the last 50-70 years. Who looked after the needy before the Govt did?

          Many private sector and/or community organisations (such as mutually societies).

          But we’re do heavily taxed that the ‘donation’ money is inefficiently wasted in the bureaucracy.

          Bill Gates foundation has done more to alleviate problems in its few short years than years of Govt spending.

          The govt needs to get out of the ‘do-gooder’ business. Oh wait – then how will they win votes…

          All roads lead to Greece… the China boom is a gift that is being wasted. But one day we will all wake up and realise we were Greeks after all.

  8. why do we persist with a centralized planning system that causes the supply issues in the first place and then have to deal with proposed policies like capped rents from more government to fix a problem they are causing. Get rid of planners altogether and free up land. Less government is the answer.

    • “Less government is the answer.”

      Why do people persist with such silly slogans? Would you like the market to determine the appropriate murder rate rather that have the government interfere and try to lower it with prison terms for murderers? Would you like the government to stop enforcing property rights so that the only property you can own is what you can literally guard at all times? How much less government do you want? And why should everyone else have to put up with just the right amount of government that suits your interests and not theirs? Why shouldn’t you have to put up with the right amount of government, be it more or less than you want, that suits them?

  9. Don’t worry, it will never get through, the construction and building union will make sure of that!

  10. At least this should stop the REIA from running to the government and lobbying for handouts/stimulus every time house prices go down.
    .
    If the REIA lobbies for government intervention in the property market, they will get exactly that.

  11. Hugh PavletichMEMBER

    George – the simple answers are (a) that Governments should not be allowed to mess around with land supply and (b) be required to finance infrastructure properly, along the lines of the US MUDs model.

    Its actually no more complex than that.

  12. ceteris paribus

    People live in society, not in an economy. That is why we have a mixed economy, not a libertarian free-for-all.

    Thank goodness. I trust elected government very little- but much, much more than rampant capitalism.

    Our mixed economy manages to achieve a clumsy and fallible balance between liberalism and equity. Capitalism would eat its own.

    • Hugh PavletichMEMBER

      Ceteris – “mixed” is probably not the appropriate term – “Mixed up” would better describe it!

      Lets use $100,000 gross annual household income (in local currencies) as a base.

      You could expect to pay $230,000 for a house in Atlanta; $250,000 in Dallas Fort Worth and $290,000 in Houston.

      In contrast $900,000 in Melbourne and $940,000. Refer Demographia Surveys.

      What I do find truly remrkable about you socialists, is just how well you “plan” people to unnecessarily become “Mortgage Slaves” to the Banks.

      What I like about capitalism is how it allows the provision of affordable housing – the “democratisation of prosperity” if you like.

      Do read up on the Levitts on my website http://www.PerformanceUrbanPlanning.org and the material on the web by Prof Peter Bacon Hales of the University of Chicago on the Levitts “the fathers of the modern production housing industry”.

  13. With typical yields of 3-4% in Australia and interest rates around 7%, it is clear that house prices are overvalued and / or rents are too low, not too high.

    If they intend to introduce such controls, expect rents to skyrocket in advance of it becoming law so landlords can future-proof themselves.

    • The rental market is very competitive, so landlords can hardly band together to increase rents in unison.

      Yields of 3-4% imply quite a high P/E ratio (to use sharemarket terminology). Normally, a high PE is only justified if you expect the dividend (rent) to increase a lot in future.

      Now, unemployment looks set to rise, among both white collar and retail sectors, also international student numbers are down a lot. At least in Melbourne, there is now oversupply.

      So my question is: Is a surge in rents feasible in current conditions?

      • If you had a property currently rented for $400 a week and knew that under new legislation you couldn’t remove your next tenant or increase the rent on them indefinitely, would you offer to continue at $400 per week or suddenly raise the rent to reflect what you needed to cover the costs of holding it, before the legislation came into effect.

        I would raise to maybe $500 per week and hold out till someone paid that. Most markets are tight enough that you could do this and everyone would do it at the same time.

        If this didnt happen, property prices would have to plunge to reflect the fact you could never increase the rent again.

      • There are typically only a few rental agencies in each area, banding together wouldn’t be that hard. Rents can escalate very quickly when the real estate agents are encouraging it. Just look at Dysart and Moranbah as perfect examples. Average houses went from $600 per week to $1500 per week in about a year.

        I think that these are the kind of markets that are drawing attention and this is now the over-reaction to an isolated problem.

  14. Might we all be missing the point here? Cap rents…drop negative gearing? After all they do have to justify there pay raise….

  15. No government would have contemplated rent caps 5 years ago…this another sign things are changing.

    Anybody who has ever done economics 101 understands what a stupid move this would be, even in a economic apocalypse scenario.

  16. The government should get rid of negative gearing and stop meddling if they are sincerely interested in helping renters.

    • I’m all for stopping negative gearing. This only penalises stupid landlords who rent out for less than it costs them to hold the property. Those of us with positive cashflow are unaffected.

  17. Or the Federal Government figures it is time to redirect most of the nation’s capital away from the banks and into the rest of the economy. Bankrupt the states in the process maybe.

  18. Perhaps I am cynical, this is probably Labor’s diversion on their recent hugh pay increase for a job welldone(?)i.e carbon tax, super mining tax, the failed Malaysian solution, the list goes on………..
    Oh, by the way, where is the No, No, No….. Tony on the pay increase?

  19. One thing we can all agree on is that this is a misguided policy. I will never forget a story of a friend of mine who had to pay quite a substantial amount of cash for a “privilege” to rent a cheaper flat in New York. Market forces work in mysterious ways 🙂

    Since the topic of “evil of negative gearing” and “stupidity” of property investors to persist with something that “generates less income than it costs to hold” pops up so frequently in the comments on this blog relating to housing issues, could any of the more analytically inclined contributors on this site be willing to take a challenge and validate those statements with “facts and figures”? And I don’t mean providing a bunch of quotes like “Saul Eslake said…” but actually sourcing hard data and doing the analysis?

    Just consider these few thoughts as potential “starters”:

    1. Amount of tax “lost” due to negative gearing in any given year is only a third of what is widely quoted in the media… and unfortunately by prominent economists and financial commentators (ie. not $6.5B but rather only ~2.2B for 2008/09)
    2. The existence of negative gearing only alters timing of cash flow to the Government but does not change the overall amount of tax paid by investors over time. That is, it is not a tax rort (although “saving tax” if frequently quoted as the main selling point of investing in property by undereducated Financial Advisors).
    3. How much does negative gearing contribute to the increase in prices of the properties? 1%? 5%? More? Nobody knows because there are no specific studies or modelling done to date. Yet everybody “knows” it must be a huge factor…
    4. The benefit of negative gearing to property investors can be easily measured: it amounts to only a few hundred dollars a year (ie. the cost of holding additional debt over loss making years, and that debt would be only ~35% more if negative gearing is removed).
    5. The most misunderstood benefit of negative gearing is that it lowers the threshold of investor’s capacity to carry debt, hance making this investment class available to lower income earners (not only rich).
    6. Rental income generates $25B in revenue p.a. and the single largest expense is interest payments of $19B. Lowering interest rates by 2% would eliminate negative gearing on all existing investment properties (all other things being equal).
    7. Comparing yields for rental income from property to interest on cash deposits in the bank is misleading. Cash in the bank does not increase in addition to interest payments. Property does, hence both (ie. growth in asset price and rental income) have to be considered in calculating returns.
    8. Property investment is not a perpetual loss generating investment class. Debt (and hance interest expense) does not increase over time but rental income and owner equity do.
    9. And a clincher: Is it possible that the move to abolish negative gearing is a conspiracy of rich to deny the possibility to participate in this lucrative investment class to those less privileged? 🙂 Really rich don’t need negative gearing, they own the properties outright. The majority of property investors are mums and dads earning less than 80K pa…

    • My modest attempt at showing, with evidence, why negative gearing is not your friend:

      http://tunswblog.blogspot.com/2011/08/negative-gearing-is-not-your-friend.html

      I must also take issue with your point 9. I would not have thought of calling a purported ‘conspiracy of the rich’ a ‘clincher’. And housing – particularly rental housing – as a ‘lucrative asset class’ bothers me. It’s an essential service that everyone needs, rich or poor – but when it comes to rental, especially the poor.

      I think it would be terrific if housing dead boring, rather than every suburban flat being the subject of a speculative adventure.

      • Interesting argument, well worth reading. My only issue is that there is an underlying assumption that negative gearing is “the cause”. There is no test if this assumption is correct in the first place. Actually, there is very little research based argument anywhere on this issue. That is why I am trying to highlight that “common belief” about negative gearing may not necessary be entirely correct… For the sake of pinpointing the real issues influencing housing affordability, the implications of negative gearing in Australia should be better understood and researched. Otherwise it is just a witch-hunt.

    • Ill bet my house that if negative gearing is removed then house prices will drop. Is that more than enough proof?

      • What percent? 2%? 5%? This is dancing round the edges. I’d bet that house prices in Aussie cities would fall 60% and remain stable thereafter, if urban growth boundaries and any other proxies for them, were abolished, so any modern day Bill Leavitt who wants to can convert farmland to new subdivision with NO “planning gain”.

        As it is, they will probably drop by 40% over goodness knows what time frame, and cyclical volatility and a squeezed economy will be the norm from there on – just like the Poms have demonstrated with THEIR urban planning system.

        • C’m Guys. “Betting”? Surely, it would be better to have some evidence before jumping to decisions one way or another… 😉

          • It’s pretty simple to model the NG price effect (to situations, with and without negative gearing, with a common rate of return sought by the investor for an identical property).

            Unfortunately the price impact very much depends on capital growth expectations. There will also by dynamic impacts.

            Stay tuned for some number crunching next week (you are right that such analysis is not commonly available, although there are plenty of academic papers addressing the price impact of NG indirectly).

    • Fabian AlderseyMEMBER

      Weird. You’ve offered all these reasons why negative gearing does very, very little. Then with your last point you say that removing it would limit it to only the rich? I’m having trouble understanding that.

    • Plainclothes_Man

      Absolutely spot on that the *real* benefit of NG is pretty negligible. However, it seems to me that the benefits are often overestimated by amateur investors and I would postulate this has led to some making increasingly irrational investment decisions over the last few years.

      An investment with negative ongoing cashflow is potentially risky for two reasons:
      1) You have to be able to continue to finance the shortfall until – hopefully – your cashflow turns positive.
      2) Your final investment will be substantially larger than the amount you initially put in.

      The general rules of investing apply.

      3) Risk increases with leverage – The higher the debt (and interest payments) the less buffer you have in the event of an unexpected cost or reduction in cash inflow.

      4) Buying an asset primarily in the hope of capital appreciation is in fact – in industry terms – speculation. Highly leveraged speculation is a very risky use of capital indeed. The recent losses suffered by small time investors after being (in my opinion) missold margin loans spring unhappily to mind.

      This last point *is* relevant. Houses are an asset like any other and are subject to the basic law of supply and demand. In a perfect market there is no reason why property prices should increase by more than inflation. Even in a situation where supply is constrained, eventually the absolute limits of affordability will be reached and will act as a brake on price growth.

      Recent data suggest property prices are slowly melting despite a continuing shortage of stock in many areas. It won’t take much to put a substantial number of recent borrowers underwater. Unlike the example of the margin loans this does not put the borrowers in immediate financial peril, as long as they can continue to make their repayments. But, if the economy really starts to slow down, the first three points will start to come into play as peoples incomes take a hit.

    • A few thoughts. Around the northern beaches residential yields are about 4-5% while commercial and industrial yields are 9-10%. Admittedly I don’t know what the relationship is like normally but that suggests that negative gearing is inflating prices by close to double. I say close to because the First Home Buyers grant would also be influencing residential yields. Yes, this is pretty much all conjecture but it’s all I’ve got.

      To your last point I’d guess that negative gearing – as it stands – is a conspiracy of the rich, because it pushes up the prices of the property the rich ALREADY own and prices poorer people out of the market completely, well, unless they get themselves up to the eyeballs in debt.

  20. On one hand I wouldn’t let labor manage my kids pocket money! On the other hand, something has to give in the housing market. It’s just a roof over your head and it’s turned into something that is barely affordable for a family with no debt, 5 university degrees and two 6 figure salaries. It’s not that we can’t but we won’t.
    Renting is getting to the point where it is only marginally cheaper in real terms, while it is a significant discount to buying, it still costs too much. This isn’t Paris or New York people, it’s Sydney.

  21. The BurbWatcherMEMBER

    This is a spectacularly stupid idea…when will people make the solid connection between govt intervention into markets, and tragic market outcomes??