Property rentier collects its spoils

By Leith van Onselen

Hot on the heels of Prime Minister, Tony Abbott’s gutless announcement that he won’t reform negative gearing, prime spokesman for the property industry, the Property Council of Australia (PCA), has released the following statement:

Executive Director, Nick Proud, said providing certainty on the future of this tax measure will benefit housing affordability and give average workers who invest in property confidence.

“The data is conclusive – negative gearing in Australia is primarily used by average workers who in the majority, own only one investment property,” Mr Proud said.

“It is great to see the Federal Government providing certainty for the hundreds of thousands of average workers whose modest investments are contributing to housing supply and rental affordability.

“There is no evidence to suggest that negative gearing drives up house prices – the opposite is true…

“With an ageing population we need to look at ways of taking pressure off the budget and negative gearing is one way for average workers to save for their retirement.

“It also helps encourage young Australians and first homeowners to take their first step into the property market by providing what can be a more economical option – purchasing initially as an investment rather than as an owner occupier.

Wow. The PCA makes Joseph Goebbels look like an amateur, since you couldn’t spin more propaganda into a few hundred words. Let’s address each of the PCA’s claims one-by-one.

First, that negative gearing “improves housing affordability” and that “there is no evidence to suggest that negative gearing drives up house prices – the opposite is true”.

Below is a chart tracking investor finance commitments against house price growth:

ScreenHunter_6797 Mar. 31 08.09

That’s a pretty damn strong correlation, suggesting that if you remove excess investor demand, via unwinding negative gearing, then house price growth would be dampened, making homes more affordable. No ifs, buts or maybes.

In turn, this would benefit first home buyers, who have been shut-out by the investor orgy:

ScreenHunter_7080 Apr. 17 08.06

And with lower house prices, younger Australians would not need to devote as much of their lifetime’s earnings to pay-off a home.

Home ownership rates, which have collapsed, would also be higher, particularly amongst younger cohorts:

ScreenHunter_5349 Dec. 09 14.34

In turn, the PCA’s claim that negative gearing “helps encourage young Australians and first homeowners to take their first step into the property market by providing what can be a more economical option – purchasing initially as an investment rather than as an owner occupier” would be null and void, since first home buyers would be able to afford to purchase as owner-occupiers.

What about the PCA’s claim that negative gearing is the purview of the “average worker” rather then the wealthy? Again, I call bullshit.

The Australian Tax Office (ATO) data that it has relied upon for this claim does show that the majority of rental properties are held by middle income earners:

ScreenHunter_2377 May. 12 13.01

However, it also shows that property investment is most popular amongst higher income earners, presumably due to the increased tax benefits on offer as one moves up the marginal tax scale.

In 2011-12, 35% of taxpayers earning over $180,000 held an investment property, with 24% negatively geared. By comparison, 15% of taxpayers earning between $50,000 and $60,000 held an investment property in 2011-12, with 11% negatively geared (see next chart).

ScreenHunter_2376 May. 12 12.51

Average net rental losses are also much higher in dollar terms (but less in percentage terms) for higher income earners:

ScreenHunter_2379 May. 12 13.27

However, there are also major issues with the ATO Tax Statistics data that significantly reduces its reliability and discredits the PCA’s argument that negative gearing is a middle-class affair.

As explained by ABC’s Michael Janda last year, the ATO Tax Stats only look at “taxable income” – i.e. after people take out various deductions to lower their tax bills – hence the income figures PCA has quoted are significantly understated:

The very reason that many housing investors fall below the $80,000 threshold is because they have used negative gearing to slash their tax bill…

The vagaries of what is counted as income for tax purposes, and of tax deductibility, mean that it is impossible to be sure exactly how many landlords really earn less than $80,000 per year.

One other interesting fact from the ATO’s figures is that the average ‘total income’ of Australian taxpayers was $55,000.

That means that on the way the tax office calculates ‘total income’ – looking at net rent and net capital gains, and excluding non-taxable items – someone on $80,000 is already a relatively high income earner.

Moreover, the Household Income and Labour Dynamics in Australia (HILDA) survey shows that the wealthy hold most of the negatively geared investment homes, as explained by The Guardian’s Greg Jericho last month:

…The Reserve Bank uses data from the Household, Income and Labour Dynamics in Australia Survey. That survey found that in 2010 that the richest 20% of households were much more likely than other households to have an investment property loan:

ScreenHunter_6668 Mar. 20 08.43

…And since 2002 there has been a surge in investors within the richest 20%. In 2002 just 16% of the richest 20% of households had an investment loan, by 2010 it was up to 23%…

Then there is the PCA’s claim that negative gearing “contributing to housing supply and rental affordability”. Really? Because the last time I checked, investors have overwhelmingly purchase existing homes, so have not added to supply:

ScreenHunter_6799 Mar. 31 08.17

It follows, then, that if negative gearing was wound-back and a proportion of investment properties were sold, they would be purchased by renters (or other investors that would rent them out). In turn, those renters would be turned into owner-occupiers, reducing the demand for rental properties and leaving the rental supply-demand balance unchanged.

As a result, rents would be unaffected, as was the case when negative gearing was last abolished between 1985 and 1987 (shown in red):

ScreenHunter_3791 Aug. 15 11.02

Finally, what about the PCA’s claim that “with an ageing population we need to look at ways of taking pressure off the budget and negative gearing is one way for average workers to save for their retirement”.

Surely the best way to ensure people’s security in retirement is to lower the cost of shelter and increase access to first home buyers? Australians would be in a far stronger financial position, and would be far better placed to save for their own retirement (and avoid the aged pension), if they were not required to pay-off some of the world’s biggest mortgages, thanks to policies like negative gearing.

On every count, the PCA’s claims are false and represent nothing more than rentier propaganda.

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Unconventional Economist

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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  1. reusachtigeMEMBER

    Negative gearing (all tax lurks actually) needs to remain as it will help break things eventually and harder too! Support it and us smart investors who are gearing up more and more!

    • Look I love your humour reusahtige – but squirrel made a good point “Aussie has FHOGs, high immigration, unenforced foreign buyer restrictions, neg gearing and CGT halved. NZ has NO CGT, neg gearing, high immigration and NO restrictions on foreign investment. Not sure who is worse.“.

      NG is a stupid tool, and it relies losses. Its benefit entirely relies on capital gains – which may or may not be coming. NG in no way created this bubble, but it certainly helped it. The biggest losers will be Mums and Dads when it bursts, and even if you got rid of NG tomorrow, it would do very little to increase the tax take…

      • What would happen though if NG were to be removed? I’m wondering if the government already realise that the statistics will show that auction clearance rates remain at their current levels and the only change will be that investor loans from the local banks have dried up. Prices will continue upwards and the system even more vulnerable and people ask. Who’s buying the houses and where’s the money coming from?

  2. how about a graph showing the inverse relationship between lower interest rates and rents?

  3. “Surely the best way to ensure people’s security in retirement is to lower the cost of shelter and increase access to first home buyers? Australians would be in a far stronger financial position,”

    Well, it depends on which particular Australians you’re taling about, doesn’t it? In aggregate, and in the longer term, you are of course 1000% right.

    In the short term and looking at the individuals that comprise the PCA’s membership and target market, you are 100,000% wrong.

  4. Preaching to the converted.
    Until you appear on The Today Show, Sunrise (good luck with that Idiot Koch there), and in MSM, you’ll just be banging the drum to the converted.

  5. Trying to share this on Facebook but just get “subscribe to MB” message to showing on FB, although article does not have padlock. (other posts work fine)

  6. Forrest GumpMEMBER

    Negative gearing and the 50% CGT concession also causes higher rents and constricts the rental market.

    This is evidenced from the 2 following scenarios that arise when an investor engages in negative gearing and/or is seeking capital gains:

    A key strategy in NG is to use the losses to drive down taxable income to a lower tax bracket. Bigger the loss=lower the tax bracket.

    Landlords use these strategies to hold out for higher rents (for months at a time) thus leaving properties vacant for extended periods of time while enjoying the benefits of a lower tax bracket via negative gearing.

    The same applies to the landlords that leave the property vacant while hanging out for higher rents, with the capital gain (many times already realized) in which they know is taxed at a concession of just 50%.

    In both cases, these activities result in restricting the market limiting the number of vacancies that would otherwise be filled if the initial asking rents were at real market prices.

    In studying this over the past 2 years, it has become evident to me that these are definite strategies that are used by landlords.

    To exacerbate matters, the real estate industry adds to the maintenance of higher rents. This occurs when a property becomes vacant and is placed in the hands of an agent for rent.

    In order to obtain a market appraisal of the rent, the agent generally simply looks performs a quick online search for other similar properties in the same location that are also being advertised and uses that asking rent as the benchmark for all other new properties coming onto the market.

    Existing advertised properties are often remaining unoccupied for many months at a higher asking price because they are too high priced. But as mentioned above, agents use these properties as the benchmark for newly advertised properties coming onto the market.

    Then over the course of weeks and months, the agents and or landlord are unable to hook any tenants at the higher price to the slow melt takes place with the asking price being reduced by $5.00 – $10.00 each month until a tenant takes the bait. Others slowly follow the lead in the following weeks

    Based on my research of a sample of 50 apartments in East Perth, the entire process takes at least 2 months from the first day of being advertised to the day that a tenant takes the bait and the property is leased.

    In the sample group, the average initial asking price commences around $520 per week on day 1. The first asking rent decrease happens around 4 weeks after initial advertising at around $10.00 per week. Then the subsequent decreases happen around each 3 weeks with decreases of around $15 per week.

    After no tenants take the bait at the 8 and 12 week marks, rents are dropped again by $20 on each occasion.

    Generally after the 12 week mark the average “Delta” from the initial asking rent to the final rent advertised is around $70.00 per week.

    From the study it appears that the 12 week mark is where the lower tax bracket is reached (averaged over a 12 month period) so the landlord now needs the cash flow since the losses are no longer being offset against income. If the landlord has unrealised capital gains accrued in the property, the game can and does continue for 8 weeks or more.

    Where the landlord is not seeking to realise the capital gains just yet, and the lower tax bracket is reached, then the landlord needs to capitulate with the rent. But this happens only after 12 weeks or more.

    This behavior strangles the market and maintains higher asking rents.

    To prevent this from continuing and impacting the cost of rentals and vacancies, a third dimension should be adopted into the deductions of negative gearing equation.

    That is, the interest and depreciation expenses on the property should only be apportioned to the duration that the property was rented out and occupied.

    In other words if you have an investment property that remains vacant for 3 months then the interest and the depreciation expenses over those 3 months should not be allowed as deductions. (Or alternatively 25% of the deductions should be void)

    In essence these tactics are the same as Holiday Rental Tactics where a landlord will only offer the holiday property for rent only during the holiday season where rents are expensive. (In the off season rents can be gained but are generally far lower).

    I believe that the ATO treats the holiday rental system different to that of normal rentals. (I’m not sure on this?) That is the landlord can only claim for the period that the property was available for rent. This same principal should be adopted to all rental properties to force the hand of landlords.

    After all, the mantra of negative gearing is to provide more rentals to the market and at a lower price. Joe Hockey needs to put up or shut up in this regard and make some changes to policy.

    • Strange Economics

      Excellent analysis.
      Works in Sydney too. I just rented a midpriced inner city house, and wondered why some of the (even for Sydney ridiculous prices) overpriced rentals would remain empty on the websites for weeks. The market price is obviously 50 to 100 per week lower. The landlords just hold out – in a rational market the holding cost would not be worth the wait. Still with a 49% tax deduction, whats a few weeks. So thats 2 or 3 extra weeks a year empty – equivalent to 5% of the rental market !

  7. Re: Nominal Finance Commitments vs House Price Growth
    There are four peaks on this chart. In three out of four, house prices (red line) rise ahead of finance commitments (blue line). If this chart indicates anything, is that finance generally chases prices, not the other way around.

    • Can’t ignore the troughs – then it’s like 3 out of 6 (one trough is cut off at the bottom).

      Anyway, seems like the chart shows a correlation without adding anything to the ’cause’ question – does one cause the other, or is there a confounding factor, such as, plausibly, favourable economic conditions?

      • Ok, fair comment on the troughs. I ignored those because they are less clear. Agreed that counting all turning points (which line turns first) there is no proof of causation, either way.

  8. I’m leaving. I have a stable (currently) job in Sydney but bugger it. I’m not saddling myself to 30 yrs of mortgage slavery with all the risks it involves to buy a unit in bloody Bankstown. Euro passport (ancestry) approved, I’m off in October. Along with a fair chunk of my friends by the looks of things!! I hate what this county has become and what it values. Greed. Its disgusting.

    • @Matt I know the feeling mate, I was living in Europe for 6 years and returned to a place that appears to offer me very little opportunity to actually buy a place to live. Sydney in particular is bat shit crazy. The only things keeping me here is family and the thought that all this will pop eventually and sense of normality will return. I really hope a big chunk of greedy investors are taken out and have their wealth halved. I can only hope the same people who blew this bubble up are the ones who suffer when it bursts.

      A big bubble pop might put some manners back on people and give people a good hard lesson. Then we can build a proper country based on industries outside of dirt. We can only hope.