Proposed Changes to Negative Gearing a Blow for Tenants, First Home Buyers and an Orderly Housing Market (Everyone)

The ALP has proposed significant changes to existing negative gearing taxation policies for residential investment.

If implemented, these policies would likely cause significant imbalances to Australia’s housing markets, impose increased financial hardship on tenants and continue to marginalise the achievement for many of the Great Australian Dream of home ownership.

The key changes as proposed by the ALP are that negative gearing would only be available for new houses, that current negative gearing policies would remain for all existing residential investors and the new policy would be implemented from July 2017.

The first and most significant consequence of the proposed policy, if implemented, would likely be an unprecedented surge in the purchase of established properties as investors flooded the market before the cut-off date.

This would produce significant price distortions and potentially re-ignite boom-time prices growth particularly in the Sydney and Melbourne markets. A wave of established home purchases by investors would have a ripple-effect activating changeover buyers similar to the impact of recent record investor activity in the Sydney market that was the catalyst for extraordinary price growth of over 50 percent in just three years.

A return to record levels of investor activity would prove problematic for APRA, the financial regulator, that in 2015 introduced policies to cap perceived unsustainable investor lending growth through higher interest rates. APRA would surely be forced to raise rates again in an attempt to moderate surging investors which would likely be passed on to tenants through higher rents – particularly in those capital city markets that have low vacancy rates. Melbourne, Sydney, Adelaide, Hobart and Canberra currently have rental vacancy rates for houses well below 2 percent reflecting chronic underlying shortages of rental properties.

Shortages of rental stock are unlikely to be significantly alleviated despite the prospect of a short-term spike in rental properties due to the implementation of the proposed ALP policy. Demand for rental accommodation continues to outstrip supply due to low levels of first home buyers forced to rent, high migration and chronically low levels of new house building – particularly in Sydney.

A surge in investor activity would also again crowd out first home buyers that typically compete for the same budget-priced, higher yielding, established properties.  A significant rise in prices as a consequence of strong investor competition would exacerbate the current difficulty of first home buyers saving for the significant deposit required to enter the housing market. With stubbornly low incomes growth in the economy, increased house prices will push home ownership further and further away for more and more young Australians.

Again this would only offset any potential rental relief through higher levels of supply in the short-term by providing increased rental demand from those first home buyers forced to rent because they have been sidelined by investors.  Currently all capital city housing markets with the exception of Perth have below average market activity by first home buyers with the Sydney market in particular a wasteland for this buyer type with near record low market share. The inverse relationship between higher levels of investors and lower levels of first home buyers is clear – particularly in the Sydney market.

The benefits of the proposed ALP policy shift to providing negative gearing taxation benefits for only new homes are also highly questionable.  Investors clearly prefer established properties to new that reflects the lengthy timelines associated with new property purchases impacting cashflow and the preference for tenants for inner city or middle suburban locations. The ABS reports that just 7 percent of residential investment loans over the past year were for new properties.

Investors will likely still gravitate to established properties rather than new despite losing negative gearing benefits by facilitating positively geared investments through increased capital input and higher rents – more bad news for tenants and first home buyers. Lower returns on residential investment will still likely be higher than alternative low risk investments such as bank deposits and certainly more reliable than shares and with the continued prospect of accumulating still tax-enhanced capital growth.

The prospect of increased housing construction levels through a perceived increase in investor demand is clearly fanciful on the supply-side of the equation.  This reflects the significant constraints to new supply that exist through restrictive planning policies and environmental considerations in all capital cities.  The resistance by local communities for higher density development in suburban areas will mitigate strongly against any substantial increase in demand by investors for new properties – as unlikely as that would be.

The Sydney market, that still accounts for nearly half of all capital city residential investor activity, in particular has almost insurmountable barriers to significant new housing supply with the highest housing density profile of any of the capitals, geographical constraints to new land supply and the highest priced and lowest relative volume of available home building blocks of all the state capitals.

Latest ABS data reveals that first home buyers are gradually returning to the market as recent strong prices growth dissipates. This will gradually reduce demand levels for rental properties and put downward pressure on rents.

Although the need by the federal budget for increased income is clear, short-sighted polices with the clear capacity to change the delicate balance of Australia’s resilient and robust housing markets have the potential to cause disorderly outcomes. And just when markets were slowly re-balancing with the prospects of a more predictable, sustainable and inclusive future for stakeholders.

Changes to housing demand–side polices typically produce distortions to orderly market dynamics particularly those that have sunset arrangements. This was clearly evident from recent changes by state governments to first home buyer benefits to only new homes that caused pre cut-off stampedes of activity. And generally the law of unintended consequences can apply to policies that arbitrarily interfere with and alter investment flows and associated mechanisms.

Government policies should be directed to improving the supply side of the housing market and other structural demographic changes such as encouraging decentralisation to take housing demand away from major capitals – particularly Sydney.

Residential investors operate typically as small enterprises that provide Australia with most of its housing rental stock. These enterprises function in a risk-enhanced, open-market environment with no guarantees on rental returns or capital growth.   Tax incentives provide encouragement for the significant capital inputs and investment risk-taking undertaken by these enterprises. The removal of these incentives for residential investors risks undermining the supply-line and orderly cost and price base of the private rental market. This would facilitate the need for a substantial back-to-the-future model of government-funded public housing which in the short-term at least may lead to an unprecedented housing crisis.

A healthy housing market provides significant, sustainable, long-term economic benefits through jobs and taxation collections to government under existing policies that are part of the inbuilt and accepted cost and price base of housing. This is clearly evidenced by the Sydney housing market and booming local Sydney economy and similarly by the recent improved performance of the Melbourne economy.  This economic dividend importantly facilitates increased spending by governments on those more permanently marginalised from the housing market.

Perversely, the likely victims of seemingly ad-hoc, narrowly focussed changes to residential property taxes such as those proposed by the ALP are the 30 percent of Australian households that are tenants and innumerable first home buyers waiting in the queue to realise the Great Australian Dream – and all clearly the most vulnerable of housing stakeholders.

Dr Andrew Wilson is Chief Economist for the Domain Group