OLIVER FRANKEL. Short-term leases – salt in the wounds of unaffordability for long-term renters

An increasing number of Australians are being forced into long-term rental accommodation, unable to afford the prohibitive and ever-increasing cost of home ownership.  In the private rental market, heavily debt-laden, individual landlords are the norm. Their short-term investment outlook deprives renters seeking security of tenure of the ability to achieve it. For tenants struggling with affordability, this is salt in their wounds.                                                                      

Growth of the private rental sector

According to AHURI research (quoting IBIS World figures), the Australian private rental market included 2.4 million rental dwellings with 5 million renters in 2014. As the cost of home ownership has spiraled further out of reach of the have-nots, the private rental market has almost certainly continued its relentless expansion since 2014.

The May 2015 report of the Senate Enquiry into Affordable Housing notes that the profile of the private rental sector has changed in recent times, with the number of long-term renters increasing significantly.

A November 2014 SMH article suggests that a third of lessees have rented for more than 10 years, up from a quarter in 1994.

The Senate Enquiry notes that rental is no longer simply a transition into home ownership for many Australians, particularly those on lower incomes. It has become a permanent feature of their lives.

Evidence to the Enquiry reveals that the private rental sector grew by 18% between 2006 and 2011, twice the rate of household growth in that period.

The Enquiry also observes that the private rental sector includes not only lower income earners and those starting out in adult life. Higher income earners, often saving for a home purchase deposit, are in some cases competing for cheaper rental stock in central areas and so putting further pressure on lower income earners, for whom choice of affordable housing is more limited. 

Debt-laden individual landlords dominate the market

Unlike some other comparable countries, the Australian private rental housing market is dominated by small individual landlords. Institutional investment hardly features, despite its prevalence in other parts of the property sector.

The driving motivation of these individual landlords is tax-sheltered capital gains, rather than rental income. They are drawn into high levels of debt by generous negative gearing tax allowances, combined with the 50% capital gains tax discount.

Our obsession with residential property as a form of investment, combined with the impact of negative gearing, has contributed to Australia having the highest level of household debt amongst developed countries.

A September 2016 article in the SMH refers to a BIS report revealing that out of 44 countries surveyed Australia had the highest ratio of household debt to GDP, at 125%.

Carrying excessively high debt makes investors jittery about even minor interest rate movements and market volatility, and even more nervous about any hiccups in their employment.

Record low interest rates have, so far, largely avoided financial embarrassment for the heavily indebted. However, for those of us who witnessed double-digit interest rates the risks are clearly, and painfully, apparent.

Short-term leases deprive tenants of security of tenure

The precariousness of excessive debt, and an inability to ride out bumps, tends to keep the small investor’s finger on the eject button. This no doubt has contributed to an unwillingness to offer tenants long-term leases, preferring instead 6 to 12 month rolling leases. 

Short-termism by investors deprives tenants of security of tenure (for those seeking it) and the ability to make long-term plans with confidence, even if in fact their lease is renewed (at the landlord’s discretion).

The need to move regularly comprises a major upheaval for renters and places a huge financial burden on those on lower incomes. The psychological impact should also not be under-estimated. Aside from the actual costs of moving, other hurdles include:

  • Uprooting school age children
  • Disrupting links with essential service providers, including local GPs
  • Breaking local community ties

The May 2015 report of the Senate Enquiry into Affordable Housing notes that 40% of tenants move 3 or 4 times in a 5-year period. 

Landlords can jack up the rent more easily

Short term leases are more prone to rent increases. Even if a rent increase cannot be justified by market conditions, tenants sometimes submit to such increases fearing that the costs and disruptive impact of having to move will create even greater pressure for them. 

Could more institutional investment help?

If debt laden small individual landlords aren’t prepared to offer more reasonable security of tenure to renters who want it, perhaps institutional investors would help.

They are certainly likely to offer long-term leases. Being primarily interested in a long-term steady income return, they would value a long-term leasehold relationship with a reliable tenant. They also have the capacity to withstand short-term market volatility, due to their scale and ability to diversify risk through a portfolio approach.

An October 2015 AHURI report by Graham Newell and others describes the lack of institutional investment in the private rental market in Australia as a structural weakness. The report concludes that it is in fact feasible to attract large-scale institutional investment in the sector with the right investment and management structures in place.

While the appetite for such investment remains low in Australia, there is a long tradition of it in the USA, Germany and France and, particularly, in the Netherlands – as demonstrated in a November 2014 research report by IPF. 

Conclusion

Many of those forced to rent long-term face not only a crisis of affordability, but also lack security of tenure. For those facing rental stress, the need to move home frequently, with its associated costs and disruption, is salt in their wounds of unaffordability.

Something can and should be done to alleviate the tenure problem. Encouraging more institutional investment in residential property may be a good start.

Oliver Frankel is a former corporate finance and M&A lawyer, who has spent the second half of his career in finance, investment and management. Most recently, he has taken a strong interest in how to address the affordable housing crisis.

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2 Responses to OLIVER FRANKEL. Short-term leases – salt in the wounds of unaffordability for long-term renters

  1. Julian says:

    Thank you Oliver for your excellent analysis.

    I note your conclusion: “Encouraging more institutional investment in residential property may be a good start.” Yes that may be a good place to start, given there’s little else on the horizon that would ease matters for those seeking a secure rental.

    I also note your warning about the level of “private” indebtedness, but the trouble is Oliver, as a nation, it appears that we are, and for some time have been addicted to debt – a dangerous phenomenon IMO, but one which is greatly facilitated by the reliance upon, and approval by our banking and financial system generally – after all, it is easier and more convenient to let someone else do the work! In another age this behaviour might have been called “rent-seeking”.

    Overall I think it is fair to say that any prospect of rising interest rates would be strongly contested by said system, and so it is that while yourself and others may justifiably seek to warn of the dangers of the ever expanding level of household indebtedness, the addiction is too strong – even to contemplate likely future consequences if the whole “house of cards” comes tumbling down.

    of having a “house of cards”

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