Understanding how unaffordable housing affects renters is increasingly important, since more Australians can expect to rent for longer. How do negative gearing and the capital gains tax discount affect affordability, amenity and security for renters? Encouraging “mums and dads” to invest in the private rental market is not all it’s cracked up to be, and tenants’ advocates have been calling for reform.
Following the release of Unsettled: life in the Australian rental market earlier this year, renters have enjoyed an unusually elevated position in housing affordability discussions. The Federal Treasurer has even noticed them, suggesting they wont be forgotten in the 2017 Budget. Even so, signs are that no meaningful change is on its way. To unpack this, we need to look at how the private rental market fits into Australia’s broader housing system, and how it is affected by the affordability crisis.
Around ninety per cent of Australia’s private dwellings were occupied at the 2011 Census. Thirty per cent of those were rented, and sixty-seven per cent were owner-occupied. We can make predictions as we await the release of 2016 Census data, but there’s no doubt owner-occupation remains Australia’s most common housing tenure. So the amount a household is willing to pay for the home they live in has significant influence on the value of Australia’s housing.
Housing as an investment
Housing is not purchased solely for its shelter function. Owning a home is regarded as a form of voluntary savings for retirement, which is the rationale for excluding the family home from capital gains tax liabilities. These savings are not only achieved by paying down a mortgage; a home’s value is also expected to rise, always. Throw in a protracted period of low interest rates, and households have been prepared to spend ever-increasing amounts on the family home. The prophesy of ever-increasing-values is fulfilled.
Investors know this. With conditions as they are, making profits from housing is all but assured, assuming you can meet significant entry costs and holding expenses in the meantime. Negative gearing plays its part, allowing investors to offset losses against taxable income while waiting for capital gains to accrue. It also encourages investors to take on higher debt, and bid up prices, for properties that are likely to achieve the strongest gains. Unlike owner-occupied housing these gains are taxed, but at half the going rate.
It’s no coincidence that house prices really started to climb after the 50% capital gains tax discount was introduced for investors in 1999.
There’s a rationale for retaining this tax treatment of property investment, too. Allowing investors to negatively gear and taxing capital gains at a reduced rate is all about encouraging “mums and dads” – small holding investors with only a single rental property or two – into the market. More of this investment means more supply of rental housing, and less expense for governments. Treasurer Morrison himself said in his recent address to the Australian Housing and Urban Research Institute (AHURI): “If mum and dad investors were not part of our private rental market, there would be fewer rental properties available, meaning higher rents, further crowding out of those on lower incomes and even greater pressure on already overstressed community and social housing resources.”
Investors versus owner-occupiers
There’s a problem with this rationale. Property investors are trading in the same market as owner-occupiers. They are predominantly buying established dwellings instead of building new ones, so increasing the supply of rental housing isn’t producing much new supply overall. It comes at the expense of housing for owner-occupiers. Encouraging “mums and dads” into the private rental market has well and truly skewed the dynamics of housing.
But what’s the concern for renters if owner-occupiers are getting priced and squeezed out of the market? Isn’t it good that investors are providing homes for those who aren’t buying them? Such questions are rarely given more than a passing thought in housing policy discussions, but Treasurer Morrison has broken ranks lately. With reference to the “Unsettled” report, he noted the majority of Australians who rent do so because they can’t afford to buy.
The dream of home ownership
Of course, many of these renters would like to own a home one day, and despite Senator Hinch’s assertion that home ownership is an Australian dream not a right, a high rate of home-ownership over several generations has produced an expectation that owner-occupation will feature in the life of most Australians. This is more than mere aspiration; it’s part of our national psyche. It’s not that renters don’t have good jobs that pay good money; prices are increasingly hard to keep up with on a decent wage. So, when renters see a pitched battle between first homebuyers and property investors they naturally side with the homebuyer. That’s where the majority see themselves, now or in the future. They also know it’s the side with the most to lose.
When Morrison invoked the home-ownership dream during his address to AHURI, it was part of a general caution: “it is a statement of the obvious that you can’t help first homebuyers save for a deposit by implementing policies that increase their rent.”
Meanwhile, several years of price growth that excludes well-paid households from home ownership has already pushed up rents, by increasing competition in the private rental market. Unless we make some attempt to rein in house price growth, this will continue.
The need for tax reform
The best way to tackle this is to shift our focus away from encouraging “mums and dads” to invest in the private rental market for capital gains alone. We’ll need to reform rules around negative gearing and the capital gains tax discount.
In his address to AHURI, Morrison also said that “disrupting negative gearing would not come without a cost, especially to renters…” He seems worried that changes to negative gearing would cause “mum and dad” investors to leave the market, leading to a reduction in the supply of rental housing that would drive up rents. Given what we know about housing supply and demand, and how it has been skewed, this seems simplistic. A negatively geared investor needs to be running at a loss.
Annual tax data shows that even with low interest rates the most significant losses come from paying interest on loans – this is higher than all other expenses combined. It’s highly unlikely that investors would respond to new tax settings by removing both themselves and their properties from the private rental market. That would require holding onto properties but leaving them vacant, foregoing rental income while continuing to service debt.
Instead, an investor might respond to new tax settings in one of three ways: hold onto property and continue to rent it out; sell to another investor who will continue to rent it out; or sell to an owner-occupier. In the first two cases, the property remains in the rental market, and the landlord is encouraged to adopt a longer-term investment strategy.
What makes negative gearing especially attractive is the prospect of low-taxed capital gains, so investors are buying and selling properties relatively frequently. They trade in the same pool of stock as owner-occupiers, and properties tend to move back and forth between the two. Without altering the investors’ objective of chasing capital gains driven by untaxed owner-occupied housing, coming up with new tax rules to discourage investor churn should see them hold properties in the private rental market for longer.
In the third case, the property is lost to the rental market, but with a high chance it will be purchased by a renter. In this case, there is no net impact on supply and demand in the rental market because both the property and the occupant change status. But perhaps a relatively high earning household has made the transition from renter to homeowner, changing the dynamics of competition amongst renters, and easing the pressure on rents.
Higher rentals won’t result from winding back tax concessions
Then there is the concern that investors who are unable to offset holding costs through the tax system will look to do so through higher rents. Rents are a function of market forces, not investors’ costs, and tax data tells us that rental revenue is increasing faster than expenses. In New South Wales the difference between annual rental incomes and investors’ expenses grew by $1295 per property, on average, between 2010 and 2013. This gap is likely to be much larger today.
Despite this, rents are increasing faster than incomes, and there’s not a lot of room left to move. The New South Wales Independent Pricing and Regulatory Tribunal recently found the median rent for New South Wales has increased by 125% since 2000, whereas median incomes rose by 77%.
Investors who try to increase rents outside of their usual cycles might struggle to find a renter who will pay. They’ll have to meet the market, and it could backfire if they try to push harder than they already do. Any loss of income will particularly hurt investors who are servicing debt. If faced with a change to their tax settings, they may need to look for other ways to offset their holding costs. Paying down debt could be one of these.
Of course, we must weigh all this against what negative gearing and capital gains tax discounts already do to the private rental market. We’ve seen how they skew supply and demand, and the impact this has on rents. But it does more. It has changed the shape of the private rental market, and contributes to renters living in poorer quality housing with no security of tenure. It has lead to a culture of fear amongst long-term renters.
Investors make “strategic” purchases, by buying properties with the highest prospects for rapid capital gains. This means well-appointed properties in high demand areas. Affordable stock tends to drop away from the rental market. The National Housing Supply Council was investigating this prior to its demise, and Hulse, Reynolds, Stone and Yates have continued to study its effects. Their research shows how the private rental market particularly doesn’t serve low-income households, as the bulk of stock in the market is becoming less affordable. The Anglicare rental affordability snapshot also demonstrates this annually. While new supply driven by an affordable housing bond aggregator will go some way towards alleviating this, the private rental market is a big dog that won’t be easily wagged by a small tail.
A significant proportion of rental properties are not well maintained
Investors are conditioned to regard their properties as capital gains producing “bricks and mortar”, rather than homes for the people who live in them. For an investor, a quick and easy capital gain comes from the rise in intrinsic value of a well-bought property, combined with the capital gains tax discount, rather than improvements to the quality of the dwelling.
There is no incentive to spend more than the minimum on repairs and maintenance. The majority of investors are small holding landlords who rely on rents to cover costs, and the cost of servicing debt takes up more than its fair share.
Even though there are repairs and maintenance obligations for investors in our state-based renting laws, sometimes they just don’t have enough cash on hand to keep properties up to scratch.
The “Unsettled” report demonstrates the extent of this problem, with 8 per cent of renters living in a property in need of urgent repairs. Only a quarter of renters reported they have not experienced a problem with their current property.
Again, the majority of investors are small holding “mums and dads” chasing quick capital gains with only a single investment property or two. As the only sure-fire way to realise a capital gain is to sell, homes are bought and sold relatively frequently. Investors trade in the same pool of properties as owner-occupiers, so they want vacant possession when they sell. They want as broad a base of potential buyers as possible to maximise their capital gain.
Renting laws have evolved with this in mind – tenancies are established on short-term contracts that, if not renewed upon expiry, carry over but can end “without grounds”. Insecure tenancy agreements rarely survive the sale of a renter’s home. The “Unsettled” report also showed the extent of this problem, indicating that 83% of Australian renters have an insecure short-term or continuing contract with their landlord.
Renters fear raising concerns and have little security of tenure
More worrying, though, is the news that renters are fearful of raising concerns with their landlord citing fear of rent increases, eviction, and listings on “bad tenant databases”. Renters’ are not only concerned for their current housing prospects; they worry about an insecure future in the private rental market. The longer a person has rented, the more likely these fears will be present, suggesting they are the product of experience.
Issues around affordability, amenity and security combine, as renters choose to keep quiet about poor amenity so as to improve their chances of staying put. This is no doubt the lesser of many evils. Rents go up with each move, competition to find a new home is always fierce, and of course, with over a million “mums and dads” running the private rental market, renters never know what they might get next.
Reforming negative gearing and capital gains tax discounts will not fix these problems for renters on their own. Proper measures to address supply are also required, as are improved renting laws. But focusing all attention on supply, without tackling the twisted dynamics of the market, is tinkering at the edges of a very big and growing problem.
To be clear, the kinds of reform that are needed are structural, and they will produce some turbulence as the system adjusts. But when the Federal Treasurer warns that changes to negative gearing could come at a cost to renters, we need to consider: what is the cost of no change at all?
Ned Cutcher is the Senior Policy Officer at the Tenants’ Union of New South Wales, and contributing editor of their blog The Brown Couch. He recently assisted in the development of Unsettled: life in Australia’s private rental market on behalf of the National Association of Tenants’ Organisations.