Negative gearing is unethical

Negative gearing is unethical

By Catherine Cashmore
Tuesday, 24 April 2012

I love reading reports that predict real estate movements.  You’ll hear it trotted out frequently that we’re at “such and such” stage of the “property clock” or property cycle.  Accordingly, over the past few days I’ve read that Brisbane is at five o’clock, unless you own a unit that is, in which case you’re at four o’clock . Adelaide is also at five o’clock, but Sydney on the other hand is languishing somewhere between ‘3.30 and 5.30’ (depending on your “time zone”, no doubt,) and on it goes.

I’m not averse to predicting property movements.  I’ve done it myself on numerous occasions.  There’s almost an irresistible urge in all of us to “foresee” the future like some modern day-prophet and to be fair, there are fundamental historical patterns that give good hints to the basic principles of timing a market.

There’s a quirky joke that goes along the lines ‘If you want to tell God a joke, tell him your plans,’ and whether you’re a believer or not it makes the point aptly.

Just take a look at the tumultuous waters over the previous few years that led the majority of economists not only to miss the GFC and the pace of international recovery, but to follow this with continuous misinterpretations on either a rise or fall in the basic cash rate and subsequent strength of the housing market.

As we’re continually told, on paper Australia has a strong economy, unemployment is low, we’re on the brink of a recourses boom, inflation is “under control”, there’s a shortage of homes, and the population’s growing.  On the surface, it’s the perfect formula for price rises.  However, it didn’t inspire purchasers to get out their wallets in 2011, as record low turnover in overall sales for a decade proved.  Like a snowball effect, as soon as something drops out of sync with a widely accepted formula, a fall in confidence hits the market and impacts predictions even further.

Second-guessing the RBA rate movement has become a popular sport on Twitter and various other media outlets.  Daily I have reports flying into my inbox regarding the most recent RBA rate call. Most are opinions, however a large number have already made predictions assuming a drop in rates for the next meeting.  It’s not based on anything specific, just an interpretation of “hints” contained in the latest minutes as if the decision has already been made – which clearly it hasn’t.

Furthermore, as far as the home buying market is concerned, it now incurs little relevance – the banks call their own tune regardless of the RBA.  Therefore the auctioneers in Melbourne these past couple of weekends who shouted out in their auction preambles that we’ll soon experience a fall in rates to take us into an upward trajectory of the property cycle are either living in a box or under the impression that the buying market is.

As for other predictions, it’s true Australia has a shortage of well-located homes where our rising population want and need to live, and it’s true the Australian market is fragmented, with some areas performing better than others as we move through various stages of the property cycle.  However, it’s also true that successive governments have played their part in creating a model of ownership designed to favour the investor and contribute to the shortage of affordable property for home buyers in the areas where most want to settle.

It’s called “negative gearing”, and it’s the proportion of seasoned investors who take advantage of this tax strategy who eagerly watch the property clock I cited above.  Investors make up roughly 35% of the buying market and many have climbed the equity ladder to own a substantial portfolio of property acquisitions.  Figures from the Australian Taxation Office suggest around 2 million Australians claim deductions for net rent, and figures from the RBA show around one-quarter of all household credit is there for the purpose of holding an investment property.  According to the ABS, the level of household debt over the last 18 years grew twice as fast as the value of household assets.  The ratio of household debt over this period has doubled from 9% to 19%.

On top of this we now have a growing numbers taking advantage of changes in policy that allow investment property to be purchased as part of a self-managed super fund.  So attractive is this proposition that for those with the funds built up to support the strategy, purchasing an established residential property with a long-term trajectory in areas where – under current conditions – an increase in value is inevitable is – for all intense and purposes – a no brainer.

Real estate industry professionals love investors.  The sales process is generally smoother with less emotional content involved, and the real estate agency often benefit from the rental management of the property, thereby creating a lasting relationship with their client’ and an ongoing income stream.  The majority therefore readily accept the policy.

I can cite all sorts of facts and figures to you regarding negative gearing and arguments for and against the strategy.  It was arguably introduced to increase the supply of housing for those unable or unwilling to buy.  Due to our changing lifestyles and the way we now live and move, most have need for a transitional period in rental accommodation at various points in their lives. Therefore investors make up an important part of the home-buying fabric.  It’s also argued that it reduces demand on public housing.  However, as I pointed out last week, due to rising prices sandwiching many out the market, demand for public housing is hardly reducing!

Then there are those who take you back to the Hawke/Keeting era during which negative gearing was to some extent “quarantined”.  The result was marginal at best, there was a dampening of investor enthusiasm and a small increase in rental yields in two states.  The changes didn’t stay around long enough to take us through this transitional period and enable effective judgment of the results. Stringent lobbying by the voting real estate fraternity and property investors ensured at first opportunity the policy was re-introduced.

At the time, there was overall fear that the market would crash, which obviously didn’t occur.  However, I have no doubt if the policy were removed, or even scaled down, there would be less demand for established stock and a subsequent dampening in prices.  No vendor enjoys the thought of their property falling in value, however isn’t this precisely what we need if we’re to allow new home buyers to gain a foothold?

Some argue that if housing were to fall in value, home buyers would be discouraged from purchasing fearing a loss on investment.  So embedded is this obsession with watching property prices rise and fall, we seem to have missed the point of why we need it in the first place. Although there’s no doubt, if prices were to stagnate for an extended period of time, or even deflate in value, some would delay a purchase hoping for further drops.  However, it would be a short-term transition.  It’s a natural human desire to own property once you reach a period of life where there’s a need to settle rather than sojourn. The desire for safety and security runs to the very roots of us all.

In countries where property prices are suffering under the consequences of the GFC, residents would still rather own than rent if given the choice. However currently in the US and parts of Europe, many aren’t able to qualify for a home loan under present conditions and therefore don’t have the choice. Regardless of this, if the current model of negative gearing were scaled down, we’d still be a long way from having a surplus of homes, making it extremely unlikely we’d see a crash as some have presumed.

Eight years ago, the RBA cited negative gearing as one reason for growing un-affordability in the market place.  However, those advantaging from the policy have argued that this is somehow OK because we’re not the only country to employ negative gearing as a tax strategy.  As Saul Eslake (of the Grattan Institute) has pointed out on many an occasion – we may not be the only one, however our policy is at the front of the queue in terms of generosity.

The fact that a few other countries also employ similar incentives provides no realistic platform to argue in favour of the policy.  The real estate market in each country, and within the localities of each country, differs in terms of supply, demand, and affordability.  It’s impossible to compare one against another with a sweeping statement to justify a policy affecting the intrinsic needs of Australia’s buying market.  Australia is one of the least densely populated countries in the world in terms of head of population per square metre.  Much of our land is currently un-liveable, and yet we have a rate of population growth that beats even that of Saudi Arabia!  To top it off, we’re reportedly set to have a housing shortage of 35 million by 2050.  With fewer and fewer able to afford their own place of residence, the future looks anything but sunny for new home buyers.

The call from successive governments to first home buyers looking to get a foothold to go to the periphery of our cities, where housing is marginally cheaper simply because facilities are scarce and public transport is all but non-existent, is hopeless.  The primary reason new estates don’t turn over a reasonable proportion of sales outside of inflationary stimulus packages such as the first-home owners’ grant., isn’t because home buyers don’t like new homes.  It’s because the new areas give no promise of essential community facilities and are hampered with expensive development overlays intended to fund the “ever-promised” schools and public transport systems that seem to take some 20 years to implement. If you want buyers to move there, you’ve got to do more than just build an excess of roof space.

Furthermore, the level of high-rise developments intended to increase the supply of affordable accommodation in our cities are often poorly designed, provide a low-quality living space, and fall out the reach of most first home buyers due to stringent lending restrictions from banks, who see the purchase of this type of oversupplied accommodation a high risk acquisition.  Coupled with this, due to the high number of investors who buy into the new developments looking for a good yield, they don’t offer affordable rental accommodation (hence why so many sit vacant).

The reason why first-home buyers are buffeted out to the outer suburbs is because our models of investment – whether it be negative gearing, land banking, or borrowing to purchase in a self-managed super fund – are solely reliant on capital growth.  You don’t need a master’s degree to understand that the levels of capital growth we’ve been used to seeing in Australia are principally caused by decades of poor planning, which has ensured everyone is squashed around our capital cities for employment and reasonable access to good schools and other essentials such as a local GP and public transport.  For this reason, 93% of investor house and apartment purchases are in the highly sort after inner-suburban locations where most people need to live if they don’t want to face a life stuck in paddock land.

Let’s be realistic about this, it’s essential we encourage personal investment as a plan to support retirement.  Furthermore, there will always be a need for property investors to provide accommodation for those unable to purchase.   However to put policies in place to encourage this in the highly sought-after home buyer suburbs, at the expense of a growing number of people who have no hope of ever owning their own place of residence, does nothing to promote a fair and prosperous democratic nation for all.  It simply splits the population down the centre between those who have and those who have not.

Joe Hockey may want to reduce the country’s expenditure on welfare; however under the current system of ownership, which tips the market in favour of the investor and out of reach of the first home buyer, there is little hope of doing so.

The reason we need a policy change isn’t just about reducing affordability in the inner suburbs, it is essential we start creating models of ownership to encourage investment in the outer suburban thresholds where new supply is dearly needed and communities need to grow. At the moment, if forced to locate into an outer suburban zone, until facilities are provided, most would rather rent than buy, at least until the level of population warrants substantial government and private investment to build the facilities to attract “settlers” not “sojourners”. Therefore investment in these areas is sorely needed – investment that does not rely on capital growth to prosper.

Back in 2007 an article was posted on Smart Company predicting “within the next two years legislation will reduce the scope of negative gearing as a taxation benefit.”  Last year the Gillard government reportedly sounded out unions opinions on scaling down the system.  It was also a key recommendation in the Henry Tax Review.  However to date, nothing has been done.

I can’t help thinking back to a talk I attended where a Victorian state minister was lecturing on the state of our economy (I won’t mention names).  During the course of his speech, he revealed he had ownership of nine investment properties – the majority of which are negatively geared.  He’s no fool – he understands under the current system of investor ownership, property prices in the inner- and middle-ring suburbs prices will continue to inflate over the long term.  Therefore, debating with him – or others like him – for a change in policy will obviously inspire opposition.

Considering we have growing numbers of investors (and voters) employing negative gearing above other investment strategies, there’s no security – should a change in policy be introduced – that it would last the course of the current or even subsequent governments.  However ethically speaking, for the sake of Australia’s growth, a change in policy (through either “quarantining” current rules or scrapping the system in stages) is a much-needed requirement.

Catherine Cashmore is a market analyst with extensive experience in all aspects relating to property acquisition. 

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