You are on page 1of 50

Short Memory

Alternative Title Shortened Memory

Negative Gearing and Capital Gains Tax: Foundations of the New


Australian Housing Model

INITIAL DRAFT
16 May 2016
Prepared by Brian Haratsis
Executive Chairman

Strategic Planning Property Advisory Economic Analysis Retail Analysis Spatial Planning Policy and Strategy Financial Analysis GIS Mapping
MacroPlan Holdings Pty Ltd | ACN: 603 148 545 | ABN: 21 603 148 545
Level 4, 39 Martin Place, Sydney NSW 2000 T (02) 9221 5211 F (02) 9221 1284 info@macroplan.com.au www.macroplan.com.au

Table of Contents
Executive Summary ......................................................................................................... 3
1. Context ............................................................................................................................... 6
2. Long Term Housing & Rental Prices in Australia ....................................................... 10
3. Impacts of Negative Gearing & CGT on Price & Rental Levels ............................ 20
4. Impacts of Proposed Changes to Negative Gearing & the CGT Discount ........ 32
5. Residential Market Downturn ....................................................................................... 39
6. Appendix 1 ...................................................................................................................... 42
7. Appendix 2 ...................................................................................................................... 43
8. Appendix 3 ...................................................................................................................... 45

Page |2

_Executive Summary
1.

The ALP proposal to permit negative gearing of

5.

The proposed ALP policy change will cost a similar

wage income only on new buildings and to reduce

amount as the revenue it collects and in addition

the Capital Gains Tax discount from 50% to 25% will

cost renters an additional $1.7 billion per annum in

have three major short term to medium term

rental costs. Direct expenditures for a modest

impacts.

mitigation of the impacts on low income renting


households are:

2.

Over the next decade it will reduce by over 1

$2.5 billion per annum capital costs for social

million, the number of negative gearing landlords.

housing due to the reduction in rental dwellings

This will directly impact on 45% of the 2.25 million

acknowledging the historically high 150,000

renting households. It will increase rents by 8.8% for

people on public housing waiting lists

these negatively geared dwellings.

$0.4 billion in operating costs to support the


additional social housing

3.

Second it will remove 205,000 dwellings from the

$0.4 billion per annum in Commonwealth


Rental Assistance acknowledging historically

rental housing supply stock. Given the current

high 50.1% of low income households in

historically high levels of housing stress (50% of lower

housing stress.

income households were assessed as being in stress


by the ABS (in 2014) and 55% are currently
estimated for 2016 that waiting lists for public

The total cost to the economy is therefore $5 billion

housing are also at historically high levels (150,000

per annum with $3.3 billion direct expenditure from

households), an immediate increase in social

government. This compares to the average per

housing will be required to replace low income

annum revenue estimated by the Parliamentary

rental stock.

Business Office of $3.2 billion per annum, resulting


from implementation of the ALP policy framework

4.

Third it will create a resale price cliff. Our detailed


study of the Melbourne CBD / Docklands /
Southbank resale of off the plan apartments

6.

In addition to the direct costs a wide range of

reveals on average currently a 12 % loss. Around

indirect costs should be considered in the

20% of the sales had losses ranging between 20%

assessment of the ALP proposed policy framework.

and 40%. Reducing the CGT discount would result

These include:

in losses in the order of 17% to 20% for off the plan

Higher new dwelling prices in areas with limited

purchases driven by an inability of the first owner to

new build opportunities

sell to a negative gearing landlord. Two thirds of

More focus on properties which can deliver

apartments are investor owned. Apartment sales

high capital gains (high end of market) to

activity levels have reduced between 30% and 40%

compensate for the reduction in the CGT

in Sydney, Perth and Brisbane and median

discount

apartment prices are dropping in all CBDs.

Higher levels of rental stress for low income


renters, as higher income renters crowd out
lower income renters seeking to reduce their
rental costs

Page |3

Lower income rental households forced out of

mortgage insurance etc and more equity from

established areas with jobs, facilities and public

purchasers.

transport to move to outer fringe areas in new


dwellings with no jobs, public transport or

10. Considering the following factors:

facilities

Australia is in the unwind period from the

Increased levels of social dysfunction on the

biggest residential boom in Australian

urban fringe

history

Increased carbon footprint for low income

Significant contraction in credit to

renters as affordable private rental stock in

domestic investors has already led to a

established areas shifts to the urban fringe.

dramatic drop in investor loans

Established house prices are estimated to decline


overall by 3% to 4%.

Significant contraction in credit to overseas


investors has already occurred
The imminent contraction in the residential
construction activity

7.

The ALP policy change forecasts 25,000 additional

Reductions in median prices for

jobs. No new jobs will be created because in the

apartments has occurred in Sydney,

long run demand and supply of new dwellings is

Melbourne, Brisbane and Perth and market

influenced by real disposal income, population

conditions in regional areas continue to

growth, employment and mortgage rates. The ALP

soften

proposed negative gearing / Capital Gains Tax

Pressure on banking shares and banking

discount will result in a similar total housing supply to

profits is increasing

the current policy setting.

The distortionary impact of the proposed


policy changes is likely to be significant

8.

Property markets in Australia are at different phases


of the economic cycle. Within 24 months,
according to the Australian Construction Industry
Forum key markets of Sydney and Melbourne will
contract by approximately 10%.Sales volumes will
contract by 25% to 35% from 2015, rents will
increase by 1.0% to 3.0% per annum and median

Market confusion on behalf of both developers


and purchasers, risks to market stability and
volatility in the short term, suggest that retention of
the current negative gearing / CGT discount is the
most rational policy position.
11. The Henry Tax Review (Australias Future Tax System,

dwelling price increases will moderate from 4% to

2010) the last comprehensive analysis into the

6% per annum.

reform of negative gearing / CGT discount


recommended that no change be made until

9.

The ALP proposed policy change will create market


chaos because it is undefined and will be difficult
to police. For example, is a refurbished building
(e.g. a former office block) for residential purposes
a new building? When is renovating a dwelling a
new building? Further, financial institutions and
valuers will take a conservative approach to the
resale price cliff anticipating that resales to
positively geared entities only will significantly
reduce the potential buyer market. This will mean
lower loan to value ratios i.e. increased deposits,

housing supply issues were addressed because of


the likely negative impacts on housing supply. This
policy position, which advocated elimination of
stamp duty and reforms to land tax, remains the
most comprehensive analysis of the best tax mix for
land and resources. The most recent views of the
RBA support the Henry Tax Review proposition. The
RBA stated in its 2015 Submission to the Inquiry on
Home Ownership that, The Bank believes that
there is a case for reviewing negative gearing, but
not in isolation. Its interaction with other aspects of

Page |4

the tax system should be taken into account (p.


23).
12. Negative gearing and the CGT 50% discount has
been the foundation of the new Australian Housing
Model, supplying private rental dwellings to

Reduced direct social housing provision


Increased management of social housing
through community housing organisations.

substitute for the real reductions in expenditure on

Policy makers proposing to change the negative

public housing.

gearing rules and reduce the CGT discount have a

Subsidised home ownership (no CGT)


Affordable housing provision by the private
sector with direct Commonwealth Rental
Assistance(CRA) to consumers

very short memory.

Page |5

_1. Context
1.

This study analyses the impacts of negative


gearing and the capital gains tax (CGT) discount
in relation to the key objectives set for this policy
setting and the implications of the current CGT
policy setting i.e. a 50% discount.

2.

A Recent study by the Grattan Institute (Hot


Property: Negative Gearing and Capital Gains
Tax Reform, 2016) focused on the beneficiaries
of the CGT discount, and failed to assess the
economic benefits of the current policy setting.
This omission led the Grattan Institute to the
wrong conclusion i.e. that removing or reducing
the CGT discount would provide saving to
government. In reality, such a change will
generate no revenue to Government and cost
renters $1.7 billion per annum.

3.

4.

These commentators failed to recognise that the


increase in supply of rental housing induced post
the 1999 introduction of the 50% CGT discount
reduced housing stress for low income renters by
over 25% prior to the GFC (2007) in a period
where the supply of public housing was reduced
significantly and demand for housing increased
dramatically to support the mining construction
boom.
The Ralph Inquiry (1999) recommended the 50%
discount to stimulate capital markets, in fact, the
first sentence after the recommendation in the
Ralph report (page 598) states: The Reviews
recommendations for capital gains taxation are
designed to enliven and invigorate the
Australian Equities markets, to stimulate greater
participation by individuals. The primary
objective for the recommended change was to
increase capital investment in nominated asset
categories including land and buildings.

5. The Reserve Bank of Australia (2003) in a


submission to the inquiry into First Home Ownership
(Productivity Commission, 2014) set some
intellectual foundations for the Henry Tax Review
in terms of neutralising treatment between asset
classes. In 2015 the RBA confirmed that negative
gearing / CGT policy should be integrated with
other tax efficiency and tax mix considerations.
6. The RBA submission highlighted that while
housing prices had increased due the significant
interest rate cuts, rental vacancies had also
increased significantly and real rents were stable
or declining post the 1999 Ralph Inquiry
introduction of the 50% CGT discount.
7. The stimulating effects of the Ralph Inquiry
significantly improved rental affordability from 1999
until the chaos of the 2007 boom and 2008 bust
i.e. the GFC. In this period the number of low
income renters in housing stress declined by over
25% i.e. renters paying more than 30% of gross
household income on rent (Australian Institute of
Health and Welfare). This outcome was achieved
in parallel with significant reductions in the supply
of public housing.
8. ACOSS (2015) and the Grattan Institute (2016)
utilised similar methodologies to assess the impact
of negative gearing and CGT discount. These
methodologies did not assess the costs and
benefits of the CGT, rather their studies simply
sought to ostracise high income individuals, hence
the identification of the direct beneficiaries of the
CGT discount from ATO records without for
example analysing the benefits to low income
renters.
9. The findings that most of the tax benefit
accrued to high income individuals was to be
expected because of their wealth and access to
capital. The broader spectrum of lower income
individuals negatively gearing and utilising the CGT
discount was the real news.

Page |6

The last comprehensive study of the issue, the


Henry Tax Review, Australias Future Tax System
(2010) recommended that no change be made to
the CGT 50% discount until:
Stamp Duty is removed
Land tax is reformed
Housing supply issues are addressed due to
potential impacts on housing supply
In addition, the Henry Tax Review supported a
continued CGT discount which improved neutrality
between asset classes (i.e. property / shares / cash)
and positively geared investors in property i.e.
investors with high levels of equity.
The Henry Tax Review recommendations refined
the CGT discount recommendations from the 1999
Ralph inquiry which introduced the 50% CGT
discount to replace the complex indexation
concession which applied previously.

The stimulus effects of the CGT discount


accordingly are almost wholly responsible for:
A 25% reduction in the number of low income
earning households paying over 30% of their
gross household income in rent from 2000/01
to 2007/08, however after this period the rate
of dwelling construction was unable to match
demand and household income increases
particularly for lowest ranges did not match
rental price increases to 2011/2012. After this
period low wage increases (the lowest post
war) did not match rental increases and
rental affordability deteriorated to 2016 (55%
of low income households assessed as pay
greater than 30% gross household income).

TABLE 2: PROPORTION OF LOW INCOME


HOUSEHOLDS SPENDING MORE THEN 30% OF GROSS
INCOME ON HOUSING COSTS

TABLE 1: HOME OWNERSHIP RATES FOR AUSTRALIAN


HOUSEHOLDS 1976-2011

45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
1976

1981

1986

1991

1996

2001

2006

Owner without a mortgage


Owner with a mortgage
Renter
Other tenure
The stimulatory effect of the 50% CGT discount can
be clearly observed in the context of the long term
supply of rental housing in Australia. The overall
trend increase in rental housing supply can be
observed between 2001 and 2011. The increase in
supply of rental dwellings can almost be entirely
explained by market entry from negative gearing
landlords as per table 1.
Source: ABS Census, AHURI (2014)

2011

Significant downward pressure on rental


levels for all renters due to significant increase
in supply.
Negative Gearing and the CGT discount are
critical elements of the new Australian Housing
Model which can be summarised as:
Subsidised home ownership (no CGT)
Affordable housing provision by the private
sector with direct Commonwealth Rental
Assistance(CRA) to consumers
Reduced direct social housing provision
Increased management of social housing
through community housing organisations.

Page |7

The economic benefits of using private capital to


generate affordable rental housing are direct (as in
the case of lower rents) and indirect in the case of
reduced government expenditure on social
housing and the opportunity to redirect
expenditure.

The direct provision of social housing still requires parallel


Commonwealth Rental Assistance (CRA) to achieve
affordable rental outcomes.
McKell Institute / ACOSS / Gratton Institute utilised the
same technique to analyse impacts on renters of
removing the CGT discount by observing the impact
on rent in the two year period (1985-1987) when the
deduction to labour income was removed by the
Hawke Government.

Even with induced effects of private rental housing


due to the CGT discount the Reform of Federation
White Paper (Issues Paper 2, Appendix A 2014)
argues that there is A lack of affordable private
rental housing for low-income earnersparticularly
in the major citieshas led to an increase in the
number of people living in marginal rental
accommodation, such as caravans, boarding
houses and motels (R Goodman et al., The
experience of marginal rental housing in Australia,
AHURI Final Report No. 210, Australian Housing and
Urban Research Institute, Melbourne, 2013, p. 8).
While on the rise since the 1990s (Goodman et al.,
p. 35.), demand for marginal rental housing has
been exacerbated by the impact of the global
financial crisis (Goodman et al., p. 8.). Marginal
housing tenancies are often poorly regulated and
highly controlled by landlords, resulting in greater
insecurity and disempowerment for tenants
(Goodman et al., p. 2)

TABLE 3: EXPENDITURE ON HOUSING ASSISTANCE AUSTRALIA, 1980 TO 2010


3500
3000

$M

2500
2000
1500
1000
500
0
1980

1985

1990

CSHA

1995

CRA

2000

2005

2010

Source: J Yates, valuating social and affordable housing reform in Australia: Lessons to be learned from
history*, International Journal of Housing Policy, Vol. 134, No2, 2013, p.115

Page |8

The McKell / ACOSS / Grattan Institute impact


analysis is technically misplaced because rental
markets cannot adjust in a two year period.
Grattan acknowledge the need for an
adjustment period in their analysis of the CGT
discount on housing prices. A key learning from
the McKell / ACOSS / Grattan technique is that
impact analysis must have regard to actual
conditions in individual rental markets i.e.
between 1985 and 1987 rents in Perth and Sydney
increased due to boom conditions and rents in
other major capital cities remained stable or
dropped.
Data from the Australian Institute of Health and
Welfare indicates that from mid-2000 to mid-2007
rental stress for low income households reduced
by 25%. This data is supported by analysis in the
reform of Federation White Paper (2014) on
housing which indicates a steep decline in rental
stress up to 2007 and a significant increase to
2011.
From an economic perspective analysts agree
that long term policy settings which influence
demand and supply have a far more significant
impact on housing prices and rentals. In terms of
longitudinal studies, Stapledon and the RBA have
produced analysis which indicates that demand
and supply factors are far more significant than
factors such as negative gearing and the CGT
discount in influencing housing and rental prices.

For analysis of the CGT impacts five timeframes should


be considered:
1985 1987 Housing CGT change to
deductibility of Capital Gains from labour
income
1988 1994 Post stock market crash and
interest rate reduction from 10% to 6%
1995 2006 Population growth. Introduction of
GST. Interest rates decreased from 10% to 6%
CGT 50% discount introduced.
2007-2010 GFC chaos period
2011 2016 Post GFC housing boom with
interest rates reducing from 5% to 1.75%. In 2015
from 2011 to 2010 credit tightening on investors
/ SMSFs / foreign investors and increased LVRs
for owner occupiers significantly cooling
market. Some markets (e.g. Melbourne, Perth
and Brisbane CBD apartments) are significantly
reducing in value. Banks withdrawing FIRB
funding.
This study focuses on:
The long term determinants of housing prices
and rental levels
Analysis of the period from 1999 to 2006 in
relation to stable economic conditions
Analysis post 2011 and the introduction of ultralow interest rates.

Page |9

2_ Long term Housing and


Rental Prices in Australia
2.1_ Introduction
The beginning of the modern era of Australian
house price and rental change is widely
considered to be 1955 (RBA Aug 2014, p.33)
Since that time, house price growth has oscillated
around a real long term growth rate of 3% per
annum and a quality adjusted growth rate of 2.22.5% per annum.
Though this long-term trend has remained
consistent, the cause of house price growth over
time is more complex, being an outcome of
multiple interacting supply and demand side
factors.

An analysis by Peter Abelson et al (2005) found that


real house prices are related significantly and
positively to real income and to the rate of inflation
as represented by the consumer price index and
are also related significantly and negatively to the
unemployment rate, mortgage rates, equity prices,
and the housing stock(p.1). The changes in these
key demand and supply factors over time are the
cause of housing price change.
Additionally, the study found no significant
relationships between house prices and income
per capita, real or nominal interest rates, or real
rental rates. (Abelson 2005, p.12).

TABLE 4: REAL (2014) DWELLING PRICES

P a g e | 10

2_ Long term Housing and


Rental Prices in Australia
2.2_ Introduction (cont.)
The insignificance of rental yield is of particular
note as it points to one of the most fundamental
changes to the housing market over the period
housing investment shifted focus to earning
through capital gains, essentially treating housing
stock as if it were an asset.

The Graphs below show that while rents have


followed economic conditions over the past 20
years real house price growth grew more quickly.

However, while housing prices took off as


speculative investment in property grew in
popularity and as household wealth and income
were also increasing over the period, rents
remained relatively flat, as demand for rentals
increased but the availability of rental dwellings
increased faster, driven by property investors.

TABLE 5: RELATIVE & RENTAL HOUSE PRICE MOVEMENTS

P a g e | 11

2_ Long term Housing and


Rental Prices in Australia
2.3_ Short-term Disruption, Long-term Change:
Effects of the Mining boom - Demand
The mining construction boom had major effects
on the entire Australian economy not just a few
mining terms.
In its Research Discussion Paper The Effect of the
Mining Boom on the Australian Economy (August
2014), the RBA discusses in detail what it believes to
be the overall impact of the Mining Construction
Boom on various metrics, notably on page 15
where it identifies that as of 2013:

It is important to underline that the RBA believes


that several of the key factors that determine
housing prices have been disrupted since the mid
2000s, and that this disruption may have caused a
one-off permanent change in long term house
prices, driven by an expansion of the entire
Australian economy.

The population is 1% higher reflecting the


response of net migration flows to relative
job opportunities
Employment is 3% higher reflecting higher
real wages as well as job opportunities
Real consumer wages 6% higher, and that
Household disposable income 13% higher
reflecting historically high levels of terms of
trade and national income.
Based on a counterfactual analysis i.e. what would
have occurred if the mining construction boom did
not happen

TABLE 6: EFFECTS OF THE MINING BOOM ON HOUSEHOLD INCOME

P a g e | 12

2_ Long term Housing and


Rental Prices in Australia
TABLE 7: EFFECTS OF THE MINING BOOM ON CONSUMER PRICES SELECTED COMPONENTS

TABLE 8: EFFECTS OF THE MINING BOOM ON UNEMPLOYMENT

P a g e | 13

2_ Long term Housing and


Rental Prices in Australia
2.4_ Short-term Disruption, Long-term Change:
Effects of the Mining boom - Supply
While demand-side changes have perhaps played
a larger role in housing market expansion since the
GFC, supply in the market has proven relatively
inelastic to this surge of demand (p19. RBA Aug
2014 The Effects of the Mining Boom on the
Australian Economy). Accordingly the mining boom
was impacting real rental prices and vacancies in
the entire Australian economy.
This has had the secondary effect of keeping rental
vacancy rates much lower than they would have
been without the mining boom.
The RBA also points out that this lack of a supply side
response to demand has led to rapidly rising rental
prices in line with economic conditions.

The RBA also accounts for the impacts of high rents


and house prices on suppliers, stating that
Although high rents and house prices encourage
housing construction, these effects are more than
offset by higher interest rates after 2009. (p19. RBA
Aug 2014)
Thus even though demand was strong the supply
of housing contracted compounding the
downward pressure on vacancies and upward
pressure on rents. (p19. RBA Aug 2014)
The paper estimates that without the mining
boom, the vacancy rate would barely have fallen
below 2% during 2006/07 and rents would have
roughly kept pace with inflation

TABLE 9: HOUSING VACANCY & RENTS

P a g e | 14

2_ Long term Housing and


Rental Prices in Australia
2.5_ Long term Price Drivers
Three major studies have been undertaken estimating
long growth in real house price indices and the ratio of
house prices to income (Abelson, Stapledon, RBA), these
are summarised in tables, 11, 12 and 13.
These studies demonstrate that post war, housing prices
moved with general economic conditions reflecting
demand and supply until the late 1990s when banking
deregulation occurred and economic growth in
Australia increased dramatically driven by the mining
construction boom. The increases in housing prices have
been driven by mortgage rates, supply shortages
caused by zoning and regulation, and increased wealth.
In the short to medium term economic cycles occur
which impact on housing and rental prices.
The RBA has sought to quantify some of the shorter term
factors and this is summarised in Table 10 (2014, RBA)
which demonstrates that ultra-low mortgage rates are
currently driving housing prices.

TABLE 10: CONTRIBUTIONS TO REAL HOUSE PRICE GROWTH

Source: Is Housing Overvalued RBA 2014, p. 21 Fig 4

P a g e | 15

TABLE 11: HOUSING PRICE INDICES 1970-2003

TABLE 12: STAPLEDON

TABLE 13: REAL (2014) DWELLING PRICES

P a g e | 16

2_ History of Negative Gearing and


capital Gains Tax
Abelson (2004, p. 9) argues Home owners were exempt
from capital gains tax (CGT) throughout the period.
Investors were also exempt from CGT up to 1985 when
the government introduced a CGT on real gains for
investors. In September 1999 the government replaced
this CGT with a tax of 50% of the nominal gain. Many
people, including the Productivity Commission (2004),
perceived the change in 1999 to be a further subsidy to
investors.

Actually, when the nominal gain is more than twice


the real gain (as often happens), the new CGT
increases the tax liability. Investors were allowed
full negative gearing rights throughout the period,
except between August 1985 and September 1987,
when negative gearing was disallowed and
investors had to carry forward losses. Rental
investment declined in this period. Further Abelson
(P.12 argued) (The study) found no significant
relationships between house prices and income per
capita, real or nominal interest rates, or real rental
rates.

P a g e | 17

Impact analysis in relation to negative gearing and


the CGT discount should focus on current market
conditions. Impacts will occur in the short to
medium term, however in the long term factors
other than negative gearing and the CGT are far
more significant in determining housing prices.
Rental prices are currently dissociated from
housing prices and impacts need to be assessed
independent of house price impacts.
The fast growth in the apartment market post 2006
particularly in CBD / Inner areas, which is
approximately two thirds investor presents a major
short term issue due to its rapid increase in price
and major dependence on high degrees of
leverage.
However, due to current policy settings restricting
Greenfield development demographic change
and changes to consumer preference, higher
density dwellings have come closer to construction
cost parity with Greenfield developments, though
at a higher price to the consumer. The result of this
is a long-term trend towards higher density
development in Australian cities, and significantly
higher proportions of household incomes devoted
to repayments on housing loans.

TABLE 14: CONSTRUCTION COSTS

TABLE 15: APARTMENT & MEDIUM-DENSITY HOUSING

P a g e | 18

TABLE 16: REPAYMENTS ON NEW HOUSING LOANS

P a g e | 19

3_Impacts of Negative Gearing and


Capital Gains Tax Discount on Price and
Rental Levels
1.

The relationship between housing prices and

TABLE 17: HOUSING PRICES TO INCOME

rental levels in Australia diverges in different


time periods due to different economic
conditions, different taxation and investment
frameworks, different investor objectives and
differing renter preferences.
2.

Rental levels in Australia are primarily driven by


the supply of rental stock available and the
ability of renters to pay. Investors determine the
stock of rental housing available. Consumers
(renters) determine ability to pay via the
amount of rent they are willing to pay. Rental
levels are an input, though not a particularly
significant input into housing prices in Australia,
unlike the international experience. In Australia
investors primarily seek capital gains. As rents
are determined by the dynamics of demand

supply i.e. is not responsive to changes in

and supply not the returns that owners are

demand and hence rental levels can spike

seeking.

quickly given that the available pool of rental


dwellings cannot expand quickly.

3.

Rental levels in Australia post 1980s tracked


with CPI (and below) until the mining

4.

Post the 1999 Ralph Inquiry change to the

construction boom. Investment housing is an

Capital Gains Tax discount1, the number of

asset with its own investment attraction and

investors negatively geared increased and the

investment criteria compared with other asset

number of positively geared investors remained

classes as already demonstrated in section 2 of

relatively stable. It is reasonable to assume that

this report. The housing supply in Australia is

the long run increase in rental (investor) stock

relatively inelastic in relation to demand to

was stimulated by the 50% CGT discount given


the take up of negative gearing and parallel

The CGT discount was set at 50%, replacing the former


framework which indexed values. The Ralph proposal
intended to stimulate investment and to create certainty
1

P a g e | 20

expansion of rental stock. This is an important

boom), suggests rental levels would have

fact because the supply of rental housing

tracked the CPI if the boom had not occurred.

increased from 20% to 25% of total housing

(Downes P. Effect of the Mining Boom on the

stock from 1991 to 2006. Rental yields declined

Australian Economy, June, 2014 RBA)

substantially and vacancy rates remained


steady through this period.

9.

Unpacking rental housing supply from 1996 to


2006, then to 2011 indicates that the new

5.

The significant increase in total rental stock


occurred in parallel with the Ralph Inquiry 1999
CGT discount change but the trend supporting
increased landlords negatively gearing was
well established in the early 1990s. This
indicates that increasing wealth, increasing
demand and changing consumer preferences
were more important in stimulating supply and
demand than the 1999 introduction of the 50%
discount alone.

6.

The rental stock supply response


accommodated real demand over the period.
As the demographic impacts of the mining
construction boom receded, the number of

Australian Housing Model is working well by


world standards in terms of generating
affordable rental levels. The percentage of
households under housing stress i.e. paying
more than 30% of gross household income in
rent reduced by 25% in the early period. This
remarkable outcome was caused by an
increase in low income housing stock and a
significant increase in household income. This
outcome is documented by the Australian
institute of Health and Welfare and by Yates
(2004). Between 1996 and 2001, the income
circumstances of private renter households
improved considerably, thereby bettering their
overall ability to pay for housing (2004, p38).

people negatively gearing residential property


flattened out by 2014 (see table 20).

10. The affordable rental housing supply situation


(Reynolds, Yates, 2014) in 2011, after the largest

7.

The supply of rental housing was an important


contributor to the mining construction boom.
Without the incentive for a significant supply,
partly induced by the 50% CGT discount,
important housing requirements in resource
areas such as the Pilbara and Bowen Basin
would not have been fulfilled. The public sector
failed to produce housing when it was required
and rentals of $1,500 per week for a 3 bedroom
dwelling were common in the Pilbara.

8.

Capital cities also required apartments for


miners and support workers as well as
international students. As the RBA (June, 2014)
analysis has indicated the 2004-2010 mining
construction boom is the largest in Australian
history, yet the Australian housing model
underpinned by negative gearing was almost
able to cope. RBA counterfactual analysis (i.e.
what would have occurred without the mining

trade episode in Australian history was still


remarkably robust. Estimating the rental supply
for quintiles 1 and 2 (i.e. the lowest 40% of
household incomes) the authors concluded,
using what is in effect a cumulative shortage
of affordable and available stock for Q1 and
Q2 households, there was a surplus of
affordable dwellings nationwide of 174,000 in
2011, significantly down from 260,000 in 2006.
The new Australian Housing Model was clearly
working, however benefits did not accrue to
the lowest income households because
affordable dwellings were being occupied by
higher income households.
11. From 2011 to 2016 rental levels increases were
modest and tracking CPI, but they were
however higher then wage price increases.
Together with a post GFC increase in
unemployment housing stress for low income

P a g e | 21

rental households increased significantly so that


by 2016 around 55% of low income rental
households are in rental stress.

16. The approach utilised by McKell / ACOSS /


Grattan has not been to assess the major rental
benefits in current policy setting, in particular

12. Negative gearing and the CGT 50% discount

the 25% reduction in housing stress for low

were important policy settings underpinning

income households to 2006. Rather each of

growth in the supply of rental dwellings and

these analysts has (strangely) analysed rental

moderating growth in rental levels. Given that

impacts from 1985 to 1987, when the Hawke

the 2004-2011 trade episode was the most

Government restricted negative gearing so

significant in Australian history the rental market

that rental losses could not be used to reduce

operated exceptionally well.

tax payable on labour income, then reversed


the decision. Clearly rental supply and rental
levels have almost no chance of responding to

13. The new Australian Housing Model was


successful inducing the supply of private rental
housing as the supply of public rental housing
contracted.
14. Rental stress for low income households

a change in tax parameters in 24 months. The


graph utilised by Grattan is reproduced below.
TABLE 18: RENTS DID NOT RISE WHEN NEGATIVE
GEARING WAS REMOVED

reduced dramatically to 2006 but due to the


mining construction boom impacts on the
entire Australian economy re-emerged, by
2011 low income rental stress requires targeted
policies to find solutions. Yates (2004 and 2014)
suggests government direct investment
developing a market to enable institutional
investment (p.49) or rental regulation and/or a
reduced CGT discount. Eliminating negative
gearing would significantly increase
expenditure requirements on social housing or
increase tax expenditure on low income
housing. Neither of these budgetary costs have
been assessed in estimation of the net budget
costs of changing negative gearing / CGT
discount as recommended by the ALP.

The key objective of these analysts is to


demonstrate that negative gearing / CGT
discount has no impact on the supply of rental
housing and the price of rent. This proposition is
at odds with the facts. As the graphs indicate

15. The significant positive impacts of negative

rents in capital cities moved in disparate

gearing / CGT discount are not calculated in

directions. This outcome was to be expected

terms of the supply of rental housing and lower

because demand and supply factors

rental costs, despite the fact that this is clearly

significantly outweigh any impacts of negative

influenced by the current policy setting. The

gearing / CGT discount. This should have

ALP proposed policy change does not factor in

informed the current ALP proposal which is to

the costs associated with higher private rentals

be implemented at a time when residential

reduced rental stock and housing

markets are contracting significantly and most

displacement.

CBD and Inner apartment markets are in

P a g e | 22

serious decline in terms of sales activity and

to a significant increase in rental housing

price. (see Table 24)

supply, supported by a change in consumer


preferences (at higher income levels) to rent

17. The Grattan Institute argues in relation to the

dwellings. This reflected significant increases in

period 1985 to 1987, Beyond these historical

labour mobility, differing personal relationship

lessons , economic theory and empirical

preferences and structures, family breakdown,

research show that negative gearing and/or

increased income for young professionals and

increasing taxes on capital gains does not

increased preferences to live in CBDs / Inner

change rents much (p.34, 2016). This is at odds

areas which increased human capital via

with the facts. The Grattan Institute analysis of

increased job opportunity and increased

the impact of CGT discount argues that almost

educational opportunity. These significant

100% of the increase in rental dwelling numbers

benefits are reflected in very high levels of

was caused by the CGT discount. Data

labour productivity in inner areas of the CBD.

analysing the period 1996-2006, i.e. pre the

This needs to be considered against the tax

peak of the boom and the ensuing GFC

expenditure generated by negative gearing

demonstrates that rental housing supply

CGT discount.

increased and rental levels remained around


CPI. The Grattan proposition is put in the
negative i.e. removal of negative gearing /
CGT discount will not reduce the number of
rental properties (p.34). This proposition (without
evidence) is at odds with the long run
evidence of the impacts of the 50% CGT
discount which has contributed to a significant
increase in rental stock induced by (as Grattan
indicates) an increase in negatively geared
properties almost wholly induced by the 50%
CGT discount.

20. Ongoing growth in highly productive services


export industries such as student housing and
tourism require the ongoing increase in supply
of inner city apartments. Detailed analysis by
Dr. Peter Brain indicates that growth in the
central city needs to keep pace with capital
cities to maintain productivity levels (ACOLA,
2015). Important niche markets such as student
housing are in part driven by negative gearing.
TABLE 19: NET IMMIGRATION

18. Grattan turn to special pleading for their case


against the negative gearing / CGT discount.
This includes the (incorrect) statement that
negative gearing reduces rates of home
ownership (p.6, Grattan 2016) and made it
harder for owner occupiers to afford to buy
homes (p.27, Grattan 2016). In fact home
ownership remained relatively constant (68%)
and private rental dwellings substituted for the
reduction in public rental dwellings.
19. Assessing long term rental trends and likely
impacts of taxation on rental levels (Stapledon,
Abelson, RBA) analysis leads to the conclusion
that negative gearing / CGT discount has led

P a g e | 23

TABLE 20: NUMBER OF LANDLORDS BY TYPE OF GEARING, 1994-2014


Positive gearing definition: Mortgage costs < rental income
Negative gearing definition: Rental income < mortgage costs, Government refunds
disparity from taxable income

2,500,000

2,000,000

1,500,000

1,000,000

500,000

Positive Rental Income

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

Negative Rental Income

Source: Grattan Institute (2016)

TABLE 21 & 22: RENTAL VACANCY & RENTAL GROWTH

P a g e | 24

TABLE 23: ANNUAL GROWTH IN REAL RENTS - AUSTRALIA

21. Since the post 2008-09 economic shocks, rental


vacancy rates have risen marginally (RBA 2014a,
graph 3) but, at around 2 % in 2016, whereas 3
years old include up to date data still below
what is generally regarded in Australia as a
market clearing rate (of 3%).
22. Over time, the cost of living in Australia has
increased. This uncontroversial statement is not
often viewed by the average Australian as a
problem directly affecting their wellbeing or
their lifestyle. However, a recent release
published by the Australian Bureau of Statistics
sparked both concern and debate when it
released its most recent update to its regular.
The ABS Wage Price Index showed that, in the
December 2015 quarter, Australia had endured
its lowest growth in wages since they began
recording it. Unfortunately, this new data was
just the most recent episode of a longer
downturn in wage price growth.

P a g e | 25

TABLE 24: QUARTERLY CHANGES, TREND, TOTAL HOURLY RATES OF PAY EXCLUDING BONUSES

Source: ABS Cat. 6345.0, December 2015

To put this in the context of the housing and rental markets,


data from the ABS (Cat. 4130, 2015) shows that since the
GFC, real rental costs have spiked dramatically, displaying
growth rates well above long-term trends and the ability
of lower income household to keep up.

P a g e | 26

TABLE 25: REAL RENTAL COSTS OVER TIME (2013 / 2014 AUD)
500
450
400
350
300
250
200
150
100
50
0

Owner without a mortgage

Owner with a mortgage

Private landlord
In the summary of its findings, the Rental Affordability
Index Release Report (Nov 2015) stated that households
falling into the lowest 40% of income consistently face
severely and extremely unaffordable rents, going on to
point out that this is the case in all regions of Australia
including all cities and all regional areas. What this
effectively means is that rising rents and dropping wage
growth is having a serious impact at the margins, forcing
some people to pay as much as 60% of their earnings
towards housing.

TABLE 26: PROPORTION OF LOW INCOME HOUSEHOLDS EXPERIENCING HOUSING STRESS


60

%
50
40
30
20
10
0

Lowest quintile
Third quintile

Second quintile
ABS "Lower income households"

Source: ABS Cat. 4130, MacroPlan Estimates

P a g e | 27

This worrying trend is corroborated by ABS data in its

RBA Key house price metrics (put in a footnote):

2015 release Housing Occupancy and Costs, 2013-14


(cat. 4130) it depicts a significant increase in lower

In Is Housing Overvalued? (2015) the RBA

income households paying over 30% of their income

decomposes housing values into contributions

on housing costs since 2007/08. This is particularly

from rents, interest rates, expected

noteworthy given that over the period the ABS has

appreciation and other factors (p.1), though

recorded this statistic, it had until recently remained in

they note that given that the supply of

a narrow band between 39% and 45%, and had been

housing is fixed in the short run, prices are

trending down in the long term.

determined by how much buyers are willing to


pay(p.1)

MacroPlan estimates that since 2013/14, the growth in


this metric has remained consistent, which means that

Source: Table 11, Abelson et al (2005), Table 12,


Stapledon (2012)

55% of low income households are paying more than


30% of their income towards housing costs.

TABLE 27: HOME OWNERSHIP RATE

P a g e | 28

23. After 2010 there was a spike in rental levels amid


the chaos of the GFC. Rental vacancy rates
stabilised by 2016 and were beginning to
increase. This is reflected in the reduced level of
inner city apartment rental growth (which
despite being influenced by increasing numbers
of international students) demonstrated the
impact of the increasing supply of apartments.

24. By late 2015 and early 2016 the combination of


tightening credit standards (APRA) and reduced
credit to SMSFs for residential investment, credit
growth to residential investors dropped to a 10
year low (excluding the GFC).

TABLE 28: HOUSING CREDIT GROWTH

25. Inner City apartment prices increased


dramatically post 2011 reflecting on asset
allocation preference for investors post GFC in
conjunction with a significant change in
consumer preferences to live in apartments,
and strong CBD / Inner jobs growth (health,
tertiary education, tourism) This growth in

P a g e | 29

demand outstripped supply until 2015 (see


Appendix 3) and both sale prices and rental
levels are dropping in real terms.

TABLE 29: INNER CITY APARTMENTS

Source: Financial Stability Review April 2016

P a g e | 30

Conclusion
26. Rental levels in Australia are driven by demand
and supply not dwelling prices. As the data

27. Post 2011, population grew at historically fast

indicates the impact of negative gearing when

rates (over 300,000 persons per annum) and

the CGT 50% discount was applied was to

the real cash rate was negative. This fuelled

stimulate a long term increase in the supply of

demand for rental dwellings with a delayed

private rental dwellings. This occurred as part of

supply response and a consequent short term

the new Australian housing model as private

spike in rental levels. Without negative gearing

rental dwellings replaced public rental

/ CGT 50% discount the supply of rental

dwellings and home ownership remained

dwellings would have been considerably lower

around 68%. Analysis of the period to 2006

and a housing crisis would have emerged. As

indicates that the percentage of low income

the analysis of the mining construction boom in

households in rental stress (paying more than

section 2 demonstrated, without the boom

30% of gross household) reduced by over 25%

rents would have been 25% lower and

in this period and by 2011 the percentage of

vacancy rates would have remained about

households in rental stress was still lower than

2%.

1994. The Ralph Inquiry outcome setting the


CGT discount had clearly met its objectives.

TABLE 30: PROPORTION OF LOW-INCOME HOUSEHOLDS SPENDING MORE


THEN 30% OF GROSS INCOME ON HOUSING COSTS

Strategic Planning Property Advisory Economic Analysis Retail Analysis Spatial Planning Policy and Strategy Financial Analysis GIS Mapping
MacroPlan Holdings Pty Ltd | ACN: 603 148 545 | ABN: 21 603 148 545
Level 4, 39 Martin Place, Sydney NSW 2000 T (02) 9221 5211 F (02) 9221 1284 info@macroplan.com.au www.macroplan.com.au

4_Impacts of Proposed Changes to


Negative Gearing and the Capital Gains
Discount on House Prices and Rental Levels
.changing the taxation of investment
1.

properties could have an adverse impact in

A number of reform models have been

the short to medium term on the housing

proposed for negative gearing and the capital

market. As such reducing net rental losses and

gains tax discount.


2.

capital gains concessions may in the short term


reduce residential property investment. In a

The Henry Tax Review (Australias Future Tax

market facing supply constraints, the reforms

System, 2010) recommended a comprehensive

could place further pressure on the availability

set of reforms to improve housing affordability.

of an affordable rental accommodation within

Henry found, though the reviews proposed

the private rental market. These reforms should

reforms to taxes, in particular Stamp Duty and

only be adopted following reforms to the

land tax, could play significant roles in

supply of housing and reforms to housing

addressing housing affordability, other policies

assistant. (Authors underlining, AFTS, 2010 E4-3,

are likely to have a move pronounced impact

p2)

on the responsiveness of housing supply.


(Australias Future Tax System, Final Report E4-3,
1.3)
3.

5.

proposed changes for negative gearing and


the capital gains tax in isolation.

The key policies recommended by the Henry


Tax Review in relation to land and resources
taxes were:

6.

The McKell Institute, Grattan Institute and


Australian Labour Party have all mistakenly

Removal of Stamp Duties

relied on a Robin Hood economics approach

Broadening of Land Tax

i.e. taking from the rich and giving to the

Reform of the CGT discount to reduce

poor to tax reform, rather than focusing on

deductibility of 100% of net income from

tax efficiency. This type of approach as the

property investment to 60% and reduction

Henry Tax Review (2010) indicated is likely to

of the capital gains discount from 50% to

cause significant short term impacts on housing

40%.
4.

Three most recent reform agendas have been

and rental levels. In 2015, the RBA also argues


that change to negative gearing / CGT

The Henry Review set the key objectives of the

discount should not occur in isolation from

reform package to improve housing

other taxes.

affordability, responsiveness of supply and to


tax rental investment in a way more consistent
with other forms of investment. The package

7.

The failure of McKell, Grattan and the ALP to

of reforms approach was a critical element of

argue for the broader policy context is

the proposed policy reform. Critically the Henry

surprising. The Grattan 2015 Property Taxes

Review argued

report recommends a broad based property


levy to be implemented by the states to collect
$7 billion annually. Grattan note that (p4, 2015)

P a g e | 32

The Commonwealth Treasury nominates

Further Grattan argue that stamp duty reform is

Stamp Duty as Australias least efficient tax. The

a game changer (2015 p.33-35 and p.67

proposed broadly based property tax might

Game-Changers: Economic Reform priorities

provide a pathway for eventual abolition of

for Australia), yet negative gearing / CGT

State Stamp duties (2015, p.4) and should have

discount was not2 identified as a game-

formed part of the Grattan (2016) proposal to

changer.

change negative gearing / CGT discount.


8.

Instead of proposing a widely acknowledged

TABLE 31: PROPERTY TAXES ARE ONE OF THE FEW

requirement for comprehensive reform McKell,

GROWTH TAXES

Grattan and the ALP focus on the tax


beneficiaries i.e. the income profile and
extent of tax benefit accruing to each income
level. The Ralph Inquiry objective (1999) was to
stimulate capital expenditure. The surprise in
the analysis of is not the fact that those with
capital will spend it to secure a capital gain as
anticipated by Ralph. The real surprise is the
large number of individuals around the $80,000
income level taking advantage of the
discount.
9.

The Grattan Institute reform proposal is as


follows:

TABLE 32: SOME TAXES DRAG LESS ON

Reduce the CGT discount for individuals

ECONOMIC GROWTH THAN OTHERS

and trusts to 25%


o

Phase in a 25% discount over five years


through reducing the value of the CGT
discount by 5 percentage points each
year

Limit negative gearing. Quarantine passive


investment losses so they can only be
written off against other investment income
o

Do not allow losses on passive


investments to be written off against
unrelated labour (wage and salary)
income.

Allow losses on passive investment to be


written off against all current year and
future positive investment income,
including interest, rental income and
capital gains.

Grattan (2015 Game-Changers p.67 modelled the impact of


replacing Stamp Duty with land tax and estimated a GDP
2

increase of $5M. The criteria for game-changers (p.62) are the


size of the opportunity and confidence in change.

P a g e | 33

Continue to allow losses from

impact on rent is estimated despite

unincorporated business sole traders

acknowledging that (p.34, footnote 111) a

and partnerships to be written off

sharp increase in rentals could occur in

against wage and salary income,

the short term. Given that over 1 million

subject to current restrictions.

negative gearing landlords must exit over

Do not create other exceptions such as

the next ten years as the ground furthered

allowing the write-off of losses up to a

properties become positively geared and

limit, on one or two properties, or on new

as landlords buy new stock significant

properties.

impacts on private rental levels is assured.

Phase in over five years by reducing the


proportion of losses that can be written
off against wage and salary by twenty
percentage points each year.
In the longer term, aim to align the tax
treatment across different types of savings

o Reduce taxes on other savings income


such as net rental income and bank
deposits so as to align with the tax
treatment of capital gains
o Reduce and target the tax incentives for
superannuation in line with the
recommendations in Grattans Super Tax
targeting report

Applying Abelson + Joyeux parameters (10%


increase in tax on rental incomes would lead to a 7
percent increase in rents) to Grattan ((2016) Box 6
p.32 Calculations) theoretically short term rents
would increase by 4.5% to 5.5%. We note that the
Grattan arithmetic appears incorrect and that
MacroPlan calculations utilising a discounted cash
flow model and all Grattan parameters suggests
that future return would be 8.7% lower (versus 6.3%
p.32). Further the Grattan analysis and arithmetic
relating average return to average price of 2.2%
excludes established dwellings (70% of the
number). In reality if the Grattan assumption are
correct the weighted average price decrease of

Grattan estimate that in implementing their reform:

rental dwellings would be 6.7%.

Reducing the capital gains discount would


raise about $3.7 billion per annum

10. Grattan acknowledge the Henry Tax Review

Non deductibility of investment income is

but fails to acknowledge the risks identified in

estimated to raise $2 billion per annum

that work in relation to short term impacts on

reducing it to $1.6 billion

housing supply and rental levels. Grattan do

Grattan do not estimate costs of their

not analyse the current negative state of the

proposed reforms in terms of additional

residential markets, significant reductions in the

rental levels, additional Commonwealth

price of apartments in CBDs and the imminent

Rental Assistance stress, additional

reduction in residential construction activity.

expenditure on social housing due to a

Grattan argues that There is little evidence

reduced rental pool, the cost of social

that negative gearing has the socially desirable

dislocation, the impact of moving

outcome of reducing rents(p.27 2016).

households from rental liked areas with


jobs, public transport, schools and

11. The ALP reform proposal is specifically rejected

community facilities and so on.

by Grattan, who argue that (p.2) restricting

Grattan estimate a small reduction (2%) in

negative gearing to new properties would

house prices. This could be considered a

improve the current regime, but would leave

negligible contribution to affordability. In

too many problems in place and introduce

the short term no impact on rent is

unnecessary distortions.

forecast and no estimate of long term

P a g e | 34

Housing Affordability3). The PBO has not


published this analysis. According to the ALP
12. The ALP proposal is as follows:

Negative Gearing
Labor will limit negative gearing to new housing
from 1 July 2017. All investments made before
this date will not be affected by this change
and will be fully grandfathered.
This will mean that taxpayers from 1 July 2017

document the PBO estimate improves budget


revenue by $565 million over the forward
estimates (i.e. to 2018-19) and $32.1 billion over
a decade. Further the ALP document suggests
that .independent analysis from the McKell
Institute estimates that these policy settings
would result in an additional 25,000 jobs. (ALP,
7/5/2016 p.13).

will continue to be able to deduct net rental


losses against their wage income, providing the
losses come from newly constructed housing.
From 1 July 2017 losses from new investments in
shares and existing properties can still be used
to offset investment income tax liabilities. These
losses can also continue to be carried forward
to offset the final capital gain on the
investment.

14. The ALP policy framework is similar to the


McKell (2015) scenario 4 (p. 9) which (p. 28)
suggests that a plausible 10% increase in the
185,000 homes currently required and overall
this would add $45 billion to GDP. This is a
misunderstanding of supply and demand
versus tenure. No new jobs will be generated
because as this study has demonstrated total
dwelling numbers depend on a demand /
supply balance in the long run.

Capital Gains Tax


Labor will halve the capital gains discount for
all assets purchased after 1 July 2017. This will

15. The McKell (2015) study attributed budget

reduce the capital gains tax discount for assets

benefit is $29.3 billion compared with the ALP

that are held longer than 12 months from the

policy of $32.1 billion.

current 50% to 25%.


All investments made before this date will not
be affected by this change and will be fully
grandfathered.

16. The key facts to assess in terms of economic


impacts are as follows:
Timing
The introduction of the new negative gearing

This means that from 1 July 2017:

provisions and CGT discount reduction is initiated

Negative gearing of labour income will

on 1 July 2017. The Parliamentary Budget Office

only apply to new dwellings

analysis indicates minimal budget revenue impact

The Capital gains tax discount for new

by July 2018, yet significant price impacts for off the

dwellings will reduce from 50% to 25%

plan (OTP) purchases would occur from July 2016 if


the ALP were elected. It is critical to understand

13. According to the ALP policy document the

current market conditions to assess short term

Parliamentary Budget Office ..assumes that

impacts on the housing market given that the

following the changes, negatively geared

Australian housing market has peaked and is

investment in new dwellings will almost double

deteriorating.

(download 7/5/2016 ALP Positive Plan to Help


Impacts

There are no reliable estimates of the actual number of


negatively geared dwellings actually constructed annually.
3

This is explained in detail by the RBA (2015) Submission to the


Inquiry into Home Ownership p. 17-21.

P a g e | 35

Lack of ALP policy specification (what is defined as


new?) will create market indecision.

19. The shift in the public sector from direct

Market instability post July 2016 will occur as

provision of public housing to Commonwealth

investors seek to understand the resale price of

Rental Assistance for private renters became

existing assets that have been negatively geared

an increasingly important issue in mid-1980s.

and the impact of off the plan purchases that

This puts into context the perceived problems

have been committed but not yet settled. For

with Hawke Government elimination of

example Melbourne CBD apartment prices have

negative gearing against wage income and

already dropped by 12% on average on the first

the view (partly true) that this policy change

resale. The loss increases to 17% for FIRB purchasers.

had caused a rental crisis.

The market distortions created by focusing policy


on new dwellings is likely to follow three phases.

20. The proposed ALP negative gearing / CGT

Initially investor demand will soften as both investors

discount policy framework will have major

and financiers seek to understand price impacts on

economic and equity impacts on low income

the first resale. It is likely that credit will tighten

renter households.

(higher LVR requirements) as financiers seek to


avoid negative equity outcomes. The second
21. The reduction in the number of landlords

phase will occur when the impacts of resales

negative gearing and utilising the 50% discount

pursuant to the new policy actually occurs. The

for wage income under the current framework

third phase will occur when a new market

of retention and purchase will, based on Wood

equilibrium is established and a new market

and Ong research (2011)4 reduce from 1.3

structure evolves.

million to 287,000 within 10 years i.e. over 1


million less negative gearing landlords. . Utilising

17. The key points to make are that the proposed

Grattan institute assumptions, based on 80%

policy changes will have a negligible impact

negative gearing and 47% marginal tax rate

on housing affordability and will accentuate

with 3% nominal income return and 5% nominal

the steep decline in residential construction

capital gain, properties typically become

already underway. This means that no

positively geared in approximately 12 years.

additional jobs will be created in the short term


(or long term). In addition rents will rise.

22. This reduction in negative gearing landlords


represents just under half of the 2.25 million

18. It is likely that chaotic marketplace conditions

renting households in 2013/14 (ABS).

will prevail as the proposed ALP policy is


specified, financiers understand likely resale
price movements and some investors transfer

23. Based on estimates of Abelson & Joyeux (2006)

purchasing from established to new dwellings.

that a 10% increase in costs will lead to a 7.0%

Given the sharp reductions in off the plan

increase in rents then rents for 1.01 million

resale values market adjustments and

dwellings will increase over this period before a

stabilisation will occur slowly.

new equilibrium in a highly distorted market is


reached.5 In total based on the Abelson &

This is based on the Wood + Ong (2011) research which


shows that a typical landlord would have a 47% probability
(p.29) of retaining a property over a 4 year period. It also
accords with the work of Seelig Et.al. (2009) that indicates a
high degree of investment irrationality is exhibited by private
rental landlords.

Utilising for consistency the Grattan Table 1 calculations, the


pro rata drop in returns for negatively geared properties is
around 12.6% and 6.8% for positively geared properties. This
implies a 8.8% increase in rentals for negatively geared
properties
5

P a g e | 36

Joyeux calculation rents rise by 8.8% for

$0.4 billion per annum in operating costs

negatively geared properties. This equates to

to support the additional social housing8

$1720 per dwelling or $1.7 billion per annum.

$0.4 billion per annum in Commonwealth


Rental Assistance acknowledging the

24. In addition to the real rental losses there will be

historically high levels of rental stress (50.1

a requirement to build additional social

% of low income households (2013/14)

housing. Based on the Abelson and Joyeux

using the new ABS definition) and the

(2006) estimates a 9.1% reduction in the supply

criticality of an equitable housing

of rental dwellings will occur. This would

outcome.

translate into 205,000 dwellings being removed


from the low income rental housing stock. The

27. In total $5.0 billion in costs would be generated

ALP proposal retains negative gearing / 25%

for the Australian economy with $3.3 billion

CGT discount for new dwellings which will

direct expenditure from the Australian

moderate this impact. It is however, particularly

Government.

having regard to the extreme levels of housing


stress and historically high waiting lists for public
housing to assume that at least 50,000
additional dwellings for public rental be
provided (16% increase). This would equate to
$2.5 billion per annum over 10 years in capital
costs. According to the Productivity
Commission6 this will add $0.4 billion per annum
in operating costs.

This compares to the average $3.2 billion per


annum revenue estimated by the Parliamentary
Budget Office.
28. The costs of market instability and market
distortions will be high compared to the
estimated average revenue impact. The PBO
revenue estimates exclude:
Higher rental levels paid by low income
renters

25. In addition Commonwealth Rent Assistance

Higher dwelling prices in areas with

should be adjusted on a one-off basis by 8.8%

limited new build opportunities as owner

(Currently $4.4 billion per annum). This would

occupiers compete with a larger pool of

add $400 million per annum to achieve

negative gearing landlords seeking new

minimum housing equity outcomes.

dwellings
Even more focus on properties which are

26. Costs to be directly borne can be summarised


as follows7:

likely to generate a capital gain due to


the lower CGT discount. This is likely to

$1.7 billion per annum in additional rental

attract investment in higher quality

costs

properties in deep markets. The major

$2.5 billion capital costs per annum in

impact will be smaller markets, and

additional social housing due to the

regional areas which have a shallow

reduction in rental dwelling numbers and

pool of buyers where impacts will be

acknowledging the historically high

accentuated

160,000 people on public housing

Higher levels of rental stress for low

waiting lists (AIHW, 2014)

income renters as higher income renters


crowd out lower income renters for

A ten year time for market equilibrium to be re-established is


assumed. Given the distortionary nature of proposed ALP
policy Framework particularly in relation to resales of new
7

property purchased after July 1, 2017 this is a reasonable


assumption.
8 2015 Report on Government Services 17.26 The annual
operation costs per dwelling is $8101

P a g e | 37

lower rent dwellings. This will occur at a

Tax Review, the RBA and the Grattan Institute

time of extreme housing stress and will

recommendations in that:

generate demand for increased levels of

Reforms to negative gearing / CGT

social housing and significant increases

discount can cause short term

in Commonwealth Rent Assistance

reductions in residential property

Geographically, lower income

investment. In a market facing supply

households will be forced to shift from

constraints, reforms could place further

established areas with jobs, facilities and

pressure on the availability of affordable

public transport to outer fringe areas with

rental accommodation within the

lower rent new housing. This situation is

private rental market. Those reforms

likely to be untenable and generate

therefore should only be adopted

demand for better located public

following reforms to the supply of housing

housing.

and reforms to housing assistance (p. 2/3

Increased levels of social dysfunction on

E4-3 Australias Future Tax System 2010)

the urban fringe

and RBA (2015 Submission to the Inquiry

Increased carbon footprint for low

into Home Ownership p. 23). This is

income and renters as affordable private

precisely the situation in Australia today

rental stock which is negative geared is

the ABS broad definition of low income

increasingly located on the urban fringe.

households in stress is historically high at


just over 50% of low income households.

29. The real budget costs of the ALP policy


platform are significantly higher than the
revenue gains.
30. The claimed increase in construction
employment of 25,000 jobs is incorrect. Job loss
will occur in the short term as the Australian
Industry Forum forecasts indicate (see
Appendix 2). In the medium to long term
demand and supply conditions will dictate
housing completions. This means that total
employment in the residential sector can only
be brought forward by taxes and incentives.
For example First Home Owner Scheme
incentives have largely been abandoned
because that cause short term spikes in
demand and price but in the medium term
demand from owner occupiers and renters is
driven by population growth and household
formation.

Grattan absolutely cautioned against


restricting negative gearing to new
properties which although they argue
would improve the current regime,
because nevertheless it would leave too
many problems in place and introduce
unnecessary distortions (Hot Property,
2016 p. 2)
32. It is likely that residential market chaos will be
created by the proposed ALP negative
gearing / CGT policy framework over the next
24-36 months. Given the current contractionary
phase of residential markets occurring in
parallel with historically high levels of rental
stress and historically high public housing
waiting lists there is a high probability that the
proposed negative gearing / CGT discount
policy framework will be quickly discarded by
the ALP when the severity of the impacts are
understood. This is consistent with the
experience of the Hawke Government reforms
which lasted only from 1985 to 1987.

31. The proposed ALP negative gearing / CGT


discount should have had regard to the Henry

P a g e | 38

5_The Residential Market Downturn


1.

The residential construction market is

and a major banking crisis. By contrast, the falls

influenced by a number of demand and

in the 2000s were slight and temporary as the

supply factors. In the long run Stapledon has

boost to the economy from the resources

demonstrated that the relationship between

boom, which began in the mid 2000s,

growth in adult population (which drives

appeared to offset the Global Financial Crisis

household formation) and growth in housing

of 2008. (Stapledon 2012, p. 294)

stock has a strong relationship and can help


explain many housing boom and busts.
Stapledon (2012) makes the point that,
housing downturns have frequently preceded
and been a major cause of recessions.
(Stapledon, N. Trends and Cycles in House
Prices, 2012 Australian Economic History
Review). This relationship is documented in
Table 29 which indicates that the rate of
growth in adult population and dwelling stock
is converging.
2.

The current cyclical position of the Australian


economy can be described as fragile. For
example Stapledon has concluded that the
two key cycles in Australian housing are the
boom-bust cycle of the 1880s and 1890s and
the boom of the late 1990s and 2000s. In the
latter cycle, real house prices rose by 88 % in

3.

In 2016 we have a combination of factors in


place:
Reducing population growth rates
Significant reduction in investor purchasing
of dwellings
Ultra-low interest rates
Dwelling completions forecast to contract
in the next 12 to 24 months
Major reductions in lending to overseas
investors
Sales periods for new inner city apartments
extending significantly
Median prices in CBD apartments in
Sydney, Melbourne, Brisbane and Perth
declining
Banking sector profits and shares are under
pressure

Sydney and 161% in Melbourne compared with


32 and 64%, respectively in the 1880s. The
1890s saw price declines of 36% and 51% in the
two markets and sharp decline in housing
activity, a depression in the broader economy

P a g e | 39

TABLE 33: Annual growth rates in adult population and housing stock

Source: Stapledon, Housing Related Data, Adult population is persons 20+ years.

technology, information technology and

4.

The forecast contraction in residential

professional services.

construction by the Australian Construction


Industry Forum is based on the current policy

6.

The ALP negative gearing / CGT discount will

mix for negative gearing and CGT discount

create significant disruption in the market due

currently in place. The new policy mix

to the off the plan apartment resale cliff.

proposed by the ALP will not have a significant

Retailed analysis of genuine resales in

impact on this contraction because in terms of

Melbourne CBD, Southbank and Docklands

total dwelling construction domestic residential

utilising resales for apartments within towers

investment purchases are likely to track down

predominantly less than three years old

from 35% to 25% as a result of more stringent

indicates that the first resale on average is 12%

credit requirements. The more significant

below the off the plan price. A large

decline in owner occupier demand will

percentage of the sales (around 20%) are 15%

continue to drive contraction in residential

to 25% lower than the off the plan price. This

dwelling construction.

means that a very high percentage of equity


(the initial deposit) is wiped out thus exposing

5.

The Australian Construction Industry Forum

financial institutions to losses if prices further

(May 12, 2016) is forecasting a 5% reduction in

reduce. (see Appendix 1)

total residential construction to 2018/19 and a


10% reduction in apartments/units (i.e. New
Other Residential). Sydney and Melbourne are
both forecast to experience contractions in
residential building of 5% to 10%. This is
particularly significant because Sydney and
Melbourne are the meter of growth in the
exportable services sectors i.e. tourism,
international education, fintech, medical

7.

Focusing negative gearing / CGT discount on


new dwelling construction will accentuate the
resale price cliff as on the one hand negative
gearing investors seek new stock, thus pushing
up prices. On resale these dwellings will be sold
into a market which cannot negatively gear.
Depending on gearing assumptions this would

P a g e | 40

increase the resale price cliff by a further 5%


to 8% over the current average loss for off the

9.

The ALP proposed policy framework would

plan sales i.e. the resale price cliff would be of

create chaos in the Melbourne, Sydney,

the order of 17% to 20%.

Brisbane and Perth apartment markets.

Financial institutions as a result will increase

Considering the following factors:

loan to value ratios to 25% to 30% to reduce


exposure to potential losses. This will reduce

The historically significant top end nature of

demand for negative gearing in due to lack of

the residential price cycle

capital available to make a deposit and also

The pending contraction in the residential

reduce the benefit of negative gearing due to

construction sector

lower losses to write off and also due to the

Significant contraction in credit to investors

CGT discount being reduced to 25%.

Significant contraction in credit to overseas


investors

8.

Apartment markets throughout Australia have

Pressure on banking shares and banking

declined dramatically in the number of sales

profits

(e.g. Sydney down 46%, Brisbane down 38%,

Market confusion from developers and

Perth down 46%) and median prices have

purchasers.

turned negative (see Appendix 3). Sydney had


the first monthly median price drop in eleven
quarters in March 2016, and year on year,
median prices are down 11% in Brisbane from
the peak (September 2014) and down 29% in
Perth from the peak (June 2013, see Appendix

Risks to market stability and volatility in the short


term are significantly higher changing the
current policy setting rather than remaining
with the current policy setting.

3). Apartment markets could be described as


being in the early stages of bust conditions.

P a g e | 41

Appendix 2
Residential Building Forecasts
Source: Australian Construction Industry Forum May 2016

P a g e | 43

ACIF RESIDNETIAL CONSTRUCTION FORECASTS MAY 2016

P a g e | 44

Appendix 3
Sales Activity Levels and Median Price Movements Sydney, Brisbane, Perth and Melbourne:
CBD & Inner Area (2011 2016)
Source: Core Logic

P a g e | 45

City of Sydney

Mar-11
Jun-11
Sep-11
Dec-11
Mar-12
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
Jun-15
Sep-15
Dec-15
Mar-16

Year
2011
2011
2011
2011
2012
2012
2012
2012
2013
2013
2013
2013
2014
2014
2014
2014
2015
2015
2015
2015
2016

Period
Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
Mar

Land Use
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS
RESIDENTIAL STRATA UNITS

Number of
Sales
1478
1784
1633
1773
1145
2045
1414
1851
1595
1853
2397
1988
1596
1548
1563
1579
1441
1465
1483
1197
784

Median
Sale
$585,000
$577,100
$580,000
$575,000
$600,000
$595,000
$615,000
$630,000
$623,000
$650,000
$690,000
$681,000
$695,000
$700,000
$738,500
$745,000
$770,000
$810,000
$832,000
$825,000
$785,000

P a g e | 46

Inner Brisbane

Year
2011
2011
2011
2011
2012
2012
2012
2012
2013
2013
2013
2013
2014
2014
2014
2014
2015
2015
2015
2015
2016

Period
Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
Mar

Land Use
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)
BUILDING UNITS (PRIMARY USE ONLY)

Number of
Sales
360
500
442
554
544
597
648
579
559
750
842
726
628
678
678
496
500
541
517
488
310

Median Sale
$445,250
$441,125
$442,250
$418,220
$427,250
$453,500
$455,000
$449,000
$456,500
$460,750
$463,750
$479,500
$499,500
$514,950
$515,000
$483,750
$480,000
$499,000
$495,000
$473,500
$458,750

P a g e | 47

Inner Perth
Year

Period

Land Use

2011

Mar

RESIDENTIAL

Number of Sales
129

Median Sale
$465,000

2011

Jun

RESIDENTIAL

150

$453,000

2011

Sep

RESIDENTIAL

122

$440,000

2011

Dec

RESIDENTIAL

123

$425,000

2012

Mar

RESIDENTIAL

163

$449,000

2012

Jun

RESIDENTIAL

145

$455,000

2012

Sep

RESIDENTIAL

140

$460,000

2012

Dec

RESIDENTIAL

147

$447,000

2013

Mar

RESIDENTIAL

169

$510,000

2013

Jun

RESIDENTIAL

216

$632,500

2013

Sep

RESIDENTIAL

149

$475,000

2013

Dec

RESIDENTIAL

160

$540,000

2014

Mar

RESIDENTIAL

143

$501,250

2014

Jun

RESIDENTIAL

146

$500,000

2014

Sep

RESIDENTIAL

156

$492,500

2014

Dec

RESIDENTIAL

137

$500,000

2015

Mar

RESIDENTIAL

150

$540,000

2015

Jun

RESIDENTIAL

112

$495,000

2015

Sep

RESIDENTIAL

94

$470,000

2015

Dec

RESIDENTIAL

86

$501,000

2016

Mar

RESIDENTIAL

82

$491,500

P a g e | 48

Inner Melbourne

Year

Period

2011

Mar

2011

Jun

2011

Sep

2011

Dec

2012

Mar

2012

Jun

2012

Sep

2012

Dec

2013

Mar

2013

Jun

2013

Sep

2013

Dec

2014

Mar

2014

Jun

2014

Sep

2014

Dec

2015

Mar

2015

Jun

2015

Sep

2015

Dec

2016

Mar

Land Use
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)
Res Company Share Unit (within multi-storey
Dev)

Number of
Sales

Median
Sale

1009

$490,000

1305

$515,000

1569

$511,000

1357

$487,000

991

$511,000

1178

$517,000

1132

$486,250

1067

$502,000

1092

$505,000

1271

$505,000

1175

$508,000

1053

$500,000

882

$498,000

1127

$529,000

921

$500,000

766

$509,750

776

$510,000

858

$503,750

750

$500,000

665

$515,000

430

$462,750

P a g e | 49

Bibliography

RBA, Submission to the Inquiry into Affordable Housing Senate Economics References Committee, February 2014

Stapledon, N., Trends and Cycles in Sydney and Melbourne House Prices From 1880 to 2011, Australian
Economic History Review, Vol. 52, No. 3, November 2012, University of New South Wales

Kohler, M., van der Merwe, M., Long-run Trends in Housing Price Growth, RBA Bulletin, 2015

Reform of the Federation White Paper, Issues Paper 2: Roles and Responsibilities in Housing and Homelessness,
December 2014

Burke, T. et al, Generational change in home purchase opportunity in Australia, AHURI Final Report No. 232
November 2014

Daley, J., Wood, D., Hot property: Negative gearing and capital gains tax reform, Grattan Institute, April 2016

RBA, Financial Stability Review, April 2016

ABS Cat. 4130.0 - Housing Occupancy and Costs, 2013-14, October 2015

Abelson, P. et al, House Prices in Australia: 1970 to 2003 Facts and Explanations, 2005

R Goodman et al., The experience of marginal rental housing in Australia, AHURI Final Report No. 210, Australian
Housing and Urban Research Institute, Melbourne, 2013

Fox, R., Tulip, P., Is Housing Overvalued?, RBA Research Discussion Paper, June 2016

Melbourne, Docklands, Southbank Off the Plan and Resales Data, Herron Todd White 2016

Sales Activity Levels and Median Price Movements Sydney, Brisbane, Perth: CBD & Inner Area (2011 2016),
Core Logic

AIHW 2014. Housing assistance in Australia 2014. Cat. no. HOU 275. Canberra: AIHW

Daley, J., Coates, B., Property Taxes, Grattan Institute, July 2015

Daley, J., Wood, D., Fiscal Challenges for Australia, Grattan Institute Working Paper, July 2015

Treasury, Australias Future Tax System: Report to the Treasurer, December 2009

P a g e | 50

Australian Council of Social Service, Fuel on the Fire: Negative Gearing, Capital Gains tax and housing
affordability, 2015

Hulse, K. et al, Supply shortages and affordability outcomes in the private rental sector: short and longer term
trends, AHURI, Swinburne University of Technology, June 2015

Eslake, S., Australian Housing Policy: 50 Years of Failure, Submission to the Senate Economics References
Committee, December 2013

Treasury, Financial System Inquiry Final Report, November 2014

Yates J 2004 'Affordable housing and first home ownership - the Productivity Commission's draft report', p. 10-11

Treasury, Review of Business Taxation: A Tax System Redesigned, July 1999

Hulse, K., Reynolds, M. and Yates, J. 2014 'Changes in the supply of affordable housing in the private rental
sector for lower income households, 200611', AHURI Final Report No.235. Melbourne: Australian Housing and
Urban Research Institute.

Holden, R., Switching Gears: Reforming Negative Gearing to Solve our Housing Affordability Crisis, The McKell
Institute, June 2015

Downes, P., et al, Effect of the Mining Boom on the Australian Economy, RBA Research Discussion Paper, June
2014

SGS, Rental affordability index: RAI Release Report, Community Sector Banking, Shelter Australia and SGS
Economics and Planning, November 2015

P a g e | 51