DOES NEGATIVE GEARING DRIVE UP PROPERTY PRICES IN AUSTRALIA

Vaibhav Gavande

Case Study Report

MAF702 -Financial Markets

Faculty of Business and Law

Deakin University

Trimester 2, 2018
Contents

Introduction .............................................................................................................................. 3
Discussion.................................................................................................................................. 5
Conclusion .............................................................................................................................. 13
References ............................................................................................................................... 15
Introduction

The debate in Australia about negative gearing and its impact on Australian property prices has
been an ongoing topic for several year. When the topic of property is discussed the focus is
always on housing as shelter and protection is a core human requirement. A house does provide
a sense of stability amongst many individuals which is also a dream that people hope to achieve
as an adult. When discussing housing affordability factors to be kept in mind are that it consists
of individuals such as those in need of a house to live in and may becomes property owners or
renters, some may be looking to enter the market and need mortgages and those who have been
a part of the market and maybe dealing with stress from existing mortgages.

With housing affordability being threatened in Australia, negative gearing is a major policy
receiving close reviews since 2017, being a political hot topic. The Australian Labour party
had proposed to limit negative gearing to new properties as a part of its tax policy proposal. It
is worth noting that no major political party has advised on scrapping this policy completely.
On one hand, population in favour of negative gearing assert that it is responsible for stabilizing
the rental market by stimulating supply of rental properties, lifting the pressure of low income
earners. While, those against this policy argue that it applies pressure on prices of houses
resulting is falling affordability. In the current scenario, government intervention is because
young individuals such as first home buyers and low-income buyers are being pushed out of
the market due to high prices and retired people living off equity in their homes and pensions.

Negative gearing is commonly referred to as a smart strategy which plays a major role in
minimising taxes. Negative gearing can be defined as a tax rule according to which losses on
an income generating investment such as dividend generated by shares, or rental properties are
deductible against an individual’s taxable income. With a combination of the right property
alongside good financial and tax advices negative gearing can become a tax efficient
investment strategy. It is interesting to note that the tax office statistic for the year 1999-2000
reported that 54% of rental housing owners were operating on a loss greater than $3 billion
which was written off in tax returns along with their entire rental earnings. This resulted in a
saving of an estimated $1 billion in taxes by these owners i.e. a loss of taxpayer’s money
(Colebatch, 2003, p. 20).
If the rental return on a property exceeds the outgoings and interest payments than the
investment is referred to as a positively geared. Such investments result in an ongoing income
and capital gain considering an increment in its value when one decides to sell it. While a
negatively geared property can be used to claim losses on property, positively geared
investment result in increasing buying power and ability to meet repayments (CBA, 2008).
According to the governor of RBA, between 1996-2001 home owners reacting to low interest
rates were responsible for housing price boom. Since 2001, inflation in property prices has
been backed by tax policies such as negative gearing (Colebatch, 2003, p. 21). An estimate of
$2 billion accounts for the annual government expenditure on negative gearing and this
constitutes 5% of the 2016 budget deficit as per data from Australian Treasury, 201).

Criticism of negative gearing intensified mainly due to views that it is an acting factor in the
assumed unsustainable property boom. Gittin, 2003 stated that this whole rocky edifice, which
he refers to the property boom, is based on the negative gearing loophole. Urban planning
expert professor Robin Goodman, RMIT claimed that a single major step the Turnbull
government could take in the direction of housing affordability was to abolish negative gearing
(The new daily, 2018, p. 2). Goodman’s claim was backed up by a study published by RBA
according to which there were negligible drawbacks of abolishing negative gearing.

Weather a bubble is present or property prices in Australia are subjectively high, is an issue of
great debate. Economist hold separate views on this, one would be housing bubble exist and
price corrections are due soon. The other is its inverse that a strong demand and low supply is
responsible for high prices. The general aim of the report is to delve into the issue of negative
gearing and examine its influence on housing affordability by analysing house price trends and
factors which influenced them as well as government policy’s, several published reports and
draw a conclusion.
Discussion

When a discussion initiates on the Australian housing market, a common narrative is that it’s
in a largely speculative bubble on the verge of bursting and crashing the economy, basically
pumped by low interest rates, tax breaks and liar loans (loans being handed out by banks
without considering the income of borrower) leading to mortgage stress, decreasing prices of
property in Sydney has further drawn attention to such statements. Since over a decade, several
reputed researchers, politicians, economist and financial institutes have made similar claim of
an over inflated property market in Australia.

Due to the borrowing bridge and rising property values, Australia was described as the ugly
sister of USA by The Economist magazine, 2004. The property market was estimated to be
51.8% above its actual value as stated by OECD. Post GFC, several predictions were rolled out
that property crash will occur, and value of property could fall as up to 40%. As per the findings
from Demographia International Housing Affordability Survey, 2011 Sydney property prices
were estimated to be 3 times of the median house income in 1980s however, recently it was
recorded to be 9 times the average income even though more member of the family work.

Figure 1: Real wages and housing price, 1970 – 2016 (CEDA, 2017, p. 17)

Figure 1 show a long tern growth from 1880 to 2011 in house prices. The 2008 GFC did not
affect Australia’s property market much. A 130% growth in housing prices is observed between
the year 1996 till 2010.
 Figure 2: Housing prices relative to long term trend (Business Insider, 2018)

Real house prices are currently in comparison to 4 decades ago 3 times higher. AMP Capital
has claimed as per major valuation metrics housing prices have risen by 27%. It is interesting
to note that the housing bubble in USA wasn’t as big when compared to property price boom
in Australia. With an estimate of 52% of household assets of Australia are housing and land
holdings. This number is much greater than that of the US household prior to the GFC.
Households in US held 33% of their investments in property when its economy crashed due to
bad mortgage debt. Hence, it has been debated for over a decade that there is major risk of a
crash, which interestingly has been averted for years.

Figure 3: Taxable landlords (left) and Real housing loan approvals in billions (right) (Cho et al., 2018, p. 6)

Fig 4 shows a comparative growth seen in both the real housing loan approval as well as
landlords in over 2 decades. From the right graph, loan approvals for investment purposes have
surpassed those for owner’s occupation by an amount of half billion dollars during early 2010s.
 Figure 4: ATO taxation statistics 2010-2011 (Eslake, 2013, p. 10)

Studying the data obtained from ATO taxation statistics 2010-2011 above helps us further
supports the claim that negative gearing has had an upward pressure on the prices of existing
property hence resulting in unaffordability amongst the Australian public. During the year
1998 to 1999 capital gain was still taxed as per the old policy where the same rate was paid as
any other income earned. A taxable amount (profits) of $700m in total was recorded from
1.3million house owners. Now the data from 2010 – 2011 has recorded 1.8million owners
paying taxes, but on the downside due to increased interest repayments and other related
expenses as compared to 1998-99, a loss of close to $8 billion in total was experienced. The
report states that assuming these losses were filed by people falling in the high tax bracket
category, it would have resulted in a cost of $5B or higher.

This negative gearing policy doesn’t contribute much towards increasing house supplies, fig
5 shows how over the year maximum borrowing has been for investments into existing
properties and not towards the construction of new houses to compliment the demand in
market. In 1985, 68% loans were for acquiring newly constructed property and 32% for
existing dwellings. Negative gearing was stopped in that year which is the possible cause of
the results. In 1987, a switch occurs with more percentage of the loans were for existing
dwellings. Further down the years this investment trend continues till 2010 when a
astonishing 96% loan were towards investment in existing dwellings, a small drop was
observed at 92% in the year 2012 (RBA, 2012).

Figure 5: Investment loans for new construction & existing dwellings 1985 – 2012 (Soos, 2012, p. 14)

Since a higher majority of investments have been into existing housing, the supply of houses
does not increase because of low demand, about 82% of all loans by owner occupiers. This is
a major reason as to why houses have become unaffordable and thus the issue must be
tackled. In a short-term scenario, the real estate supply will become stagnant and with every
increasing investor there would be one less owner occupier being able to buy a house. Its is
possible that it can lead to a situation where an occupier will be forced to rent a property due
to shortage (Hanegbi, 2002). From a long-term perspective without increasing housing prices,
higher number of rental properties in comparison to owner occupier houses does not make
sense as investors keep in mind the returns from capital gain when selling the property.

Now let’s say investor are convinced that property prices will further increase, result would
be a large increase in investors which will send prices spiralling further up than what they
already are and vice versa. Australia has experienced this as visible from figure 5, if the
market continues to remain favourable for investors a dominance of no of rental properties
over owner occupier will occur because of influx of investors.

Over the years real estate in Australia has shown a steady growth, between the year 1995 to
2005 a growth of greater than 6% per year was recorded. From 2001 - 03 average annual growth
of close to 15% was observed. On comparison with other advanced economies, over the past
20 years Australia’s real estate has been reported for its relatively rapid growth Tumbarello
and Wang (2010). Between 2000 – 04, Australia was recorded to have experienced the 3rd
largest growth rate in its house price inflation growth amongst the organisation for economic
co-operation and development (OECD) countries. British and Spain were the only 2 countries
which were leading ahead of Australia (The Economist, 2011, p. 2).

It is globally accepted that demand and supply constraints are the driving force behind the real
house price increase. The data collected from Treasury, ABS show a trend of steady growth in
real housing prices from the year 2000 onwards. Real wages haven’t shown a hand in hand
growth i.e. wages failed to keep up with these rises.

Abolish - Negative Gearing 1980

Political decisions are greatly impacted by 3 groups of electorates, first a group who want to
own a house, second those who already own one and third are the group paying off debts.
Recently politicians such as Bill shorten have taken an unconventional stand on removing
negative gearing and capital gain tax. The change in housing policy such as negative gearing
will have a huge impact on the market and thus needs to be proceeded with careful
consideration. Scott Morrison has also added that keeping in mind negative gearing has been a
key component of the economy, scrapping it would have a wide spread impact on Australia’s
economy (The Guardian, 2017).

Scott Morrison also defended negative gearing by drawing attention to the outcomes of
abolishing negative gearing in Australia during the year 1980. The Labour govt in 1980
scrapped this tax law for future investors. However, losses from rental could be carried forward
and reduced from future gains thus reducing the taxable rental income. The graphs on the
following page shows variations in rental prices after negative gearing was briefly abolished.
It is evident that Sydney and Perth were two states which experienced an increasing rent were
all other states saw a fall.

Sydney

Perth

Figure 6: Annual real rent price (The Guardian, 2018)

During this period a backlash also occurred in which investor made up for their losses by
increasing rent of houses (ABC, 2016, p. 2). Hence, this acts as a counter argument that
abolishing negative gearing doesn’t necessarily mean rents would decrease. Such a scenario in
which falling housing prices and increasing rent would greatly impact lower income
households. Now the idea is that negative gearing to an extend promotes investors to construct
new dwellings for rental. When there is a surplus of rental property, it acts in favour of the
lower income population as it keeps prices low (Hockey, 2015).
So only Sydney and Perth has experienced a rise in rent and clearly the remaining states did
not, as per the consumer price index. The reason behind this observation was the rental vacancy
rates which have been low even prior to the abolishment of negative gearing (Eslake, 2011, p.
11). Fig 6 shows the trend or vacancy rate and rents during the period.

Figure 7: Rent and Vacancy data for 1980s - 1985 to 87 NG was not present (Eslake, 2013, p. 11)

It can be speculated that had owners decided to sell their properties after negative gearing was
scrapped that would have led to falling prices of houses. Now there are other economics in the
world who have had negative gearing at one point in time but have scrapped it despite of which
higher rental vacancy exist in these economies. One such example, is US were NG was
abolished in the mid-1980s. Despite which rental vacancy over 30 years have remained
between 5 and 9 % as compared to Australia where rental vacancy rates are between 2 to 3 %,
figure 8.
 Figure 8: Rental Vacancy Data for US and Australia, (Eslake, 2013, p. 12)

It is also important to note that interest rates were at 15.48% & 19.39% in July and December
1985 respectively. This was a huge 25% rise in rate, however by the end July of 1987 rate had
reduced to 12.43% (RBA, 2012). Data shows that during increased interest rates investments
fell as loan amount dropped from $193M to $130M in a period of 5 months which is a logical
reason behind the 5.4% drop in house prices in Australia during this period.

Hanegbi, 2003 argues that even if negative gearing may promote owners to pass on their
benefits to tenants it is not a strong point to consider just for rent affordability. He disagrees
that tax concession is the path to go on. The government could start rent assistance from the
income it generates by scrapping NG. Currently, the commonwealth rent assistance scheme
help low income individuals only. As per reports the CRA scheme is costing $3.1B for 2010-
11(PC, 2012), the subsidy amounts can be increased rather than continuing with NG as its still
a better deal.

Negative gearing will impact the composition of owners. The category of owners who are
dependent on loans to repay their mortgage will reduce largely as a result. A welfare analysis
by Cho et.al, 2008 claimed that 76% of household would rather have an economy free from
negative gearing as this would make houses more affordable & also an overall 1.5% increase
in welfare for the economy which result in more transfer payments, cheaper prices make it
easier to move up the ladder also making it easier. However, on the downside it reduces the
disposable income of high earner who might have high mortgage repayments.

Conclusion

In conclusion it can be said that, negative gearing (NG) has resulted in reducing net revenue
generated by the Australian government and created the issue of housing affordability. Rental
interest deductions amounted to an amount of $21.5B as per ATO, 2017 report. The Australian
dream of owning a house has morphed into a tax evading instrument for owners with multiple
properties. Rise in housing prices are considered bad by some and good by others especially
those who own them.

Scrapping negative gearing immediately may create instability in the market. It is important
for the approach towards the issue be a carefully calculated resolution. It is understandable that
negative gearing doesn’t not classify as a policy which considers problems of equity or
efficiency. Negative gearing causes speculation in the market as a result distortion of the
property market and increases its susceptibility to the asset bubble. It would be wrong to
assume that alone scrapping negative gearing would make housing in Australia more
affordable, however there will be a price fall in housing prices as well as generate a huge
revenue which could be diverted to help low income households in need of rent assistance.
From figure 9, as negative gearing is brought into effect Demand will shift left from D1 to D2,
Price will fall from P1 to P2 as equilibrium shifts left i.e. lower demand resulting in lower
housing prices (assuming supply remains constant).
 Figure 9: Supply & Demand Curve for House Prices

Several other factors such as capital gain taxes, employment, immigration and wages will also
influence housing prices. CBA has stress that’s falling house prices may have reaction of a
sharp drop in consumption which can stall the economy due to reduced income and wealth
(ABC, 2017), further adding that rising house prices and household debt is a threat to Australia.

There is a lack of evidence in support of NG and more finding against NG. Political factor does
play a major role when implementing any changes o existing policies in fear of backlash from
investors. The consistent back and forth see in the news is a clear evidence and vested interest
on several influencers can delay the complete implementation of negative gearing.
References

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