Because of the Negative Gearing myths most of us are hearing, we set about sorting the fact from the fiction with the help of Jamie Alcock, Associate Professor of Finance at the university of Sydney.
Kevin: There is so much misinformation about negative gearing – on both sides; it’s become such a political issue – and just trying to find someone who can give us the facts is really difficult, but we’ve done that. Jamie Alcock, who is Associate Professor of Finance at the University of Sydney joins me.
Associate Professor, thank you very much for your time.
Jamie: It’s a pleasure, Kevin, thank you.
Kevin: In your article, you’ve looked at five key myths surrounding negative gearing. I thought we might work through those, then at the end of that, I’d just ask you for a bit of a summary and your points on the issue.
Myth number one: negative gearing is responsible for the recent house price surges in Sydney and Melbourne.
Jamie: Yes. Most people are aware that Sydney and Melbourne house prices have dramatically increased in the last three years or so, and that hasn’t seemed to have abated. It seems to be slowing down a little bit, but it hasn’t completely stopped.
People have to remember that negative gearing has been around for well over a quarter of a century. It’s extremely unlikely that something that happened 25 years ago is now suddenly kicking in and affecting house prices in only Sydney and Melbourne.
If negative gearing would truly be responsible for these sort of things, then you would have expected, firstly, for it to be nationwide – as the tax laws are nationwide – and secondly, for it to have occurred long ago.
The real driver of these house price increases is, of course, it all comes down to supply and demand. There’s an increased demand for housing in those cities and there’s restricted supply, and at the same time, the cost of getting into housing – i.e. the interest rates – have also dramatically reduced.
Kevin: Yes, and to believe that myth, you would have to let go of that well-founded theory that it is all based on supply and demand – prices.
Jamie: Yes, absolutely, and I think that we have to also keep in the back of our mind what is driving the demand. Of course, jobs and income are big sources for demand, and also interest rates. If interest rates are high, then there are fewer people that can afford to get into the market and repay the mortgage, whereas if interest rates are dropping, then that drives demand up.
Kevin: Myth number two is that negative gearing makes property unduly attractive for investors.
Jamie: This one I find particularly bizarre. Investors pay tax on this investment. The timing of the tax cash flows are that they get a deduction for the costs initially but when they sell the property, they pay a capital gains tax. In most states, they also pay a significant land tax that owner-occupiers don’t have to pay.
To my mind, if you have the same asset with the same returns, but you have two different investors competing for it, one pays a lot of tax and one pays no tax, who’s going to be driving the market?
Kevin: Yes, but negative gearing is available for all investments, not just property, isn’t it?
Jamie: Yes, absolutely. If you borrow money to invest in shares, then you can deduct the cost of the borrowing against the profit made in the shares, and it’s exactly the same thing in property.
Kevin: I do think it’s so highlighted because it is such an emotional issue – young people trying to get into property. Let’s blame negative gearing for increasing prices.
Jamie: Yes, absolutely. All of us who have bought our first home remember how difficult it was. It’s been difficult forever. It was difficult in 1960 and 1970, and it’s difficult today. The question is, of course, is it any more difficult? I think there are a lot of side issues that have been taken out of the discussion – things like back in 1960, most families were one-income households. These days, it’s two. The costs of other goods, in real terms, have dramatically reduced in that time.
If you go back 60 years, the cost of a return airfare to London was about $2000 or $3000. It’s the same price today, but of course, $2000 or $3000 back then was a significant sum of money. Even if you go back 15 or 20 years ago, the entry level for a new car was $20,000, and that remains the same price today, even though people’s incomes and wages have increased. The costs of living have actually decreased, so we have more money to throw into our mortgage, at the same time as interest rates are dropping.
Kevin: That pretty well covers off on myth number three – doesn’t it – negative gearing pushing aggregate prices out of the reach of average Australians.
Jamie: Yes, and there’s just absolutely no evidence for it. Prices are going up, but that’s not the key determinant of affordability. At the end of the day, you can imagine an extreme situation where interest rates were not just lower but in fact, negative. Let’s say there are negative interest rates, which there are in some parts of the world. Well, if it’s $10 million and you’re actually being paid to borrow that money, then it’s very affordable. It’s not the actual sticker price that determines affordability.
Kevin: How does the current cost of servicing new loans today compare to, say, a decade ago?
Jamie: That’s a good question. The Reserve Bank in the submission to the Senate inquiry demonstrated that the cost of servicing new loans at the moment is significantly lower than it has been over the past decade. If you go back even further in time… Everybody brings this up, but young people trying to enter into the market do have to remember that their parents were entering a market where interest rates were 18%.
Kevin: That’s right.
Jamie: It was very difficult.
Kevin: It was. I lived through that. Myth number four: negative gearing benefits the wealthy at the expense of the poor. I love this one.
Jamie: Yes, and this is something that always comes out, but the tax statistics are there and plain for everybody to look up on the Web. They’re very easy, and they show that the vast majority of investors are actually on the lower end of the income scale. They’re not all making millions of dollars a year. And I love the twist that they say somebody on more than $200,000 is three times more likely than somebody less than $80,000 to have an investment property, but there are a hundred times more people on $80,000 than there are on $200,000, so three times one is still much less than one times a hundred.
Kevin: Yes, and we’ll deal with the most emotional one, I guess. Myth number five is that negative gearing rules make it more difficult for first-home buyers to enter the housing market.
Jamie: There are a number of dimensions to this one. The first one is, of course, the supply and demand of rental housing. With more investors, of course, there are more houses for rent, more properties for rent, which means the supply is greater and rental prices come down. This allows first-home buyers a greater opportunity to save for a deposit.
But I think the other thing to remember in this whole discussion is that why are people trying to buy a house in the first place? It’s not for the need of housing; they can get that through the rental market. What is it that people are actually seeking through purchasing a property?
Kevin: Wealth creation.
Jamie: Wealth creation, and importantly, tax-free wealth creation.
Jamie: It’s the only tax-free asset that we have in this country – owner-occupier housing – and that’s what people are chasing. Negative-gearers pay tax. They’re not tax-free, so they’re not driving the market. They’re trying to anticipate market movements, but they’re not driving the market. It’s owner-occupiers who are driving the market. 85 to 90% of properties are owner-occupier, so they’re definitely driving the market.
Kevin: Associate Professor, let’s deal with another – not so much a myth, but some commentary surrounding negative gearing. Some commentators have suggested that rents did not increase during the 1985 negative gearing upheaval that we experienced. Could you address that for us?
Jamie: Yes. It’s a complex issue, but the very first thing that you need to remember with property is that all property markets are slow to respond. If I make a change today, it’s very unlikely that you’re going to see a change in property tomorrow. These things occur over a medium to long term, so even over an 18-month period, you’re very unlikely to see markets change, simply because, for example, most rents are locked in for extended periods of time. In addition, if demand goes up, then it takes many, many years for markets to respond, to get planning permission, to actually construct the properties, to sell them, etc.
It takes years for the markets to respond, so just making one change and looking at what happens over the next 18 months is not a particularly good test, but even if you do believe that, even if you think that that is a good test – which I don’t, but if you do believe that – then don’t just look what happened to rents at that time; look what happened to prices. During that time, prices rose 20%, so if negative gearing was the cause of all this and you remove it, then prices should have gone down, not up.
Kevin: Yes, we don’t hear about that side of it. There’s another side that we don’t hear about, and that is the impact, if negative gearing were to be scraped, on those who actually relied on investing property to build their wealth. What would be the impact there, say, of a 10% reduction in the average house price?
Jamie: Let’s assume for a moment that all the doomsayers are correct and there is a reduction in house prices that did occur rather rapidly. Not only is this going to affect a lot of people who are currently owners of property and have established their wealth, but it’s also likely to create a banking crisis, because 90% of retail banking business is mortgages. You’re likely to have a real systemic crisis brought on by a sudden drop in house price. As we saw in the US, there was a sudden drop in house prices, worldwide crisis.
I think another issue that is worth discussing is to look at countries that have similar property titles to ours, and say what happens there and how does their housing affordability rank?
Kevin: Which countries would they be?
Jamie: The ones that I usually look at are the US and the UK, because both of those countries have perpetual title, as we do. There is no mandatory leasehold, and they have secure titles, so there are very few challenges to ownership, which there are in a lot of countries.
In the UK, they have tax-free status for owner-occupiers, as Australia does, and they have no negative gearing rules like Australia does. They have something similar to what the Labor Party is suggesting. And housing affordability in the UK is even worse than it is in Australia. It takes 10 to 12 years of income to crack into the entry-level housing as opposed to eight or nine.
Then you compare in the US, where they have taxes on their owner-occupiers – and they’re significant taxes. Depending on the state, they are usually somewhere between 1% and 2% of the market value of the property each year, so if you have a $1 million property, that’s a $20,000 tax check you have to pay out of your after-tax income. And their housing affordability is a lot lower.
When you compare the UK and Australia, and you have one has negative gearing and the other one doesn’t, then they’re both unaffordable. Then you compare Australia and the US, one has tax on owner-occupiers and one doesn’t, and that does affect affordability. It becomes quite clear that the driver of housing unaffordability or high house prices is not negative gearing rules; it’s the sweet tax deal that we give to owner-occupiers.
Kevin: Yes, interesting. I just wonder if we could deal with one last issue, and that is maybe a solution here. If the government genuinely do want to make housing more affordable, how can they go about it? What options should they explore?
Jamie: There are so many options available to them to make housing more affordable. Clearly, the planning system is incredibly complex. There’s a lot of red and green tape, and most of that is unnecessary. That could be easily reduced, increasing supply. They could also simplify and relax the stamp duty system in its totality. It’s an incredibly inefficient tax. It’s a tax not on occupying or housing; it’s a tax simply on moving, on improving your life. Also – and this is possibly a little bit controversial – is to reduce social housing.
Kevin: How would that work?
Jamie: Social housing has two components to it. One is the construction of new housing, and then the second part is restricting access to that housing. I’m all for building new houses – that will certainly increase supply and increase affordability – but the free market can do that; that’s not the domain of social housing. The key part of social housing is restricting access to housing that exists, and that reduces supply and drives up prices, not the other way around.
They could also start tightening up trade union legislation and increasing urban infrastructure coverage, and they could also think about possibly changing the tax from a stamp duty to an annual land tax for all housing owners, not just investors.
Kevin: Broaden it out a lot more.
Jamie: Broaden it, absolutely.
Kevin: Jamie, thank you so much for your time. My guest has been Associate Professor of Finance at the University of Sydney, Jamie Alcock.
Jamie, thanks once again.
Jamie: Thank you, Kevin. Cheers.