Negative Gearing – Page 2 – Digital Finance Analytics (DFA) Blog

Investor Property Footprints And Negative Gearing

The argument trotted out to defend negative gearing from reform is that the bulk of investors are “typical mum and dad” households.

Of course it depends on how you look at the data, but lets look at output from our core market model.

What we have here is the relative VALUE distribution of investment property held by our core household segments, based on marked to market values. We see that whilst some households in most segments are represented, the relative value is massively skewed towards more wealthy segments. Exclusive Professionals, our most wealthy segment holds 27% of all investment property by value, Mature Stable families hold 18%, Suburban Mainstream 15% and Wealthy Seniors 9%.

Another way to look at the data is through the lens of our property segmentation. Here investor only segments (they have no owner occupied property) hold 33% of investment property. Within that Portfolio Investors who hold multiple properties hold 3% by value. Those holding property but with no plans to move – Holders – have 20% by value, whilst those trading down hold 19%.

When we look at households by employment type, we see that employed workers hold 62% by value, whilst 17% are help by those not working, 10% managers, 9% expert professionals, and 2% by executives.

But if we look at the use of negative gearing, we see that three segments, by value have the largest footprint. Exclusive Professionals have 42% of negatively geared property, Mature Stable Families 27%, and Wealth Seniors 14%. Other segments are much less likely to negatively gear.

Looking again by Property Segments, Investors and Portfolio Investors have 32% of all negative gearing by value, but other segments also use this technique.

From this we conclude that it is important to separate the holding of an investment property from the use of negative gearing against that property. In fact we think negative gearing is predominately used by more affluent households, and they get the biggest tax breaks as a result, which of course other tax-payers have to subsidise.

There is, in our view, overwhelming evidence that curtailing the excesses in negative gearing (for example, a $ limit) would assist in cooling the market and inject needed cash into the budget.

But as we pointed out the other day, if the political agenda wins out, this just will not happen.

First Scramble the NBN, Now Housing

The AFR reports today that Scott Morrison is advocating increasing supply as the recipe to solve the current housing issues, and is standing firm against a crescendo of calls to curb negative gearing tax breaks (though may be more amenable to capital gains changes).

I was reflecting on the current state of play, given RBA, APRA, ASIC (three members of the Council of Financial Regulators – the Treasury being the fourth) are all underscoring the risks in the housing sector. Investors are in the firing line. Logically, negative gearing should be curbed.

But then I started to consider the political agenda, and wondered if there are parallels with the second class service the current NBN solution is delivering; at least to me. Essentially, Turnbull wound back Labor’s fibre to the end-point solution by arguing that there was a better, cheaper, quicker way. It became do anything BUT what Labor proposed. The result, in my case at least is a slow, unreliable NBN solution, unable to deliver acceptable bandwidth at peak times, and no upgrade path. The political battle may have been won, but the end outcome is frankly horrid. As a digital business we suffer the result every day! The cabinets on the local street corners (now daubed with tags and grafiti) will be a lasting tangible monument to a politically catalysed outcome.

But, now, are we seeing the same with Negative Gearing changes, which Labor proposed, and which have been opposed by the Government ever since? Has it become caught in the same trap as the NBN? Had Labor kept it’s power dry, would we have seen changes to negative gearing already?

Could it be that on principle, the Government won’t concede this to Labor, and so will literally go round the houses to avoid changes to negative gearing?

This despite the many calls, from responsible and well informed sources who say that it is the tax breaks which are driving the investment property sector. This is also confirmed in our surveys.

Will the legacy of the unwillingness to tackle such a core element in the landscape cost us a housing crash? As we argued recently, it is looking more likely that we will need a correction to defuse the current heady trends.

But if the needs for a political wins outweighs good policy, it is highly likely we will get the housing equivalent of the NBN. We think Australia deserves better.

The Great Housing Conundrum

We discussed housing affordability, negative gearing, household debt and interest rates on Weekend Breakfast, ABC News 24 today.

Do Investment Property Investors Also Use SMSF’s?

We recently featured our analysis of Portfolio Property Investors, using data from our household surveys. We were subsequently asked whether we could cross correlate property investors and SMSF using our survey data. So today we discuss the relationship between property investors and SMSF. We were particularly interest in those who hold investment property OUTSIDE a SMSF.

To do this we ran a primary filter across our data to identity households who where property investors, and then looked at what proportion of these property investors also ran a SMSF. We thought this would be interesting, because both investment mechanisms are tax efficient investment options. Do households use both? If so, which ones?

We found on average, around 13% of property investors also have a self managed super fund (SMSF). Households in the ACT were most likely to be running both systems (17%), followed by NSW (14%) and VIC (12.8%).

Older households working full time were more likely to have both an SMSF and Investment Property, but we also noted a small number of younger households were also using both tax shelters.

We found a significant correlation between income bands and use of SMSF among investment property holders (this does not tell you about the relative number of households across the income bands, just their relative mix). Up to 30% of higher income banded households have both a SMSF and Investment Property.

Finally, we look across our master household segments. These segments are the most powerful way to understand how different household groups are behaving. The most affluent groups tend to hold both investment property and SMSF – for example, 30% of the Exclusive Professional segment has both. Less affluent households were much less likely to run a a SMSF.

This shows that more affluent households are more able and willing to use both investment tax shelter structures. It also shows that any review of the use of negative gearing, investment properties and the like, needs to be looked at in the context of overall tax planning. Given the new limits on superannuation withdrawals, we expect to see a further rotation towards investment property, which as we already explained has a remarkable array of tax breaks and incentives. We expect the number of Portfolio Property Investors to continue to rise whilst the current generous settings exist.

The Rise and Rise of Portfolio Investment Property Households

The number of Property Investing households in Australia in rising. Today we look specifically at the fastest growing segment – Portfolio Property Investors.

This sector, though highly leveraged, is enjoying strong returns from property investing, are benefiting from generous tax breaks and many are expecting to purchase more property this year. However, we think there are some potential clouds on the horizon, and that the risks linked to this segment are higher than many believe to be true. Our latest Video Blog post discusses the findings from our research.

The investment property sector is hot at the moment, with around 1.5 million borrowing households now holding investment property and the number of investment loans is the rise. In December according to the RBA, investment loans grew at 0.8%, twice as fast as owner occupied loans, and around 36% of all loans are for investment purposes.

But not all property investors are created equal. Using data from our large scale household surveys, we have looked in detail at those who hold multiple investment properties.

These Portfolio Investors have become a significant force in the market. For example, in November about twenty per cent of transactions were from portfolio investors – or about six thousand transactions. Whilst overall investment loans grew at 0.8%, there was an estimated 4% increase in transactions from Portfolio Investors.

If we plot the overall loan growth trends against the proportion who are Portfolio Investors, we see a that since late 2015, it is these Portfolio Investors who have been driving the market. In addition, more than half of these transactions are in New South Wales, which is the property investor honeypot.

Many Portfolio Investors will have three or four properties, though some have more than twenty and the average is about eight. Some of these households have taken to property investment as a full-time occupation, others see it as their main wealth building strategy.

Property portfolios vary considerably, although we note that there is a tendency to hold a portfolio of lower value property – such as would be suitable for first time buyers, rather than million dollar homes. This is because the rental income is better aligned to the value of the property, and there is more demand from renters, and greater supply.

About half of portfolio investors prefer to buy newly build high-rise apartments, whilst others prefer to purchase a property requiring renovation, because they believe renovation is the key to greater capital appreciation in the long run, even if rental income is foregone near term.

Property Investors are able to get a number of tax breaks, especially if negatively geared. They are able to offset both capital costs by way of adjustments to the capital value on resale and recurring costs, which are offset against income.

Together negative gearing and capital gains makes investment property highly tax effective. There is good information on the ATO site which walks through all the benefits, but in summary you can claim:

advertising for tenants
body corporate fees and charges
council rates
water charges
land tax
cleaning
gardening and lawn mowing
pest control
insurance (building, contents, public liability)
interest expenses
property agent’s fees and commission
repairs and maintenance
some legal expenses
travel undertaken to inspect the property, to collect the rent or for maintenance.

In terms of financing, you can also claim:

stamp duty charged on the mortgage
loan establishment fees
title search fees charged by your lender
costs (including solicitors’ fees) for preparing and filing mortgage documents
mortgage broker fees
fees for a valuation required for loan approval
lender’s mortgage insurance, which is insurance taken out by the lender and billed to you.

Stamp duty and legal expenses can be claimed as capital expenses.

Given the strong capital appreciation we have seen in property values, especially down the east coast, portfolio investors are less concerned about rental incomes than capital values. Indeed, in recently published research we showed that about half of investment property holders were losing money in cash flow terms – but significantly, portfolio investors were on average doing better.

But these capital gains are now being crystallised by sassy portfolio investors.

If we chart the proportion of portfolio investors who have sold an investment property, to buy another property, it has moved up from 5% in 2012, to 11% in 2016. These transaction means they are able to release net equity for future transactions, and offset capital costs in the process. Once again, portfolio investors in NSW are most likely to churn a property.

Our surveys also show portfolio investors are most likely to transact again in 2017, are most bullish on future home price growth, and will have multiple investment mortgages.

Significantly, many portfolio investors are using equity from one investment property to fund the next, and are reliant on rental income to service the mortgage. They often have multiple mortgages with different lenders. In addition, we found that many portfolio investors are using interest only loans, to keep loan servicing to a minimum and interest charges as high as possible for tax offset purposes.

So long as property prices continue to rise, this highly-leveraged edifice will continue to generate high returns, which are, after tax, better than cash deposits or the share market. Of course the world would change if interest rates started to rise, capital values fell, or the banks clamped down on interest only loans. Overall, we think there are more risks in this sector of the market than are generally recognised.

In addition, we think there is a case to look harder at the tax breaks available to portfolio investors, and suggest that a cap on the number of properties, or value which can be so leverage should be considered. This is because as property values rise, tax-payers end up subsidising portfolio investors more than ever.

So, in summary, our analysis shows the market is being severely distorted, making homes less affordable, and shutting out many owner occupied purchasers who cannot compete. Risks are building, but meantime Property Portfolio Investors are having a field day!

Negative Gearing Debate Re-ignites

From The Real Estate Conversation.

NSW Planning Minister Rob Stokes has called for the federal government to change negative gearing arrangements to help ease Sydney’s housing affordability crisis. The comments come ahead of next week’s housing affordability meeting between state treasurers.

The Prime Minister Malcolm Turnbull took a policy of preserving the current negative gearing arrangements to the federal election, and said on Melbourne raido 3AW this morning that remains the government’s policy.

Turnbull said the government hasn’t “got any plan to review the policy we took to the election.”

He said housing affordability was a supply problem, and urged the NSW government to maintain its focus on what he says is the states’ responsibility to free up more land for development.

Stokes is due to give a speech today to the Committee of Economic Development. Reports in The Australian and on the ABC have revealed he will use the speech to call on the federal government for more measures to improve housing affordability for ordinary Australians.

The ABC has reported Stokes’ speech states, “Surely the focus of the tax system should be directed towards the type of housing we need. Why should you get a tax deduction on the ownership of a multi-million-dollar holiday home that does nothing to improve supply where it’s needed?”

Property Council urges NSW to stop the blame game

The Property Council’s Chief of Policy and Housing, Glenn Byres, said housing affordability in NSW is the worse of any state in the country, and the Baird Government should take responsibility for it, rather than blaming others.

He said the NSW government has the nation’s highest property taxes and charges, and it should take practical actions to improve housing affordability rather than engaging in another round of the ‘blame game’.

“NSW is playing gesture politics to distract attention from its own failures and excessive taxes on homebuyers,” Mr Byres said.

“The mix of taxes and charges built into the cost of purchasing new homes in Sydney adds over $100,000 to the burden facing homebuyers.

“If Rob Stokes was serious about affordability, he could walk down the corridor, tap on the door of Mike Baird and Gladys Berejiklian and tell them to abolish stamp duty,” he said.

“The average homebuyer in Sydney is gouged for more than $40,000 on a purchase – and NSW has doubled its stamp duty revenue from $4 billion to $8 billion in the last five years.

“NSW also has the highest infrastructure taxes and charges in the nation, which are backed into the cost of new housing and add tens of thousands of dollars to the cost facing homebuyers.

“They add to the woes by running the worst planning system in the country which adds time, cost and red tape to new projects – which is where Rob Stokes should focus his time.”

Of changes to negative gearing, Byres said, “even supporters of change can only point to a difference of between 0.2-0.5 per cent in house prices – hardly the sea change we need in the affordability debate.”

“Over 70 per cent of people who use negative gearing own one investment property, and another 18 per cent only own two.

“And more than two-thirds of people who use negative gearing have taxable incomes below $80,000 per year, including teachers, nurses and clerical workers.”

ABC Lateline Does Housing Affordability

ABC Lateline included a segment on housing affordability, and an extended interview with Angus Taylor, Assistant Minister for Cities. His focus was on supply side issues, but he rejected the notion that investors, and their tax-breaks have messed with the market. He suggested the only way to examine the property sector was at an aggregate level, rather than looking at the behaviour of specific groups. We are not convinced!

Why rents will rise under Labor’s negative gearing proposal

From The Conversation.

In the current housing tax debate a number of studies have come out arguing that while prices will fall (by varying amounts) rents will not be affected. That rents will be unaffected is surprising and (in my view) wrong.

Outside of the heat of an election, the Henry Tax Review’s comprehensive review of the tax system argued for lower taxes on savings, a proposition that most economists would regard as unexceptional. (There is now a (small) school of thought arguing for higher taxes on savings but this author for one does not subscribe to that.)

Specifically, the Henry Review recommended the marginal tax rates on interest and rental income should be 40% lower; for example, the 35% and 45% income tax rates on labour income would be lowered to 21% and 27%. For property investors these rates would also apply to capital gains and net losses, thereby reducing the value of negative gearing.

For ‘ungeared’ investors (those who do not take on debt), the effective tax rate would be lower while for highly geared investors the effective tax rate would be higher, leading to less incentive to leverage (making the Reserve Bank of Australia happy). Overall, the effective tax rate for the “average” investor would be higher.

Now the Henry Review acknowledged that its proposed changes would, by lifting the user cost of capital of investors, lift rents. It therefore explicitly said that its proposed changes would need to be accompanied by measures to both lower the cost of housing by removing supply constraints, and to lift levels of rental assistance for households in the private rental market. In short, it did not see the increases in rents as immaterial.

If the increase in user cost of capital (on investors who are ‘geared’ by borrowing money to invest) with the Labor proposal is higher (roughly double), on what basis could rents not rise? It is not evident to me.

The key component of the user cost of capital, and the one which varies the most over time, is interest rates. When interest rates rise or fall, we expect prices to fall, or rise. But interest rates also change rents, since rent = user cost × value of house.

And what we also see is that a rise in interest rates causes the rent-price ratio (that is, the ratio of home prices to annual rent, also referred to as the rental yield) to rise, while a drop in interest rates will see it fall.

To illustrate, consider Melbourne for the period 1991-2014 when interest rates have fallen significantly and the rent-price ratio has followed suit. This has seen prices increase significantly (4.9% pa in real terms), and faster than the rise in costs (3.2%). In inner areas where there is a significant location premium (over living at the urban fringe), the rise in prices has been fastest (5.8%) as the value of that location premium has been bid up.

That is, most of the change in the rent-price ratio has come from rising prices. On the other hand, in the outer areas, where there is no location premium and the value of a house is the structure plus the cost of land, prices (3.4% pa) have moved in line with costs (3.2% pa) but rents have risen much more slowly (1.4%). That is, rents explain the decline in rent-price ratios.

So, while the assumption of most commentators is that price movements do the work in changing rent-price ratios, and that is so over the short term, over a longer time span, rents do some of the adjustment.

Changes in interest rates are uncontroversial. But the same principles apply to changes in tax if they change the cost of capital, which is why the Henry Review expected rents to rise.

In the case of the Labor’s negative gearing changes, the waters are muddied for some by its proposed exemption on new housing. A couple of points here. Firstly, ABS figures (see Table 8 from ABS5671.0 – Lending Finance, Australia) are quoted to suggest that investors’ purchases are 93% established housing, and only 7% new housing. This significantly understates the role of investors.

The NAB residential property survey has domestic investor purchases of new housing at about 20-30% – that is, domestic investors are already a significant component of the new market (adding to supply!).

Secondly, Henry also expected a change in the mix of landlords to consolidate from one with a large number of small landlords, to one with a smaller number of large landlords. More marginal investors – middle income/low wealth investors – will be the first to vacate the field as their entry point is typically cheaper, old stock not premium new stock.

High income/low wealth investors will have the option of new dwellings. High income/high wealth individuals will benefit from the higher rents and lower prices on established dwellings.

That is, the ownership of the dwelling stock (and tax benefit!) will shift to the top end of income earners. But it is not clear that the special treatment of new housing will add materially, if at all, to supply of new dwellings.

In short, the law of unintended consequences will apply. Logic says that rents will rise, and with the 30% renting in the private market skewed to low income earners, that means housing affordability will have declined for these people.

Author: Nigel Stapledon, Andrew Roberts Fellow and Director Real Estate Research and Teaching Centre for Applied Economic Research, UNSW Australia

Is The Root Cause Of High House Prices What You Think It Is?

A snapshot of data from the RBA highlights the root cause of much of the economic issues we face in Australia. Back at the turn of the millennium, banks were lending relatively more to businesses than to households. The ratio was 120%. Roll this forward to today, and the ratio has dropped to below 60%. In other words, for every dollar lent now it is much more likely to go to housing than to business. This is a crazy scenario, as we have often said, because lending to business is productive – this generates real productive growth – whilst lending for housing simply pumps up home prices, bank balance sheets and household balance sheets, but is not economically productive to all.

There are many reasons why things have changed. The finance sector has been deregulated, larger companies can now access capital markets directly and so do not need to borrow from the bank, generous tax breaks (negative gearing and capital gains) have lifted the demand for loans for housing investment, and the Basel capital ratios now make it much cheaper for banks to lend against secured property compared to business. In fact the enhanced Basel ratios were introduced in the early 2000’s and this is when we see lending for housing taking off.

So how much of the mix is explained by tax breaks for investors? If we look at the ratio of home lending for owner occupation, to home lending for investment, there has been an increase. In 2000, it was around 45%, now its 55% (with a peak above 60% last year). This relative movement though is much smaller compared with the switch away from lending to business. Something else is driving it.

We therefore argue that whilst the election focus has been on proposed cuts to negative gearing and capital gains versus a company tax cut, the root cause issue is still ignored. And it is a biggie. The international capital risk structures designed to protect depositors, is actually killing lending to business, because it makes lending for housing so much more capital efficient. Whilst recent changes have sought to lift the capital for mortgages at the margin, it is still out of kilter. As a result, banks seek to out compete for mortgages and offer discounts and other incentives to gain share, whilst lending to business is being strangled. This is exacerbated by companies being more risk adverse, using high project hurdle thresholds (despite low borrowing rates) and smaller businesses being charged relatively more – based on risk assessments which are directly linked to the Basel ratios. Our SME surveys underscore how hard it is for smaller business to get loans at a reasonable price.

The run up in house prices is a direct result of more available mortgage funding, and this in turn leaves first time buyers excluded from the market. But it is too simple to draw a straight line between negative gearing and first time buyer exclusion. The truth is much more complex.

We are not convinced that a corporate tax cut, or a further cut in interest rates will stimulate demand from the business sector. Nor will reductions in negative gearing help that much. We need to re-balance the relative attractiveness of lending to business versus lending for housing. The only way to do this (short of major changes to the Basel ratios) is through targeted macro-prudential measures. In essence lending for housing has to be curtailed relative to lending to business. And that is a whole new box of dice!