Negative gearing is not your friend

An updated version of this post is now available here.

On this day 38 years ago, a gunman walked into the Kreditbanken branch at Norrmalmstorg Square in Stockholm, Sweden, to hold up the bank. Police were called, the gunman took hostages, and a six-day siege ensued. When the police finally took the bank and the gunman and his associate, there was observed amongst the hostages a feeling of solidarity with their captors. A criminologist dubbed this feeling 'Stockholm syndrome.'


In the Brown Couch's never-ending quest for elaborate extended metaphors by which to describe the Australian housing system, Stockholm syndrome sounds like an appropriate diagnosis for our relationship with negative gearing – that is, Australia's almost unique tax arrangement that allows landlords to deduct interest payments from not just their rental income or capital gains, but from all their income, thus reducing the amount of tax they pay.

Talking with tenants, we occasionally hear them mutter ruefully about how their negatively geared landlords are making out like bandits, but then say, 'oh well, I wouldn't be able to afford to live here if it wasn't for negative gearing.'

Our political leaders feel captured too, repeatedly refusing to countenance any changes to negative gearing and, furthermore, positively supporting it. Politicians of otherwise such divergent points of view as John Howard and Tanya Plibersek have defended negative gearing, claiming that if it were ever changed, rents would go up.

That's the claim: that negative gearing makes renting cheaper than it would be otherwise.

We need an intervention. Negative gearing does not make renting cheaper. On the contrary, negative gearing pushes rents up. Tenants, policy makers: negative gearing is not your friend.

First, let's be clear: landlords set the rent at what they can get. If you really think that because of negative gearing, a landlord will accept less, try this experiment: pay your rent $50 short, and tell your landlord that you're helping him reduce his tax. Observe his angry reaction. Note his insistence that you must pay the going rate and if you don't, he'll find another tenant who will. Try another experiment: offer to pay more rent. See if your landlord doesn't take you up on it.

The committed negative gearist who finds themselves faced with the prospect of actually making money – that is, their revenues are greater than their costs – is not going to cut their revenues just to keep posting a loss. They are going to refinance, take on more debt, and buy another property.

But, we hear you say, negative gearing works to reduce rents by expanding the supply of rental housing.

Well, it certainly has expanded the supply of landlords. The popularity of negative gearing saw the number of Australian landlords grow by almost 50 per cent over the last decade-and-a-half, and the proportion of them posting a net loss grew similarly.

(ATO TaxStats, various years)

But look what they've spent their (borrowed) money on: established dwellings, not new construction.

(RBA, Table D06)

So they've expanded the supply of rental housing, but only by turning dwellings that might otherwise be owner-occupied into rental. In other words, along with any expansion in the supply of rental housing goes an expansion in the supply of renters.

This is reflected in the declining rates of home-ownership amongst younger households (25-44 year-olds) – and, for that matter, middle-aged households (44-65 year-olds).

(Source: Flood and Green (2010) 'Australia's Changing Patterns of Home Ownership' AHURI Research and Policy Bulletin no 133. Click here for more.)

These households are in the prime income-earning years of their lives, and many would be owner-occupiers if they weren't priced out by big-spending negatively geared landlords. Instead they are renting – alongside the low income households who have always rented. AHURI researcher Maryann Wulff and her colleagues have charted over the period 1996-2006 the rise in the number of renters who are in the higher segments of the income scale:

(Wulff, et al (2009) 'Australia's private rental market: changes (2001-2006)', AHURI positioning paper. Click here for more.)

Wulff et al explain: 'overall, the number of private renter households in the lowest seven income categories (Y1-Y7) stayed relatively stable over the three census years [ie 1996, 2001 and 2006]. The growth in private renter households occurred in the top five income segments.'

Now, these higher-income renters can afford to pay more than their lower-income competitors, so their presence in the market helps push up rents. They also out-compete the lower-income households in terms of risk and general attractiveness to landlords, so if they want to save a bit of money and live in a relatively cheap rental dwelling, they very often can – which means a lower-income household, who really needs the lower rent dwelling, will have to look at renting another, more expensive dwelling.

We can put some number on this problem, thanks to the National Housing Supply Council. As of 2007-08 (the latest figures), Australia has 814 000 low-income households (that is, in the bottom 40 per cent by income) who are renting in the private market... and the private rental market has 1 410 000 dwellings that would be affordable for these households. That's apparently more than enough affordable rental dwellings... except that fully 1 089 000 of those relatively cheap dwellings are occupied by households above the 40 per cent line. That leaves 493 000 low-income households paying a higher rent.

And it is not just a problem of how the relatively low-rent properties are shared around, because the number of low-rent properties is declining, too – thanks to negative gearing. As a strategy, negative gearing depends on the prospect of capital gains: the negatively geared landlord makes a profit only if the (lightly taxed) capital gain at the end of their speculative adventure is more than the total income lost to interest etc along the way. So negatively geared landlords will go for properties where there's strong expectations of capital gain... and pass on properties that are not so blessed. The latter properties, as economists Woods, Ong and Stewart point out (in a paper for the Henry Review), are the relatively low-value, low-rent properties that low-income renters seek out. Over time, as properties are bought and sold, these sorts of properties drop out of the rental sector, and as they become scarcer, they become less cheap.

We can put numbers on this too, again courtesy of the National Housing Supply Council. Between 1996 and 2006, Australia's private rental stock grew by 234 000 dwellings. All of this growth was in dwellings that rent for more than $200 per week – and mostly more than $300 per week. Over that period, we lost 125 000 dwellings in the $232 or less price range (and all those dollar amounts are 2006 dollars, so we're comparing apples with apples). The Council provides a graph to illustrate the changing shape of the rental market, under the influence of negative gearing. Notice the bulge in properties around $200 flatten down and push up further along the scale of rents at $300 per week, $400 per week....





To recap:

• negative gearing does not cause an individual landlord to charge less rent;

• negative gearing does not create net additional rental housing;

• negative gearing has contributed to more higher-income households renting, which both pushes rents up, and pushes lower-income households out of lower rent properties;

• negative gearing has contributed to low-value proprties dropping out of the rental market, which pushes up the rent for those that remain in rental; so therefore

• negative gearing is not your friend.