Will rents rise if Australia votes for tax reform?

We've heard that some people - let's call them real estate agents and a couple of prominent politicians - have been saying rents will rise if Australia votes for tax reform. We thought we'd better check this out.

We've already looked at how negative gearing and capital gains tax discounts distort the rental market at a macro level - you can read about that here - so it's hard to know exactly what these soothsaying ne'er-do-wells are getting at. Affordable rental housing couldn't really disappear from the market any faster than it already does. And if the current reform proposal does get up, existing arrangements will not be affected, so current landlords would not be able to use the old "suddenly I am paying more tax, and I must pass this unexpected cost on to my tenant" excuse.

Still, we can't shake this feeling that, should it come to pass, landlords could try to use a new tax regime as a screen for putting up the rent. Real estate agents' bottom lines would benefit from higher rents, and because they favour the status quo they have nothing to lose from cultivating an expectation that change means rents will increase...

One of the first claims you'll hear a real estate agent fall back on is that rents took off after Paul Keating made some adjustments to negative gearing back in 1985. If it happened then, they say, it will happen again. Never mind that the claim has been contested and discredited time and time again - see, for example, this 2003 article from Ross Gittins, which discusses rents rising in Sydney and Perth in the late 1980's, but not in other parts of the country; or this more recent piece from the ABC's Fact Checker, which reaches a similar conclusion before quoting a 1987 Cabinet Submission:

With the notable exception of Sydney, conditions in the residential rental property market are not unusually tight. The evidence suggests that local influences, rather than tax measures, dominate in metropolitan rental markets.

The Fact Checker article goes on to examine some of the "other influences" that could have been contributing factors. It cites high interest rates as well as high prospective capital gains in other investment classes, making residential property a less attractive option. But one of the influences that hasn't been mentioned is the impact on rents of residential tenancies legislation at the time.

Keen followers of renting law reform will know that tenancy agreements in New South Wales were not regulated by the Residential Tenancies Act 1987 until it commenced in 1989. This means that back in 1985, putting the rent up in Sydney was much easier than it is today. Landlords would simply offer a rent increase, and if the tenant didn't accept it they'd usually get a notice to quit and have to move out. But some other states - notably Queensland, Victoria and South Australia - had brought in new renting laws somewhat earlier. Which means that rent increases were better regulated in other parts of the country while Keating was tinkering with tax, and Sydney rents were doing their thing...

Of course, renting laws still vary from state to state, and tenants in some states may again be better equipped to handle wholesale rent increases than in others. Even so, to the extent that rents are now regulated, they are still very much tied to "the market". Landlords set the rent based on what tenants are prepared to pay, and if a tenant challenges an excessive rent increase it is generally decided by a tribunal with market comparisons in mind. But the important thing is that such a challenge is possible, and tenants should not hesitate to exercise this right if the need arises. This right was not available in Sydney in the mid-1980's.

Landlords who claim they will set rents according to tax policy, rather than market factors, should have cause for caution. Rents continue to reflect a fine balance between vacancy rates and tenants' incomes, and landlords cannot move the market by sheer force of will. Thankfully, those bad old days are over.

Nevertheless, we expect there will still be some landlords, real estate agents and politicians who continue to insist that tax reform will result in rent increases. Here are a couple of useful points to keep handy, just in case you ever find yourself in conversation with one:

Rents are not tied to other costs
Rents increase faster than the general cost of living. We'd have thought this was common knowledge, but SQM Research's recent report suggests perhaps it is not - they've suggested Labor's tax reform proposal could lead to "an acceleration in rents above and beyond the CPI rate". But here's what rents already look like against CPI, over the last quarter of a century:

Rents v CPI, from the TU's Rent Tracker (coming soon!)

There's been plenty of "above CPI acceleration" in there, even without tax reform.

We also know from tax data that rents increase faster than landlords' costs. We explored this in our report 5 years of the Residential Tenancies Act:

... landlords collect significant amounts of income from their tenants each year. In the 2009-10 financial year landlords declared $9.7billion in rental income for properties in New South Wales. This increased to $12.1billion in 2012-13. An increase is to be expected given the growth of the sector, but even so this represents approximately $2,175.00 more rent to landlords in 2012-13, per property, than in 2009-10. The average costs declared by landlords over the same period rose by $880.00 per property.

So we can conclude - rents go up because they can, not because they need to, and certainly not in response to any particular cost factors for landlords.

There's no room in the market for higher rents
Rents go up because they can, unless for some reason they can't. At some point, rents become unaffordable, and tenants cannot continue to pay them. When this happens, tenants are forced to find homes in a more affordable area, or they're forced to share a home with others. In their 2013 report Long term private rental in a changing Australian private rental sector, Stone, Burke, Hulse and Ralston found that families with children now make up the largest group across Australian private rental markets. These households may not be inclined to share, which means landlords need to keep rents within their reach so as not to price them out.

None the less, the report also shows that the fastest growing group is shared households. Tenants are increasingly responding to high rents by pooling their resources and living together. Further research suggests that share housing is not the domain of young people alone, with a marked increase in the number of people over 40 recently using the share house finding website flatmates.com.au...

Meanwhile, the Rental Affordability Index continues to reflect the grim reality of high rents across the country. The RAI reveals that under current conditions, low-income households typically need to pay 50 to 85 per cent of their income on rent. And as we showed in another recent post about rents, even a modest - and much needed - increase to Commonwealth Rent Assistance couldn't open the gate for higher rents.

If tax reform happens and the rent goes up, who's going to pay it?

Landlords really, really need the rent, and so do their banks
Even though rents are no reflection of costs, it's really quite expensive to be a landlord. As we discussed in our Tenants' Guide to Tax Reform, their biggest expense comes from the purchase of a property in the first place. According to tax data, the interest payable on loans amounts to more than all other expenses combined, even with record low interest rates:

Landlords' expenses ($billions) Source: ATO

That's not surprising when you consider that banks have been lending, on average, more than $550million to Australian landlords each month for the last year.

If landlords were to increase the rent beyond what the market could bear, or even beyond what the market can anticipate, many would start to experience periods of vacancy. Even a short-term loss of rental income could have serious consequences for landlords - at best it would affect cash-flow arrangements and compromise their ability to meet a mortgage commitment without making other sacrifices; at worst it would lead to mortgagees calling in bad debts.

So, all things considered, if you come across a landlord, real estate agent or politician who insists tax reform would lead to higher rents, we reckon you should call their bluff.