If Labor wins, negative gearing reform is go. But who is it going to hurt?
Labor has announced that their negative gearing and capital gains tax reforms will come into effect on January 1, 2020.
Like most people, I was expecting them to go for the end of the 19/20 financial year, so this means two things:
- there’s going to be a rip-the-bandage off approach, and I think that’s probably a good thing.
- Labor knows it’s onto a vote-winner and is happy to double-down.
But like all things in politics, there must be winners and losers, so who is going to be worse off under the new policy settings?
Well, literally everyone, according to the Real Estate Institute of Australia:
“The REIA has always been concerned with the impact the policy would have on housing markets, buyers, renters and economic activity,” REIA President Adrian Kelly said.
“This concern is magnified in the current market.
“There is almost truck loads of analysis and reports showing the adverse impacts of the policy on mum and dad investors, home owners, renters, the construction industry, state governments and the economy.
Investors, home-owners AND renters?
How does that even work? I actually struggle to think of a scenario where all three are made worse off under ANY policy proposal – maybe something like “All housing will be nationalised and turned into jumping castles for Swedish tourists.”
Or are we using a definition of “worse-off” that I’m not aware of?
I want to pick this apart a bit, not to be cruel to REIA, but to make a point about how the housing market actually fits together. I think it will be useful.
Anyway, if we’re saying everyone in the market is going to be worse off, then I assume we’re saying that house prices are going to fall (bad for investors and owner-occupiers) and rents are going to rise (bad for renters).
That’s the only scenario that makes sense. If rents fell, that’d be bad for investors, but you’d have to chalk that up as a win for renters.
Likewise, if houses became more expensive that would be bad for renters looking to buy, but would be a win for owner-occupiers and investors.
So we’re talking about falling house prices (though I know a café full of millenials cheering that on), and rising rents. But how would negatively gearing actually make rents go up?
They might go up if the reforms exacerbated our housing shortage, but since negative gearing will remain in place for new stock, it’s hard to see how removing it for existing homes will have any affect on construction rates…
But, just for arguments sake, let’s imagine that somehow negative gearing reform does increase rents.
What happens then?
The point to remember here is that since housing is an asset, like all financial assets, the return is linked to the price.
The link between the rental return and property prices is captured by “yield”.
Now the thing to note about property yields is that they’re affected by structural conditions in the market – interest rates, risk appetites etc. Yields are not determined by rents and prices themselves.
That may sound counter-intuitive, given that yields are a calculation of prices and rents, but the causation actually runs the other way. Yields determine prices.
If you track yields over recent years, you’ll see that they’ve been very stable.
For 15 years, they’ve barely deviated from 4%. Even though rents and prices have been all over the shop, yields have barely changed.
So if rents go up, what happens to yields?
Well, you’d think yields would go up as well. But that doesn’t happen, because prices are set by people buying property, and the people buying property are happy with yields of 4%, on average.
So if rents go up, yields stay constant, and the adjustment is forced on to prices. Prices go up and yields remain at 4%.
Statistically, that’s been true for as long as we have data for.
But if prices go up, isn’t that a win for owner-occupiers and investors?
Personally, I think the reforms will have no impact on rents, and push prices down at the margin, but not by a huge amount. Yields will adjust a little because the ‘cost of carry’ appetite will have changed (I’ll talk more about that another time).
But all this ‘everyone is worse off’ is just BS.
But remember this. If you want to know what’s happening to prices, look to rents and yields first.