Is Negative Gearing Really the Problem?

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Thursday, June 2nd, 2016
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With the election drama now a fixture in our news season, those in charge of determining the screenplay of issues initially placed the politics of housing centre stage.

A few weeks ago, the debate on negative gearing looked set to blossom into a major election theme. It has instead been relegated to sub-plot status by Malcolm Turnbull in his recent broadcast from the front yard of a battler’s bastion.

It is a shame that what looked likely to become a robust public tax policy debate was curtailed. Amid the claims and counterclaims about the effects of negative gearing, I think members of the general public are still trying to unravel the many strands of that story line.

Together with an historic rate cut, it briefly seemed that the negative gearing debate might also bring housing affordability to the fore of the election narrative. This now seems unlikely to eventuate. For the property industry, ‘affordability’ is anathema. Just the concept of affordability conjures up prospects of reduced commissions and lower profits – as unpalatable as higher interest rates. The public media instead focuses incessantly on the latest price gain news from the real estate industry.

Whilst the question of whether or not a change to negative gearing will reduce housing prices remains unanswered, tax policy is only one of the many, and probably lesser influences on real estate price escalation. It is, after all, only one amongst many drivers of demand – population growth being the key influencer. Tax concessions of some form on rental property apply in many countries so Australia is hardy unique.

With respect to affordability, tax treatment is perhaps a distraction from other issues that are more influential. One less commented on is the incredible recent growth in cost of a key property input – development land. The market for this finite resource, which is under increasing pressure and the use of which is governed by complex overlays of planning laws, has recently been achieving eye watering price growth and delivering super profits to those lucky enough to hold well-located parcels.

A small measure of this can perhaps be taken by some figures published by the Urban Development Institute of Australia in its 2015 State Of The Land report. It noted the large change in land price in Sydney (not surprising), 
where the price of land increased by $119 per square metre, from $636 to $755 per square metre, an increase of 18.7 per cent over the year. 
Across Australia, land prices are up by an average of 40 per cent in the five years to 2015.

Land speculation is a phenomenon as old as the colonie. However, today the effects of globalisation are making the impacts more acute. It is not easy to get reliable stats on the average rise in prices of multi-unit development sites. What has been very apparent is that some land holders are making a killing, with international buyers taking advantage of favourable exchange rates and flocking in to grab what are seen as good deals.

Anecdotally, stories such as one published in the AFR mid last year of Legacy Property, a Sydney apartment and housing developer headed by Matthew Hyder, selling four of its sites to Chinese developers is compelling.

“The uplift premium on the sales is close to, if not more than, the profit we expected on the entire project,” Hyder said. “Since mid-2012, development site prices have doubled. Three years ago you could buy in North Sydney at a site price equivalent to $148,000 a unit. Now its not less than $300,000.”

Similar stories are common in Melbourne, where overseas interests often outbid local developers who are trying to maintain the key supply input for their businesses – so much so that it has been common to see Melbourne developers flying to other capital cities with lower Asian demand in order to secure sites at prices they can afford. The scale of Melbourne CBD land price variability is highlighted by the uproar at new planning rules proposed by Planning Minister Richard Wynne for the Melbourne CBD. As reported in The Age, a recent Ernst Young report for the Government suggested the lower plot ratio proposed could hit development site values by up to 44 per cent.

The flow on cost effect of the incredible recent land price escalation in the Eastern states is obvious as it reflects in housing prices for apartments. And the cycle of value increase does not stop with new off the plan sales. As developments are completed and purchases settled, valuation benchmarks for the locality in which they are situated rise as an eventual natural consequence.

Land is, of course, only one input cost. Construction costs are also inexorably on the rise and according to a respected tender price index; Sydney costs for example rose 4.5 per cent in the 2014-15 year. However, these increases tend to be incremental and are governed by a suite of regulating factors. Land speculation, with its exposure to globalised demand suffers few limitations other than free market forces.

We live in an age of global capital. Stemming the tide of money finding its way into Australian property can be an effective lever as is demonstrated by impact on investment sales by recent changes to property lending rules for overseas buyers. Tougher FIRB rules may be another option if affordability is truly a goal worth aiming for.

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