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CEO AllenWargent Property Buyers, & WargentAdvisory (institutional). 6 x finance author.

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Wednesday, 29 April 2015

Cabinet papers & negative gearing furphies

Rents from June 1985

The prevailing "negative gearing" tax legislation was amended in July 1985 so that interest expenses on rental property were quarantined and could only be claimed against rental income and no longer other income.

In the period thereafter rents in Sydney and Perth surged higher, until the old legislation was restored in September 1987.

The below chart shows what happened to rental indices from June 1985 to September 1988, being one year after the reversal of the rulings in September 1987 (since the impacts of tax legislation obviously tend to take a period of time to work their way through illiquid property markets).

Some like to argue that the growth in Sydney and Perth rents was due to pre-existing vacancy rates.

As you can see below, Cabinet Papers show that over the 12 months to June 1985 Perth had a vacancy rate of 2.4 percent, which is close to the "comfortable" 2.5 to 3.5 percent rule of thumb range as determined by the Real Estate Institute of Australia (REIA).

Sydney's average vacancy rate in the year to June 1985 was somewhat tighter, although not chronically so, at 1.4 per cent.

What the Cabinet Papers do clearly show is that in the 18 months following the tax legislation amendments in July 1985 vacancy rates then collapsed in these two cities to 0.9 per cent and 1.2 per cent respectively as rental supply was vaporised.

Vacancy rates also fell in Melbourne, but only marginally so by comparison, from 2.0 per cent to 1.9 per cent.

Unlike many other cities, Melbourne was in the midst of a massive boom in real house prices. 

In nominal terms house prices in Melbourne screamed higher from $65,000 in 1985 to $109,000 by 1988, an incredible jump of 68 per cent.

Unsurprisingly the net result was a huge surge in net interstate migration from Victoria, more than quadrupling from just 3,340 in the year to June 1984 to a then near-record 14,423 in the year to June 1988.

Population growth in New South Wales was well over 50 per cent higher than that of Victoria in 1985, implying a very different dynamic in the respective rental markets of Sydney and Melbourne.

Brisbane had high vacancy rates in 1985 of above 4 per cent and although these declined a little rents were not unduly impacted, whilst population growth in all other cities was so slow by comparison that pressure on rentals was necessarily more muted.

With Australia having since embarked upon on a huge population growth programme since that time, the same dynamic is not true today, however, with ongoing population growth dramatically stronger that it was in 1985, in Victoria's case by a factor of an enormous 2.4 times.

Apples and oranges

Far more pertinently, comparing the property markets of 1985 with those of 2015 is akin to comparing chalk and cheese, leading to an arguments of a similarly sieve-like consistency.

The data shows that annual investor demand accounted for scarcely $2 billion of housing finance in 1985 (13 percent of the total) compared to a whopping $139 billion today (40 percent of the total).

For better or for worse, there exists a considerably greater concentration of investors in our largest capital cities today than ever was the case three decades ago.

If a prevailing 2.4 per cent vacancy rate in Perth in June 1985 was enough to send rents skyrocketing then logically there should be many regions today experiencing exactly the same dynamic.

But of course, with an evident surge of investor demand in response to low interest rates and the ensuing upwards pressure on prices leading to Australia's greatest ever building approvals boom, this is very far from being the case.

In fact rental growth is now tracking at its slowest level since September 2005, rents are already declining in nominal terms in Perth and Canberra, and will soon follow suit in Darwin and all probability elsewhere.

Concentration of investors

Extensive work by CoreLogic-RP Data has consistently shown that there is a very heavy concentration of investor-owned dwelling stock around the inner suburbs of our largest capital cities.

Naturally enough, therefore, these are also the very same suburbs which would see real rents explode higher were negative gearing rules to be tinkered with again.

Data from the Real Estate Institute of New South Wales (REINSW) shows that inner Sydney vacancy rates have been as low as 1.3 per cent within in the past 12 months.

In a large and relatively mature inner capital city market, with its many itinerants leading to frictional vacancies, vacancy rates simply will not fall much lower than that today.

Lately rising prices have led to a supply response and a burst of construction which has helped to ease apartment vacancy rates a little.

What the full REINSW data series does also imply is that rental pressures remain unlikely in, say, Coffs Harbour, or the Far West, or Orana. 

It's abundantly clear that any changes in negative gearing legislation would clearly have little or no impact in Walkabout Creek or woop woop, in the boondocks or beyond the black stump.

On the other hand in the inner suburbs of Sydney and our other large capitals, the simple laws of supply and demand dictate that a reduced demand for rental property would very quickly result in an sharp rise in rents.

To assume that an equivalent number of renters would =summons a deposit and mop up the ex-rental stock by electing to buy is na├»ve.

It is true that any resultant rental growth would be less dramatic in nominal terms today with inflation well under control and sitting comfortably within its target 2 to 3 per cent range, while rental affordability might also play a restricting role.

However, with rental growth nationally set to track below the rate of inflation for the foreseeable future, it is very easy to envisage that a scrapping of the prevailing negative gearing legislation would lead to a jump in inner suburban rents in real terms.