February Market Update

Market Overview

Table 1 shows the capital growth, rent and sales summary for January 2016.

Table 1: January 2015 Summary

Table 1_Statistics_Summary

Source: Residex

As discussed last month, it is evident that the Sydney market is coming into downswing. Annual growth in the Sydney house market was 14.76% in January, which is down almost 4 percentage points from the previous month. Quarterly growth in Sydney house values was -1.19%, bringing the median value down to $1,046,000 from $1,065,000 in the previous month.

Also notable is a sharp quarterly fall in the value of Darwin houses, falling a whopping 4.05%. This has dragged annual capital growth in this market down to just 0.91%. The Darwin unit market was the worst performer among the capital city markets over the year to January, with the median value falling 6.00% to $392,000 for the year.

Like the Perth market, Darwin has been susceptible to divestment from mining, due to the economic dependence on resource exports. Exports in Darwin accounted for approximately one third of economic output in 2014, compared to a national average of approximately 18%. Since the sharp fall in commodity prices, the value of Darwin houses are steadily coming down, and units more markedly so. At January 2016, units in the Northern Territory were at their lowest value since March 2012.

The global confidence crunch will likely impact the NT economy in the short term. Until there is significant development in the tourism sector, or an improvement in the international economy, subdued economic growth may translate to further loses on dwellings in the NT in 2016.

Steady performance in Melbourne was expected, as the market is likely to come to a peak growth rate sometime in 2016.

The standout performer in the year to January was Hobart houses, where the median value increased 4.15% to $388,000. Tourism had a positive impact on this economy in 2015, with the number of visitors to Tasmania increasing 7% in the year to September 2015, while visitor expenditure increased 10% to $1.92 billion. Within Australia, visitors from New South Wales saw the largest increase (14%), likely driven by the strong wealth effects from a rapidly growing housing market.

This year may see steady capital growth in Hobart houses, however due to stagnant rental yields and economic threat from bushfires and government debt, the growth experienced may not be as strong as it was in 2015.

Structural and environmental factors continue to shape the growth in our housing markets. The last few weeks have been dominated by discussions around reforms to negative gearing. In case you are not totally familiar with the subject, here are my thoughts…

A World without Negative Gearing

In a surprising political move, the Labor party has outlined the reforms to negative gearing they would implement if they are the elected government. The policy involves removing the ability to negatively gear established investment properties from the 1 July 2017. At this time, anyone already holding a negatively geared property may continue to do so. This is known as ‘grandfathering’.

Anyone wishing to negatively gear after 1 July 2017 would have to buy new properties to do so.

In response, the Turnbull government indicated they may leave the tax parameters untouched, but it is not entirely clear what the government’s stance on negative gearing is.

Several barriers exist for the reformation of negative gearing. Firstly, Labor would have to be elected. Running on the basis of changes to negative gearing may not be popular. ABS data reveals that two thirds of Australian households either own property outright, or are in the process of paying it off.

With reforms to negative gearing potentially lowering dwelling prices, capital gains and equity in the family home may be threatened for many, making it an unpopular decision.

Secondly, negative gearing has been increasingly influential in encouraging investment in property, increasing property values and generating large revenues for the real estate and construction sectors.

Over the year to June 2015, construction revenues grew a significant 13%, and real estate services grew 9%. These were the largest increases of any sector in New South Wales, contributing to almost 30% of growth in the NSW economy.

This is not to say that the real estate services and the construction of houses are the most sustainable or productive ways to boost national economic growth. Sydney’s property market appears to be coming into a downswing in its current cycle, which will make it very difficult for these sectors to maintain the same levels of revenue and employment as in the last few years.

The peak and potential downswing in the Sydney house and unit growth cycles are shown in Graph 1. Growth in the current cycle appears to have peaked in late 2015, with growth rates beginning to come down sharply since this time.

Graph 1: Historical Capital Growth Rates, Sydney

G1_Hisotical Growth Cycles, Sydney

Source: Residex

Negative gearing also presents an increasing constraint to the government budget. According to Australian Taxation Office data, there were approximately 1.26 million landlords negatively gearing in the 2012-13 financial year. These investors claimed over $12 billion in losses in that financial year.

Academics and economists have argued that negative gearing contributes to unaffordable house prices, along with capital gains concessions and high levels of finance relative to other assets.

As arguments for housing affordability become more salient, policies like Shorten gains popularity. Thus it is well worth considering what consequences (intended and unintended) the policy would have on Australia’s housing markets.

This is difficult to do, because a counterfactual does not exist. A ‘counterfactual’ is a scenario where the thing you are measuring does not exist. If you think about it like a science experiment, we do not have a ‘control group’. Housing markets have performed with negative gearing in place, as we know it today, for over 30 years.

The only thing near a counterfactual available, one consistently referred to by journalists, was the brief period between the July 1985 and September 1987 where negative gearing was temporarily quarantined.

I was not alive at this time, so I do not know the Hawke-Keating policy intimately, but there are several reasons I do not think it is an appropriate indication of what may happen if Shorten’s proposal comes into play.

As with the Labor proposal, the Hawke-Keating government ‘grandfathered’ negative gearing in houses. Unlike the current Labor model, rental losses could still be deducted, but only from income that was made on property. Losses in one year could be deducted from the income received on property in another year. This was applied to both established and new property, but only on new purchases.

Graph 2 shows the capital growth rates in houses during this time in Sydney, Melbourne and Brisbane, as indicated by the shaded area.

Graph 2: Historical Capital Growth Rates: Sydney, Melbourne, Brisbane 

G2_ Historical Capital Growth versus Negative Gearing

Source: Residex

There does not appear to be any causal relationship between changes to negative gearing and capital growth movements in this graph. While it is true that growth rates here are subdued, the market was also in a cyclical downswing at this time.

Should we take this to mean that dwelling prices would not be affected by changes is negative gearing?

Consider the difference in this period in Australia’s housing markets: it is likely that there were a lot fewer investment properties in 1985-87 than there are today, as the purchase of investment properties has increased in Australia over the last three decades.

This is partly because the ability to negatively gear rental properties against salaries and wages was only introduced six months before it was temporarily repealed in 1985, and it was not until the mid-1990’s that individuals could leverage their property to buy more property without having to come up with any other deposit. These changing frameworks made it easier to buy investment properties over time.

This means that phasing out negative gearing today is not the same as it was in 1985.

A paper modelling the tax benefits of the opposition’s proposal was released in February 2016 by Associate Professor at the Australian National University, Ben Phillips. The paper was aimed at understanding the tax revenue that could be made in the long run from reforming negative gearing. It was estimated to be between $3.4-3.9 billion per year.

However, the research note on Professor Phillips’ modelling does not attempt to model behavioural changes of investors. He did not set himself that task.

Behavioural changes in response to changing policy can lead to unintended consequences. Theoretically, tax revenues will go up if you start charging investors more tax, but this assumes your investors won’t divest from property or they will keep buying property at the same rate.

In the lead up to grandfathered reforms, there could be an effort to purchase established properties to negatively gear before July 2017. It could create a kind of ‘happy hour’ in the housing markets.

After July 1 2017, the inability to negatively gear existing stock might mean that a new cost-benefit analysis would go into the purchase of existing stock. Unless an investor can positively gear a property, or they believe the capital gains will offset the costs of an investment property, they will not buy it. This could drive prices down.

If prices are driven down, and I cannot say for sure that they would be, but if they were, this would present opportunities for people who wish to buy a family home. However, it could also threaten the capital gains of those relying on their investment properties for later in life. It also creates risk for those with large mortgages if they are not able to make repayments.

In any case, more modelling needs to be done on the potential behavioural reactions to reforms to negative gearing.

Eliza Owen.
Market Analyst for Onthehouse.com.au.