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Why negative gearing is not the problem

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By David Bassanese

The rise and rise of property prices across Sydney in particular has once again led to the usual bevy of alleged causes and solutions. These days, it’s again popular to blame one alleged culprit in particular: negative gearing.

So desperate is the New South Wales Government to absolve itself from blame for the desperate plight of first home buyers within its borders trying to gain a foothold into the property market, it has conveniently pointed the finger at one of the few policy levers beyond its control – the Commonwealth income taxation system.

Yet those that would seek to blame negative gearing need to deal with a few awkward questions. If negative gearing is the problem, why aren’t property prices across the nation taking off? Why isn’t negative gearing causing an explosion in prices in Adelaide and Hobart? 

And if negative gearing is the problem, why did Sydney property prices essentially go nowhere between for eight years up until mid-2012?

To my mind, short- and longer-term factors explain the specific strength in Sydney at present. There are short-term cyclical factors at play – especially the re-balancing of national economic growth back from the mining states of Queensland and Western Australia in recent years, which has allowed Sydney prices to largely catch-up after years of relative weakness.

Structural factors are also at play – namely the express preference of foreign investors (especially the Chinese) to buy in both along the more familiar East Coast cities rather than more remote counterparts. As regards Sydney, we can also blame geographical constraints that limit our ability to expand East and West. 

And Sydney also faces a huge “proximity premium” from poor planning that has concentrated most job opportunities in the urban centre, yet provided far from adequate transport links to the regions where more affordable homes could be built.

Rather than blame negative gearing, the NSW Government should be concentrating on both improving regional-city transport commuting times and/or encouraging more jobs growth in the more affordable regions.

Of course, there's one factor that is largely to blame for the nation-wide lift in house prices relative to household incomes in recent years – and which also happens to have particularly hurt first home buyers. 

That factor is interest rates. By now, most (but not all!) of those concerned about housing affordability tend to understand how lower interest rates have effectively allowed households to bid up the value of housing relative to their incomes. After all, if interest rates half, you can effectively double the size of your mortgage while keeping more payments as a percentage of your income broadly constant. In the main, that’s what we’ve done since the early 1990s.

Yes less well understood is the insidious effect lower interest rates and the associated lift in house prices-to-income have had on the ability of first-home buyers to get a foothold in the market. Indeed, if for example banks, have tended to demand a 10% deposit on home purchasers (i.e. the maximum loan to valuation ratio is 90%), then a doubling in the house price to income ratio doubles the upfront mortgage requirement as a share of household income.

Not only that, low inflation means share of household income devoted to the fixed nominal value of mortgage payments (as under a traditional credit-foncier loan) declines relatively more slowly – so the burden or mortgage repayments remains higher for longer.

Strange as it may seem, it’s been the structural decline in interest rates and inflation that has been the real killer of first-home buyer aspirations in recent decades.

Published: Wednesday, November 30, 2016


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