Negative gearing: More distortion than a shitty dub step track

Have you heard the latest joke? The housing market is cooling off and it’ll be affordable again sometime soon!

Heh, that old chestnut. Conveniently popping up in our news feeds every time politicians feel the pressure to address self-made distortions in the Australasian housing market. 

I wonder why that is?

With only a few days until the next New Zealand General Election such objective sources as ‘Barfoot & Thompson Realty’ are on hand to spin us another yarn about increasing housing affordability. So, millennials, break out that 180k you’ve got laying around, the average Auckland sale price might fall to $900,000 over the next two years and you too can take advantage of blah blah, etc, etc.

Last night ‘The Block NZ’ managed to climb its way into the national conversation, its contestants wore turgid expressions as the auction process confirmed they would not be rich, that after spending the entirety of winter putting up with Mark Richardson.

In what has been an incredible assumption of egg before chicken, the comparatively lower auction prices at this years’ season finale are being used to claim that the Auckland housing market is now in a state of decline.

Not perhaps that there is an election looming and that housing policy is in fact one of the few areas of substantive difference between the major parties and their allies.

No, of course not, lets just gloss over that little nugget of context. 

The housing situation is a mess on both sides of the Tasman, and it is impacting just about every metropolitan area with more than two supermarkets in its city limits.

The housing market is so f**ked in places like Auckland, it is making Hamilton a more appealing place to live. And because of that, housing in my beloved hometown is now pretty well f**ked too.  

Bank of New Zealand Chief Economist (whom I affectionately consider as the curly haired face of fascism in this country) played a straight bat for the ears of home owning baby boomers recently, berating those desperate to get onto the housing market by suggesting they were either whiny, wasteful or expecting too much.  

He was of course merely engaging in a bit of low-brow millennial bashing, using the sort of language that would have appealed to his investor buddies, whose explosive growth in their property portfolios no doubt gives them better erections than the more conventional diamond-shaped blue pill they’re typically prescribed.

It was also a lazy argument that bordered on plagiarism, which in context made his seriously shit remarks that little bit more ironic.  

Housing is a complex issue, beyond the musings of economists there is an idea being touted by some politicians that it can be addressed by transforming everyone’s favourite “f**k off we’re full” slogan into a nationwide immigration policy. While immigrants usually take a couple of generations before they’re discussing stock options down at the country club, they are already good for some things; in this case, taking the blame that might otherwise fall on the type of people who donate to political parties.

It’s also important to remember that it is immigrants doing the jobs we can’t be f**ked doing ourselves – such as shift work in hospitals, working in one of our genuine growth industries (prisons) or even wiping the asses of our parents as they begin to populate retirement villages. Those new migrants will all need somewhere to live too. So, we need to build more homes to at least keep pace with their arrival.

But, there is something else driving demand at such a breathtaking pace; it’s the unseen incentives we give people to park capital in the real estate market.

This obscene policy is called ‘negative gearing’. It’s a process only allowed to operate so liberally in our two fine countries. While it’s banned entirely throughout most of Europe and the United States.

It is practically undisputed among top economists, people such as Philip Lowe, the Reserve Bank Governor of Australia, that negative gearing is a contributor to the considerably over-inflated housing market we’re all chained to.

Negative gearing is defined rather succinctly here.

“It is when the cost of an investment is greater than the income earned from it. For rental properties, costs can include interest payments on a loan or mortgage (but not the principal payments), and expenses such as maintenance, rates, water, insurance, depreciation, accountants and agent fees.

If a property owner has a loss on their investment, they can claim a tax deduction and offset that loss against income earned elsewhere.”

Housing investors are almost always borrowing money to fund their new purchases, and with any mortgage, the amount of interest paid in each installment is more at the beginning of the loan. Therefore, in the first decade at least they can write off such losses against their personal income taxes because their interests costs are high.

This makes property a compelling option for investors, because while they may not be earning the passive income you’d typically hope for from a rental property, they’re able to limit their tax burden while watching the equity in their investment home skyrocket.

After a few years the investor can reach a cost equilibrium but also a substantive capital gain. Provided enough equity has been realised, those same investors can buy another home.

And another one

And another one

And another one

And another one

And another one

And another one

The result is that more people are competing to buy the same number of homes, which pushes prices even higher. When the investor finally secures that shitty old run down ex-state house for 700k, they then need to rent it out for a weekly amount that at least keeps within range of their monthly mortgage repayment.

The end result of this madness is that housing in Australasia has become a multi trillion dollar ponzi scheme that would make Bernie Madoff gush from his federal prison cell.

Even old mate Tony conceded that by ending the practice it will have some impact on the housing market – he must have wanted to shower after admitting that.

It’s also around this moment you start to realise why New Zealand has over 41,000 people (about 1% of the population) either sleeping rough or in woefully inadequate forms of housing (read: cars, garages and boarding houses) throughout the country.  

Census data from way back in 2011 puts the Australian number at over 100,000.  I would bet the value of a week’s’ rent for my tiny studio apartment that the figure is higher now.

How can we fix this mess?

Clearly, you could do nothing and hope for the best – it’s certainly what the Property Council of Australia and New Zealand Property Investors’ Federation would like you to do.

OMG DID YOU SEE THE BLOCK LAST NIGHT??!! 

Or, you could drastically cut immigration as suggested, boot a whole lot of people out and then transform the country into some form of agrarian utopia by pushing people from the cities and into farms (google ‘Khmer Rouge’ for further information).

The first part of which is kind of what happened in Perth, except it wasn’t Government-directed; the decline in the resources sector caused a mass exodus of the formerly employed; many of them Kiwis now returning home to greener pastures.

That’s another reason negative gearing sucks; if growth flatlines and the economy tanks (in the way it has done in West Australia) the housing market will collapse in an even more dramatic fashion, leaving a lot of people in negative equity (where their mortgages are higher than what they could sell the home for).

So, negative gearing must go or be significantly curtailed, because even if the market stutters for a few months in times of uncertainty (as it is currently doing) it will simply rebound at some point if nothing is done to fix the structural issues created by artificial demand.

In the long run, negative gearing is a ‘no one wins’ type scenario for just about everybody – except the boomers who have cashed out already, and of course the banks, politicians, and lobbyists who awarded themselves the liberty in the first place.

TL;DR?  The housing crisis is an issue of both supply and demand. In times of uncertainty, demand will taper off. However, unless you change the underlying structural issues in the market, demand-driven distortions will inevitably return.