Australia vs the World! 

A poll conducted by the Australian National University found 87% of people surveyed were concerned that future generations will not be able to afford to buy a home of their own. And in typical Australian fashion, the first question we ask is…

‘Who is to blame?’

The Federal opposition has blamed investors. Property investors represent about 8% of the population and have a high net worth. 92% of the population aren’t property investors so the argument is simple and attractive, not likely to be challenged by the majority and suggests that fixing it won’t hurt most Australians.

The assumption is that encouraging property investment causes property values to rise and makes buying a first home out of reach for many young people. From there, the reverse is assumed to be true. That discouraging investment will cause property values to fall and make it easier for people to buy their first home. Abolishing negative gearing seems rational and socially responsible.

In science that argument is called a Hypothesis because while it seems reasonable it is yet to be confirmed in the real world by research and testing. When its confirmed then science calls it a Theory. I have spent the last few months trying to find the economics to support the argument and I have to say, there really isn’t any proper economic modelling out there that I can find. I found papers written by economists that argued in support of the hypothesis, but the arguments are moral and social, not economic and they have no modelling to back up their assumptions.

Then I found information from overseas that was a lot more concerning, not so much for investors but for tenants.

Late last year, you might remember listening to your car radio and hearing a lot of discussions on talk back radio about the new laws for NSW tenants. The Victorian and NSW State Governments were finalising their new Residential Tenancy Acts. The Tenants’ Unions and their supporters were pushing for the Governments to abolish the right of landlords to give a ‘no grounds’ 90-day notice to a tenant to have them vacate. In effect, they wanted tenants to be able to stay in property for as long as the owner wanted to rent it. Opponents called this a version of protected tenancies.

The idea of protected tenancies has been around for a while. Some of the more left-thinking welfare groups believe that tenants need to be guaranteed a place to live regardless of whether the landlord is a government or a private individual. NSW Labor has it as their policy if they are elected, to amend the Residential Tenancies Act so that 90-day notices are abolished. Owners will still be able to get vacant possession, but it will be a bit more difficult.

Anyway, many callers to the various radio talk back programs justified this argument by comparing us to European countries where tenants often stay in properties for 10 or 20 years. Side note, I found out you can only shout at your car radio for so long before people in traffic queues look at you with concerned alarm. The callers were right about tenancy tenure, in Europe they are a lot longer and the same in the US. But they are also ignorant about a couple of key aspects of renting in those countries that would freak them out (good scientific term that) if they understood.

First up, in many of these European countries, the properties that tenants rent are basically building shells. Tenants must install their own kitchens and their own appliances and having installed their own fit out, they are responsible for maintaining it. In Australia, we provide a finished product and landlords are responsible for maintenance. However, the biggest difference, is the rent paid by tenants compared to the cost of owning the properties.

In Australia in 2016, the average interest rate on a property investment loan was 4.4%.  At the same time the rent paid by a tenant was also equivalent to 4.4% of the property’s value.  Now this is an Australian average rather than a Sydney average. Sydney’s rate of rental return has always been lower than average.

For example, if a property was worth $600,000 and its rate of return was 4.4%, it would be generating a rent of $26,400 per year or $507 a week. And to purchase that unit using a bank loan with an interest rate of 4.4%, you would pay the same $507 per week in interest.

Owning the property costs you more than that. You must pay the rates, insurance, maintenance, management and letting by an agent. You would also have no income whenever the property becomes vacant. The point is, owning an investment property in Australia costs a lot more money than the interest rate.

In Sydney, rent returns were far less than the 4.4% average, more like 3.5%. For example, the rent on a $600,000 property is around $400 per week. Sydney’s property investment owners have accepted lower rents in preference to long running price growth.

Now let’s look overseas, and these figures come from SQM Research

In Germany in 2016 the average interest rate on an investment loan for property was 1.54% while the average rent return was 3.34%.  In the Netherlands, interest rates were 2.6% and the rent return was 5.45% and in Sweden the interest rate was 2.4% and the rent return was 5%. In each of these countries, tenants were paying their respective landlords twice as much rent as the landlords were paying their banks in interest. Properties in these countries are positively geared because the rent covers everything plus more.

In many of these countries, most rental property is not provided by individual investors but by rather large investment companies. The relative interest rates and rent returns make property cashflow positive. The tenants pay more than enough rent to cover the full cost of the property, maintaining it and providing a reasonable net return.

And because a large proportion of investment property is provided by companies rather than small investors and private individuals, tenancy lengths are much longer. And that has nothing to do with the law, it’s the same in Australia. We manage for several investment trusts and many of these tenants stay put for 20 years or more. Their long length of tenancy doesn’t require special laws, it requires special landlords.

Now back to these rent returns being twice the interest rate, if this happen in Sydney, here’s how it would look.

 

Rent per annum on a $600,000 unit $58,590
Interest if the property was fully mortgaged $27,000
All other outgoings include rates etc $  8,100
Net income before tax $23,490

 

And this is for a 50-year-old, 2 bed unit. You wouldn’t need negative gearing as a tax deduction because you would never make a loss. There would be plenty of property investors shouting, ‘bring it on!’ And for the tenant in this scenario, they would be paying $1,127 per week. With this system, you won’t need property investors, you’ll need a lot of cardboard boxes because that’s about the only thing a tenant could afford.

Rent.com.au ran a survey asking tenants across Australia if paying a 4-week bond at commencement of tenancy was a financial concern. 60% said they struggled to raise the money. If 60% of tenants have trouble saving the money for a bond, they certainly don’t have enough money or financial resources to get a loan.

Rent growth will start sooner than property value growth because the supply of available rental accommodation will dry up a lot faster. And expect when rents rise that the Tenant’s Union will complain loudly and blame landlords for being avaricious. It has happened before.

That’s the wonderful thing about ideology and market behaviour. Market behaviour happens regardless ideology. Property investors are individuals.  Individuals make decisions based on what’s best for them, not what’s altruistic. If you make something unattractive to invest in, less people will invest; a lot less than there are people who want and need the rental accommodation.

This is what happened in the two years Paul Keating’s changes to negative gearing were in place.  I remember what it was like for tenants and how everyone blamed everyone else. In other countries that haven’t had negative gearing or anywhere near the interest in property investment as Australia, tenants pay twice as much in rent compared to what their landlords do in mortgage interest.

Then the reality will be first home buyers can’t get into the property market because they are being bled dry paying rent.

Ideology stops you understanding what’s happening until it is too late

Ah, Australian politics, unpredictable one day, screwed up the next.

And just to finish, these are some of the changes to the tenancy laws that are due to come in this year:

Rent increases once every 12 months 

Rent increases will be a 12 months affair now. In the past we could increase rents as many times as was deemed appropriate. There are already rules about increases not being more than market and there is a need to give at least 60 days’ notice.  Right now, rents are falling so this probably won’t have any real impact on either tenant or landlord.

Strata By-Laws

We must give the tenant a copy of the current Strata By- laws as part of the lease. Our system is set up to do this, but it does require that we obtain the By-laws from the strata manager. Some are happy to send us copies without cost, others are charging. If the Strata changes their By-laws, I can guarantee they will not update us.

Landlords Information Statement

Every landlord will need to sign a statement to say that they understand their obligations as a landlord. The statement verifies that the landlord understands their rental property must be structurally sound, have adequate lighting, ventilation, electricity outlets for every room, not be damp, not have mould and so on.

The idea behind this statement is that it puts the owner firmly in the gun if the property suffers mould or does not quite have the electrical capacity typically needed for many modern-day appliances. (You might be surprised how many units have this issue). With this statement in place the tenant will be able to apply to tribunal to require the owner to meet their obligations. The landlord will have very little defence and they could be looking at reasonable claims for compensation from tenants.  An owner won’t be able to say anymore, ‘but it’s an old house!’.

 

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