Opinion

Felix Salmon

I want to rent in Australia

By Felix Salmon
August 17, 2010

Over recent decades, public companies have steadily paid out fewer and fewer dividends, with little if any complaining from shareholders. They often prefer it when the money is retained in the company or used for share buybacks, because that way they don’t need to pay taxes on their dividend income.

Someone should remind Australians that houses are not, in this respect, like stocks. It would be wonderful for landlords if they could simply capitalize their rental income, seeing it reflected in a higher value for their property rather than having to be paid out in taxable income. But of course that can’t happen: whether or not a house increases in value is entirely unrelated to the amount of rental income that a landlord manages to extract from it.

Even so, reports Clancy Yates,

According to Tax Office figures, the proportion of taxpayers who own rental property has swelled from 6.5 per cent in 1989 to 13.5 per cent in 2009, two thirds of whom claim a loss on their investments.

Why this doubling in the number of Australian landlords, if they’re not making any money renting out these houses? The psychology is obvious: it doesn’t matter if I lose money on a cashflow basis, so long as I’m making money in terms of rising home equity. Of course, this is a classic bubble mentality, and is fundamentally unsustainable. I just hope that the banks have done a very solid job underwriting the mortgages on these rental properties.

(Via Kedrosky)

Comments
8 comments so far | RSS Comments RSS

Sigh… Close, but no cigar. Start by reading this.
Oz residential real estate has bubble-ish qualities, but the fundamentals are supported by the tax system and so it is not a classic bubble, ie not inflated just by extraordinary popular delusions or the madness of crowds.
Oz landlords are making money from capital gains *and* from the tax system. In theory, yes, renters should be getting cheap rent. And, compared to the rents that would be required by the cost of the properties, they are.
The joker in the pack is that the Oz population is growing very rapidly and most people want to live near the centre of the 5 main capitals, so there is a Krugman-esque “zoned zone” in Oz that also supports higher rents and higher house prices in the main capitals.

Posted by Zardoz | Report as abusive
 

Felix, am I wrong in assuming that Australian landlords can deduct both mortgage interest and depreciation from rental income? It wouldn’t surprise me if many of these properties showed net losses but were cash flow positive by dint of not spending their depreciation allowances, especially soon after they were purchased (i.e. while interest is a high percentage of total P&I payments).

Posted by kyle_s | Report as abusive
 

kyle_s… they definitely cannot deduct mortgage interest, but there is a tax deduction landlords earn if they make a loss on the renting – and as you can see above, 2/3rds of them do. This is negative gearing.

This deduction is somewhat ridiculous and helps inflate the bubble, but the politics behind removing it are delicate, because Australians are culturally obsessed with housing.

Landlords get a tax deduction in essence for overpaying for buying property. Common sense would say this could be a problem. Capital gains is what they’re really relying on though of course.

“I just hope that the banks have done a very solid job underwriting the mortgages on these rental properties.”

It’s not at subprime levels, but the fact is house prices have so far to fall (40% by some estimates) and the banks are so exposed to mortgage debt (triple as much as bubble-era US banks), that there will be problems regardless of the underwriting. (Until recently though, no deposit loans were around.)

Posted by SBa | Report as abusive
 

Felix,

While I can’t speak authoratatively on the residential rental market in Australia I can tell you it’s probably not wholly dissimilar to the US.

Here most small operators, people who own just one or two rental properties show negitive income and positive cash flow exactly as kyle_s suggested above. If they have enough income the Alt-Min tax will hammer them but if they stay under those limits and file under the regular tax rates it’s a super sweet deal from a tax stand point. Claim a deduction against your W-2 wage income while receiving positive cash flow on an investment.

It’s not much different with residential REIT’s… yahoo finance lists 13 with market cap above 1 billion. The average P/E is around 50 implying an earnings yeild of 2%. They pay dividends averaging 4%.

The amazing thing is that in a market like this one they are trading at about 3 times book value. That is unexplainable to me… the sector is pretty small only about 50billion market cap… the value of privatly held residential rental property would be at least 10x that number… which begs the question if REITS are trading at an average of 3 times book and there is huge supply of rental properties avalible on the market why aren’t we seeing new REIT IPO’s left and right?

Posted by y2kurtus | Report as abusive
 

I’d be amazed if *landlords* were not able to deduct all expenses (including mortgage interest) from their rental income. In fact if they couldn’t deduct mortgage interest, it would be almost impossible for anybody to run a loss — mortgage interest is roughly half the cost of ownership given the usual financing structure.

And y2kurtus got it correct. In most markets, at most times, a landlord can structure the investment to return an initial cash flow of 1% to 3% of the property value which gets wholly wiped out by depreciation. Everybody wins, except for the government which doesn’t recoup that tax revenue until the property is sold.

Posted by TFF | Report as abusive
 

and if you are a small operator who is making a small profit .. who is going to know if you don’t declare it? Thus further skewing the statistics.

Posted by bruce1963 | Report as abusive
 

Bear in mind that the mortgage is secured on the person, not just the property. So when the bubble bursts, or more likely deflates, the investors will end up with a debt and no asset if they “walk away” American style. This is the main reason that deflation is more likely than a bursting of the bubble, as house owners who can’t pay their mortgages (remember, most are variable rate, and Aussie interest keeps rising) can’t just post the keys back. So they’ll probably also delay putting the house on the market hence slowing the decline (but exacerbating their problems).

Posted by nicfulton | Report as abusive
 

The losses are paper losses, due to depreciation deductions that are not available on non-rental property.

Posted by TaxLawyer | Report as abusive
 

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