Secondary markets

Saul Eslake is reported in The Age as saying

Mr Eslake said 92 per cent of investors in rental property purchased established properties so it did nothing to increase the supply of housing or keep rents down.

To be fair, I don’t what else he might have said on that issue, but that statement by itself is probably wrong.

The purchase of established properties occurs in the secondary market. The argument that secondary markets have no economic value is a common fallacy. Secondary markets provide liquidity to primary markets by allowing primary investors to cash in their investments. This establishes a market that generate price signals to guide investment in the primary market. While I’m happy to believe that property markets are likely to be less efficient than, say, stock markets, I’m not convinced that the secondary property market would have no effect on the primary market.

The comments were made in the context of negative gearing. This is a topic that seems to generate extraordinary amounts of commentary. Yet the principle itself is uncontroversial; expenditure incurred in the production of a taxable asset is itself deductible.

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51 Responses to Secondary markets

  1. Davo of Thorneside

    The current mob in power will see to this Negative Gearing I feel sure!

  2. sdfc

    A quick look at the housing finance figures suggests Eslake’s figure probably isn’t too far wide of the mark.

    However if they can negative gearing are they also going to exempt the rental income or capital gains from tax while they’re at it?

  3. JamesK

    #

    A quick look at the housing finance figures suggests Eslake’s figure probably isn’t too far wide of the mark.

    I don’ think Sinc was disputing the figure it was the second part of the statement that he quite rightly disagreed with.

  4. sdfc

    Saying investors do nothing to increase supply is a big call but I’m fairly sure they do next to nothing to lower rents given they mainly play pass the parcel with the existing housing stock.

  5. Sinclair Davidson

    How much lower should rents be? My understanding is that rental yields are usually below mortgage rates. (Open to correction on that point).

  6. Infidel Tiger

    How much lower should rents be? My understanding is that rental yields are usually below mortgage rates.

    Outside of a few regional areas they would be.

  7. sdfc

    Rental yields are in comparison with the value of the house aren’t they?

  8. Sinclair Davidson

    Like an earnings yield.

  9. sdfc

    But that’s just the running yield. Investors are also after capital appreciation. When there is increased demand and supply does not respond fully prices rise, rents go up. This is especially a problem when a speculative element creeps into the market.

  10. JamesK

    How much lower should rents be? My understanding is that rental yields are usually below mortgage rates. (Open to correction on that point).

    My inexpert understanding is that landlords are doing well with rents in the city with the first 3 figures of the value of the property per week in rent.

    So $600,000 – equates roughly to $600/week rental income = roughly $30,000 per annum = 5% return.

  11. Jeremiah

    I thought foreign investors into Australia’s property market had to purchase newly built properties because there are rules stopping them from investing in established properties?

    Does the figure above take this into account?

    Depending on where the newly built properties are I’d say its probably not too wise buying off the plan in an outer suburban area right now. A wise investor would probably be going for established properties in inner suburban areas. If those stats only capture recent trends then thats just the equivalent of property investors taking a “flight to safety” in tough times same as in capital markets.

  12. Capn Jack Walker

    [Comment deleted. Sinc]

  13. wreckage

    [Comment deleted. Sinc]

    Please ban this idiot.

    [Done. Sinc]

  14. Sinclair Davidson

    Can’t do it on the tab – but as soon as I get to a laptop …

  15. sdfc

    Jeremiah

    Calculating the value of investor constructcion loans to total investor loans gives us a monthly average of 7% over the past year and 10% since 1991. Not a perfect measure of what Eslake was saying but a pretty good proxy.

    Yes the share has gone down but it has been relatively low for most of the period since the turn of the century.

  16. ar

    If there is no ability to negative gear, then rents will need to rise so the property is positively geared. If there is something this government can fuck up, they’ll do it.

  17. sdfc

    ar

    It’s difficult to say what it would do to aggregate rents. It’s a segmented market, some investors might be able to charge higher rents others may find it is no longer rational to keep the investment, putting downward pressure on prices in some segments of the market and assuming no change in rents upward pressure on rental yields. Those who cash out may well seek investments with a greater tax shield.

    This isn’t an argument in favour of ending negative gearing. I don’t think housing investors should be taxed any differently to other investors.

  18. wreckage

    I have amazing internet powers. I better only use them for good. Please keep chatting away about negative gearing, I never did figure out why it existed.

  19. sdfc

    It’s an investment wreckage earning taxable income.

    Judith Sloan’s on the tellie. Now she’s got a face.

  20. Mark P

    Negative gearing artificially raises the value of real estate by allowing a deduction (benefit) against income that is unrelated to the asset.
    The interest deduction should be limited to the productive capacity of the specific asset to avoid real estate price distortions.

  21. .

    Negative gearing artificially raises the value of real estate by allowing a deduction (benefit) against income that is unrelated to the asset.

    No it doesn’t.

    There is a good reason why Keating and Hawke back pedalled on the issue – because without it investment dropped and the stock declined relative to population and rents jumped up.

    At the tax summit it was revealed that a 640k house and land package in NW Sydney was 46% tax. Clearly reducing taxes would increase supply, investment and affordability.

    Remember out of that $640k that gets a mortgage paid on it after income and payroll tax is paid out, $294.4k of that mortgage capital base is tax.

    What a cruel and prosperity destroying system we have.

  22. Jim Rose

    rents would be much higher if there was no secondary markets for durable goods ssuch as housing.

  23. No Worries

    Isn’t housing a consumption item ? ABS seems to think so. The price of building a house is in the CPI. Land on the other hand seemingly can’t be consumed, (excluded from the CPI) even though there is an opportunity cost in occupying land.

  24. Mark P

    No it doesn’t.

    There is a good reason why Keating and Hawke back pedalled on the issue – because without it investment dropped and the stock declined relative to population and rents jumped up.

    Thankyou for confirming you know nothing about economics. If you don’t understand how economically distorting ‘negative gearing’ is to investment allocation, then I will feel extremely comfortable ignoring any future comment you have.

    Same goes for Sinclair too. I must say this post was a surprise.

  25. Elizabeth (Lizzie) B.

    Housing is a tangible and emotional purchase, even for investors and it’s hard to get a grip on its variable types and markets. It seems to me that’s why so many otherwise sensible people get upset about negative gearing and think it is somehow ‘unethical’. I have some friends like this, generally clear-headed home owners, but who think the yearly short trip ‘inspecting’ a geared property and allowably and reasonably tax-deducting that, plus other fun things like fixing it up a bit or choosing the furniture for it are somehow added personal benefits that shouldn’t offer a tax break. Like two bites (or more, depending on your evil proclivities) of the housing fun cherry? They see it as a sort of zero sum game: not a market, but a means of grabbing too much and keeping it away from others while making whoopee with the Rachmanesque rental income. Risk taking and opportunity cost and often low levels of real return do not come into this emotionally-driven debate. For the negative gearing naysayers, housing capital gains are seen as merely sinful, worth taxing till the pips squeak. All of this from people who may own large share portfolios and play those markets for all they are worth, heavily gearing their choices with margin loans. Yes Mark P, I agree that more investment would go elsewhere (thus less ‘distorting’? less ‘pure’?) if we had a completely different system of allocating housing, but we don’t. We have housing markets and a building industry and a flight of capital from these is what happens when negative gearing is removed.

    As an innocent economic bystander, I’m genuinely interested to hear other viewpoints – economic ones though, not emotional upsets. Back in the morning.
    Jetlagged Lizzie, back from chasing gnomes in Zurich.

  26. wreckage

    At the tax summit it was revealed that a 640k house and land package in NW Sydney was 46% tax. Clearly reducing taxes would increase supply, investment and affordability.

    Remember out of that $640k that gets a mortgage paid on it after income and payroll tax is paid out, $294.4k of that mortgage capital base is tax.

    In other words, even with negative gearing, real estate gets the hell taxed out of it? How does that stack up to other ways of generating income?

  27. wreckage

    If you don’t understand how economically distorting ‘negative gearing’ is to investment allocation, then I will feel extremely comfortable ignoring any future comment you have.

    Oh no. MarkP is going to flounce off with stampy-feet and a big pout. How uncharacteristic.

  28. Mark P

    @ wreckage
    I keep mistaking this for a serious economic blog. One minute there’s chanting for laissez faire, the next there’s apparantly no problem with the distorting impacts of using the tax system to favor one form of investment over another. Please make up your mind.

  29. Mark P

    @ wreckage
    I keep mistaking this for a serious economic blog. One minute there’s chanting for laissez faire, the next there’s apparantly no problem with the distorting impacts of using the tax system to favor one form of investment over another. Please make up your mind.

  30. Sinclair Davidson

    In what way is negative gearing a violation of laissez faire? Deducting expenditure incurred in the production of taxable income or a taxable asset is a standard feature of the tax system. If anything you’re arguing that real estate should be the exception to this general principle. The fact that it can be deducted against other income is sensible too in that this recognises that capital is fungible. Do you have any evidence to support the claim that the Australian property market is (a) distorted relative to other asset classes and (b) this is due to negative gearing. As I indicated in the post this is a common argument, but its very hard to find argument and evidence beyond that.

  31. Mark P

    I have no objection to any cost deductions against an income producing asset, including interest.

    Laissez-faire would say investments should stand on their own merits and not be cross-subsidized by a government tax policy. The 08/09 ATO figures are clear evidence – property investors making losses amounted to over $11 billion, deductible against other income. Well outstripping those making profits for a net loss of $6 billion. (This is available through the ATO web site.) Assuming a 40c tax rate this gives property investors a $4.4 billion advantage over other investment classes, each year.

    By providing a benefit to property investors, it simply bids up the value of real estate since it allows people to borrow more with the same monthly payment.

    You can go back years in the ATO statistics to see that property investors really aren’t interested in making profits on the productive use of the asset. The tax policy simply encourages real estate speculation to the point where we now have a property price bubble funded, partially, by taxpayers. I don’t think that’s a particularly good use of tax dollars, nor is it encouraging good investment choices.

  32. Colin Suttie

    “Deducting expenditure incurred in the production of taxable income or a taxable asset is a standard feature of the tax system”

    Fair enough if negative gearing is subsidising production of new houses, but if it’s just allowing investors speculators to bid up the price of existing stock beyond what an owner-occupier can sensibly pay without the tax break, what’s the point?

  33. .

    Thankyou for confirming you know nothing about economics. If you don’t understand how economically distorting ‘negative gearing’ is to investment allocation, then I will feel extremely comfortable ignoring any future comment you have.

    Shut up, look at the results {edited}.

    [Mark – that is unnecessary. Sinc]

  34. .

    Fair enough if negative gearing is subsidising production of new houses, but if it’s just allowing investors speculators to bid up the price of existing stock beyond what an owner-occupier can sensibly pay without the tax break, what’s the point?

    That is NOT what is happening. The IRRs are so low due largely to taxation that investment has shit itself and we have a supply crisis.

    Believe the tape, stop juking the stats.

  35. Mark P

    Sinclair, is this sort of disgusting language and bullying acceptable on this blog? It must be, since you clearly have no intention of doing anything to the serial offenders.
    Let’s be clear – these people are not interested in robust debate, it’s just out and out bullying and profanity.

  36. .

    You are full of shit and wade into a debate with that old “you know nothing about economics” after repeating numerous logical and factual errors.

    {Edited}

    [Mark – unnecessary. Sinc]

  37. Mark P

    … and I will continue to call out anyone who bullys, uses physical threats or profane language.
    Perhaps the blog should just ban me for attempting to call it out. That would be quite a statement.

  38. .

    I will continue to call out your uneducated tripe and unwarranted smears, deal.

  39. Colin Suttie

    “That is NOT what is happening. The IRRs are so low due largely to taxation that investment has shit itself and we have a supply crisis.”

    Or the IRR is so low because speculators have bid the price of the asset way beyond what is supported by the asset’s income, in part due to the tax system favouring capital gains?

    “Believe the tape, stop juking the stats”

    In English?

  40. .

    Or the IRR is so low because speculators have bid the price of the asset way beyond what is supported by the asset’s income, in part due to the tax system favouring capital gains?

    There is no effective supply response. Favouring capital gains would see a strong supply response wouldn’t it?

  41. Colin Suttie

    “There is no effective supply response. Favouring capital gains would see a strong supply response wouldn’t it?”

    Perhaps this would be true if negative gearing were limited to new houses only, but why would it be so if we’re all encouraged to flip houses to each other?

    Leith van Onselen has done some good work on the supply response at macrobusiness.com.au. According to him, if we’d had less red tape there would likely have been a supply response that would have averted the house price bubble we’re in the middle of.

  42. .

    When are you guys going to accept that taxes are wealth destroying as is reducing liquidity?

    Let’s get rid of capital gains then. From now on, all short terms trading of financial instruments is banned, as is flipping houses and if shares and IPOs are traded rather than held for dividend, and any resulting capital gain arising from the sale of an asset, gets taxed by another 46% on top of the normal taxes paid.

    I bet this will not be as popular as beating up SMSF retirees. Yet it is what we do or you guys expect for housing.

    Alternatively, you could make IPOs subject to a 78.6% entrance VAT to make the transaction equivalent to housing investment.

  43. .

    Perhaps this would be true if negative gearing were limited to new houses only, but why would it be so if we’re all encouraged to flip houses to each other?

    1. Liquidity.

    2. A&A

    3. Changing preferences.

    4. Successful use of leverage.

    This is not easy given the transactional taxes.

  44. jtfsoon

    I agree we should just get rid of capital gains tax by moving completely from an income base of taxation to a consumption base, and leave the States to tack on their own income tax. But then Jim Rose would chime in with the silly idea that this ideal efficient taxation base might lead to big government.

  45. .

    So be it, net GDP would be higher than the spending to GDP ratio would be lower for various reasons.

  46. Sinclair Davidson

    . – stop. You’ve gotten out of the wrong side of bed this morning.

  47. .

    Leith van Onselen has done some good work on the supply response at macrobusiness.com.au. According to him, if we’d had less red tape there would likely have been a supply response that would have averted the house price bubble we’re in the middle of.

    He is absolutely right. But why quarantine taxation from red tape and other imposts?

  48. Colin Suttie

    It’s difficult to have a sensible debate when the other party replies in something that only superficially resembles English.

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