How to fix Australia's affordable housing problem

I'm sure most readers don't want another tedious run-down on the negative gearing debate. I don't want to see another one myself. We've all read the articles declaring that the tax legislation is unethical and must be abolished. And correspondingly, we've all read the dismissive replies of vested interests.

Accordingly, we also already know that abolition is unlikely to happen in one fell swoop since there is a risk of rapidly increasing housing waiting lists and spiralling rents, such as occurred in the areas of low supply and vacancy rates back in the 1980s, especially Sydney and Perth. Proponents must surely know deep down that scrapping the negative gearing in such a manner risks hurting the very sector of the population that they are trying to help: 'Generation Rent'.

Disclosure: I own a few negatively geared properties myself, and clearly when I bought them my motives were not concerned for whether the outcome would be an increased supply of dwellings for first home buyers at the low end of the market. Rather, like most rational investors, I was centred upon optimising returns, and thus in Australia have looked towards Sydney's established stock, in the inner/middle ring suburbs within the $500,000-$800,000 range.

Whilst on the subject, it remains baffling to me how yield-focussed investors continue to suggest that the highest future capital growth will be in the outer or fringe suburbs and regional centres, particularly when study after study (and article after article) have concluded that Australia's capital cities - like so many others in the world - are instead building iniquitous "cones of wealth" in the desirable and centrally-located suburbs. Meanwhile, under-investment in outer suburb infrastructure and dwellings is gradually yet surely wrenching the gap between the haves and have-nots into a a "yawning chasm".

For my money, although the negative gearing legislation likely increases the supply of housing in aggregate, the gnawing issue is that it doesn't necessarily increase supply of affordable housing which is most appropriate for first homebuyers. We'll come back to the solutions shortly.

Perhaps more importantly than even this, the negative gearing legislation is not the reason for Australia's relatively high dwelling prices, although it has surely not helped. The main issue concerns the word highlighted above: supply. Other countries have tax deductions on mortgage interest on the principal place of residence yet relatively lower house prices. In fact, historically, negative gearing has not even represented the most significant section of tax legislation at play in distorting dwelling prices - instead, that has been...

Australia's capital gains tax legislation

By far and away the most significant sections of the tax legislation which have impacted Australian house prices and the trend towards an abnormally high rate of Australian home ownership have been the capital gains tax (CGT) rulings.

It was perhaps possible in days gone by to overcome the ongoing impracticalities of being a long-term renter. But there was little incentive to do so when Mr. and Mrs. Jones next door were continually crowing about the financial benefits enjoyed from being aboard the so-termed "housing escalator" on their suburban quarter acre plot. And how galling must it have been when the Joneses were able to sell their house capital gains tax free and thus trade up to a bigger house in a 'better' neighbourhood? The vision of being a long-term renter must have been pure anathema.

While the 'fairest' way to balance up the tax system might therefore appear to be to assess homeowners for imputed rents reflecting the manner in which landlords are assessed for rental income (perhaps surprisingly, this has been done in Australia before between 1915 and 1923 as noted by Australia's Treasury), I believe that a tax reform of such a nature is unlikely to materialise, and the probable best solution lies in a recurrent property tax as I'll explore below.

Addressing supply issues

So if the negative gearing legislation has done little to increase the supply of housing appropriate for lower income tenants, how is this issue to be addressed? Through subsidies most probably, such as have been employed in the past by German governments by making discounted loans available to commercial housing companies to meet social and lower income housing objectives.

With a colossal $1.5 trillion in Australia's superannuation coffers according to the Treasury - "equivalent to our national GDP" - there are vast reserves of pension fund capital available for this purpose should it be considered a desirable objective.

With self-managed super funds (SMSFs) controversially also now enabled to borrow and invest in residential housing, one wonders whether we are presently missing an opportunity here too? This is particularly so now that SMSFs have some ~$500 billion under management (figure recorded as at 30 June 2013 according to the Australian Taxation Office). Due to the substantial deposits commonly required by lenders, SMSFs are frequently only empowered to invest in residential housing at the lower end of the market in any case.

Funding of subsidies - tax reform

Assuming that Treasury would desire any such reforms to be fiscally neutral, how should any shortfall be funded? Given that homeowners have effectively received a material 'wealth dividend', a substantial element of which has been derived from state investment in infrastructure and urban development, it strikes me that the common sense answer would be through a progressive and recurrent property tax (i.e. one which is charged annually, with owners of the largest dwellings attractive the most tax).

As Australia has an elevated rate of home ownership when compared to many equivalent developed countries, such a tax could be spread widely enough not to be damaging, and if accrued annually the impact could also be spread over time too. It's likely that such a tax would be best introduced with an exemption in the early years of ownership for first time buyers, and perhaps with a lower level of tax to be levied on certain types of required dwellings (i.e. medium/higher density units and apartments).

Why moderation is best

I'm not hugely enamoured with concept of drawing straight-line comparisons between Australia's most expensive cities and America's cheapest large equivalents. I'm referring to humid Houston, of course, the largest city in Texas, famous for its oil, and now being promoted as Australia's model solution for affordable housing.

I've never even visited Texas, although I've gleaned from friends who live there and via the Fifth Estate (the group in modern society promoting weblogs, not the movie) that apparently Americans who relocate to the city are frequently "disgusted" to discover that their expected income tax savings are swiftly clawed back through immoderate property taxes of 2.5% (in some cases even up to 3.5%) of the assessed property value. By contrast, in Australia, material stamp duties are currently levied upon property acquisition.

Easier zoning restrictions must surely play a role in Houston, yet if housing is so affordable, then why are home ownership rates in Houston so low? Presumably because the incentive to buy a home is also diminished by a high annual property tax levy. Assuming that Houston is held up as a model housing system in order that more Australians can achieve home ownership...well, that doesn't work, because we have far higher home ownership rates in Australia already then Houston, or, for that matter, Germany (in fairness, this could be something of a circular argument - do higher home ownership rates cause higher prices?).

If three of the principal financial reasons for Australians wanting to own a home are (1) to participate in future capital gains (2) benefiting from a capital gains tax exemption allowing them to trade up the housing ladder, and (3) owning an unencumbered home in retirement, then elevated or excessive property taxes instantly remove the very financial reasons for home ownership.

Strong capital growth will not be experienced, and even where growth is attained the unfortunate owner will continue to be zinged by escalating taxes until the day they drop off. If you do aspire to paying off your (albeit 'cheaper') mortgage debt by the age of, say, 50, you still could face another half a century of paying a high ongoing cost for your right to home ownership.

It's see easily possible to see some real-life examples of what high recurrent ownership costs can do to housing developments in certain parts of, say, Sydney. There are a number of warehouse-style buildings and older apartments blocks with incredible harbourside locations or water views where the potential entry costs appear too good to be true. And indeed, they are. Where strata schemes have fallen into disarray and quarterly maintenance costs spiral, defaults and elopements inevitable follow, owners look to sell at almost any price, and buildings decay into tomorrow's slums.

The very reasons for home ownership can be quickly stripped away by excessive property taxes, and thus tax reform should be appropriately considered and any proposed property taxes levied reasonably moderate.

His new book 'Four Green Houses and a Red Hotel' is out now.