Tax, regulations should avoid encouraging over-leveraging into property: RBA
Policy should not advantage property investors at the expense of prospective owner-occupier home buyers, according to the Reserve Bank of Australia.
In the submission to the inquiry into Home Ownership, the Reserve bank stated that financial stability considerations would suggest that tax and regulatory frameworks should avoid encouraging over-leveraging into property, whether by owner-occupiers or investors.
"In considering opportunities for reform, the Bank believes that it is worth bearing in mind that there are both benefits and costs of owner-occupation.
"The broad policy objective of ensuring that all Australians can access suitable housing at reasonable cost need not translate into an objective that all households should purchase their home early in life, let alone that they should all be able to purchase their first home in their ideal location.
Home ownership in Australia increased considerably over the past century, but has been stable at around 70 per cent since the 1960s.
"The increases were concentrated in the periods immediately after the two world wars, particularly World War II (WWII), as a result of significant government assistance including War Service Homes programs."
According to the latest Census, around 68% of Australian households owned their own home in 2011.
"The general stability in home ownership in Australia over recent decades has masked some marked changes in home ownership among different age groups.
"In particular, there has been a pronounced decline in home ownership among younger households, particularly in the 25–34 and 35–44 age groups. Home ownership rates have generally been more stable among older households.
Factors contributing to lower home ownership rates among younger households include the following.
"An increase in income inequality over recent decades, in part reflecting the simultaneous rise of two-income households with increasing workforce participation by women as well as the rise of single adult households (with or without dependents).
"This led to increased borrowing capacities for households with high home ownership propensities, which will tend to have advantaged older households over younger ones. Accordingly, the decline in home ownership rates over the past decade or so has been concentrated in the third and fourth income quintiles, while that of the top income quintile has been little changed.
"Financial innovation in the 1990s and the 2000s arguably led to greater relaxation of restrictions on borrowing for higher-income households than for lower-income households.
"Increased labour market flexibility, accelerated technological change and other factors may have increased employment and income insecurity and so reduced the willingness of some households to take on the long-term financial commitment of owning a home (or the ability to service a loan) and the capability of some to remain in home ownership."
The home ownership rate in most states remains above levels. While all states had home ownership rates between 65 and 75 per cent as at the latest Census, there is still considerable variation across states, with home ownership ranging from a low of around 65 per cent in Queensland to a high of almost 72 per cent in Tasmania and Victoria.
"The transition to a low-inflation regime, implying lower nominal interest rates, has significantly increased households’ borrowing capacities relative to their current incomes, and therefore their capacity to service debt on owner- occupied housing.
"Survey evidence suggests that total housing costs of owner-occupiers have not moved much relative to incomes over the past couple of decades.
"Alongside the other demand drivers, one fundamental determinant of housing demand will be the rate of new household formation, which is in turn dependent on the interaction between population growth and developments in average household size.
"After relatively stable growth from the early 1990s through to the mid 2000s, Australia’s population growth stepped up significantly owing to higher net immigration and, to a lesser extent, a slightly higher rate of natural increase.
"The composition of population growth can also influence housing demand. Much of the fluctuation in population growth rates over the past decade has been driven by fluctuations in net arrivals of people on student visas."
Recent rule changes have made it easier for students to remain in Australia after graduation, including by becoming permanent residents.
"Over the shorter term, fluctuations in interest rates can be expected to affect the demand for housing. By reducing the burden of debt repayments relative to income, lower interest rates may ease cash-flow constraints and increase borrowing capacity at the margin. This effect applies both to owner-occupiers and investors.
"Lower interest rates also encourage households to save less and borrow more in the present, thereby shifting consumption from the future.
"However, prudent buffers on the minimum interest rates that lending institutions use to calculate allowable mortgage loan sizes imply that this effect might be smaller when interest rates are already low.
"The Australian Prudential Regulation Authority (APRA) has recently provided guidance to lenders that the interest rate used in these serviceability tests should be at least 7% (APRA 2014). The Bank estimates that the lower limits on interest rates used in these calculations are probably binding at present, or close to binding.
"Thus, households that already planned to borrow as much as lenders would permit would not see an increase in borrowing capacity from a decline in interest rates at present.
The proportion of the housing stock owned by investors looks to have risen over recent decades, offsetting the decline in the prevalence of public housing.
The investor share is also likely to have risen a little further over the past few years, as investors have accounted for an increasing share of property purchases since 2012.
"While the incidence of property investment increases with the level of income, the Household, Income and Labour Dynamics in Australia (HILDA) Survey also suggests that most investor households are in the top two income quintiles.
"These households hold nearly 80 per cent of all investor housing debt, and appear well placed to service their debt: they typically use less than 25 per cent of their income to service their total property debt, and around half are ahead of schedule on all their mortgage repayments.
It would be counterproductive to try to encourage more home ownership by making it easier for marginal buyers to borrow more. Both for this reason and in the interests of financial system stability, the Bank would not support measures that expanded credit supply to households at the expense of prudent mortgage lending standards.
The Bank believes that there is a case for reviewing negative gearing, but not in isolation. Its interaction with other aspects of the tax system should be taken into account.
"The ability to deduct legitimate expenses incurred in the course of earning income is an important principle in Australia’s taxation system, and interest payments are no exception to this. To the extent that negative gearing induces landlords to accept a lower rental yield than otherwise (at least while continued capital gains are expected), it may be helpful for housing affordability for tenants.
"It is worth noting, however, that the interaction of negative gearing with other parts of the taxation system may have the effect of encouraging leveraged investment in property.
"In particular, the switch in 1999 from calculating CGT at the full marginal rate on the real gain to calculating it as half the taxpayer’s marginal rate on the nominal gain resulted in capital gain-producing assets being more attractive than income-producing assets for some combinations of tax rates, gross returns and inflation.
"This effect is amplified if the asset can be purchased with leverage, because the interest deductions are calculated at the full marginal rate while the subsequent capital gains are taxed at half the marginal rate.
"Since property can usually be purchased using higher leverage than other assets that produce capital gains, property is especially affected by this feature of the tax system.
"Another change in the landscape since 2003 is that superannuation funds are now able to borrow. Some self-managed superannuation funds have taken advantage of this by adding geared property into the fund portfolio, both residential and, in particular, commercial property.
"The Bank has previously observed that leverage in superannuation funds may increase vulnerabilities in the financial system and therefore supports limiting the scope for leverage in these funds.
"Additional housing supply ought to dampen housing prices, and more probably will reduce the growth rate of housing prices that occurs in response to increases in demand for housing.
"There is no example in Australia or internationally where supply expansion on its own generated housing price declines of a similar order of magnitude to the increases in prices seen in some Australian cities in recent years; some academic work on this issue suggests that removing supply constraints in a single population centre might not reduce prices significantly (Aura and Davidoff 2008)."
Housing Debt Serviceability
