## Rental crisis or distorted market? Russell Degnan

After the better part of half a decade of laments over the price of houses and the problem for first home buyers, the last year has seen a shift into concern over declining rental vacancy rates and a different kind of housing affordability. As a problem though, it is both better and worse then we think. Worse because the problem of insufficient housing stock and rising rentals - particularly where people are really concerned, in gentrified inner cities - is not going to go away quickly, and better because market distortions have meant there are substantially more people renting than perhaps there normally would.

To understand why we need to go back to the late 1990s. Back then, a decline in interest rates, and a surge in investment actually brought vacancy rates up to around 4-5%. Obscenely high, and investors - particularly apartment investors - got burned. From that point onwards, we've seen declining vacancy rates, dropping slowly down to the 1% level being reported in the past few months. House prices also levelled off during this period, before surging again - for no reason I can discern - after 2004.

But rents didn't increase with them. In fact, rents haven't even been increasing with wages, despite an apparent increase in the number of potential first home buyers (and therefore, reasonably well-off) people renting. Once again, negative gearing is partly to blame.

The argument put in favour of negative gearing is that it increases rental affordability and rental investment. This is undoubtedly true, as is the claim that it encourages speculation and increases house prices in a rising market. Up until very recently, when interest rates began to increase and prices seem to have stalled, buyers could be sure of receiving capital gains on their property, and weren't much bothered with rents. The RPA summarises the last few years quite well:

"[...] we need to look back to the start of the housing boom in the mid 1990s. At that point, commonly used measures of gross yields on rental properties were in the order of 5-6 per cent. Over the subsequent decade, rents rose much less than dwelling prices, so that rental yields fell to relatively low levels – about 3 to 4 per cent (Chart 14). During this period, investment continued to flow into rental properties, as investors anticipated that capital gains would more than compensate for the low yield.

"However, once it became clear that dwelling prices may no longer keep rising, the rental yield by itself was not sufficiently attractive to sustain the rate of investment, and the vacancy rate started to fall."

How big a subsidy for renters? Well, if the reports of $2.4 billion in tax losses because of negative gearing are accurate then (at a tax rate of 40%) that translates into$3.6 billion in rental subsidies bfrom investors to lucky tenants. More, probably, but across the 3 million or so rental households that translates to an average of $1200 year, or$100 a month in rent.

Which brings us to the two key problems we are now faced with. Firstly, as David Tiley's post on the topic points out, investors (90% of whom are mom and pop investors with only one property) can't afford these levels of subsidies under rising interest rates and rising inflation. Their hand is being forced, to either raise the rent, or sell up, and there is no incentive for new investment in the market. At the moment, we are seeing rapid rent rises in a tight market - a market that, after several years of stagnant prices and increased incomes, has a reasonable level of flexibility to do so. But it can't continue forever, and eventually, either rents will stop rising as the market opens up, or the owners will need to sell, with current renters making the switch to homebuyers (though what that might mean for prices is anyone's guess).

The second problem is more troublesome while the market shakes itself out. At the bottom end of the market, where a thousand a year in rental subsidies makes a big difference, the rental market consists of poor families and young households (mostly students). The latter are a fluid group, preferring to rent, but often able to share houses, bedrooms or live wih their parents, when money is tight. The fact that the rental market has gone from flooded to dry in such a short period is not just to do with increased population in Melbourne. It has to do with the subsidies investors have happily worn in exchange for capital gains, and the concomitant increase in the number of rental households.

As of the 2006 census, there were some 20,000 spare bedrooms sprinkled through Melbourne's group households, most of whom rent. There are as many as that again in lone person households, but it is hard to distinguish those between renters and the elderly. You don't hear about boarders as much anymore, it seemingly being something people did in the 1960s. With an ever ageing population, no shortage of needy renters, it might be time that idea was revived.

Sterner Matters 17th May, 2008 18:27:33   [#]