Tuesday, 16 May 2017

Negative gearing & surging rents: Is Andrew King disingenuous; delusional; or just plain dumb?

The NZ Herald recently reported on the Labour Party's proposal to eliminate negative gearing tax deductions for property investors. The proposal drew fire from NZ Property Investors Federation executive officer Andrew King, who warned that if the policy was introduced, rents would rise sharply, penalizing renters and particularly those trying to save up a deposit for their first home. It was implied that rents could rise by as much as 65% - the degree to which the after-tax cost of providing rental accommodation would rise for landlords absent present-day tax deductions.

While it is standard fare for those with a vested interest in the property market to - shall we say - 'incline towards an optimistic interpretation' of the facts - this sort of scaremongering about rents is something that has always deeply irked me. This line of reasoning is so cynical, and so shamelessly self-interested and false, that I can't resist writing something about it.

Andrew King is not the first, nor will he likely be the last, to make this argument, I might add, so singling him out is a bit unfair. However, he is perfectly representative of the flawed and self-interested reasoning coming out of the property investors lobby - the 'three Ds' - deceit, delusion, and just being plain dumb.

It is easy to demonstrate why the scaremongering about rents is false. Rents are set by the demand and supply for rental accommodation. Rents will therefore go up if and only if demand rises and/or supply falls (or some combination thereof). This is economics 101. It is true of any market excepting those that feature monopoly power, which the rental market does not.

If negatively geared tax deductions are disallowed, will this suddenly reduce the amount of rental accommodation supply? Will the stock of houses suddenly disappear? No. The houses will still be there. Will landlords suddenly remove supply from the market? Why would they? They would then be shooting themselves in the foot. Already suffering from higher carrying costs as tax deductions are disallowed, they will be all the more in need of rental income to service their mortgages. If anything, in the short term it will increase supply and pressure rents on the downside, as the after-tax cost of landlords keeping rental properties vacant will rise significantly.

What about if landlords were to throw in the towel and sell out of their properties and stop providing rental accommodation? Wouldn't that reduce rental supply? This argument is also an obvious fallacy of composition. If a landlord sells a property to somebody that was previously renting, both demand and supply for rental accommodation simultaneously fall, and market prices for rents will therefore be unaffected. If they sell the property to another investor, it will not impact rental supply at all, and rents will similarly be unaffected.

The only possible way the policy could increase rents over time would be if it discouraged the construction of new properties. However, for that to happen, property prices would need to fall significantly, which would render the policy a success. In addition, Auckland has long suffered from an under-build, and that has a lot more to do with bad government policy & community resistance to intensification ('heritage' is a great excuse for keeping central suburbs low-density, and in the process driving up prices to the benefit of existing residents). Negative gearing is a sideshow to these more fundamental impediments to increased supply, so it is unlikely negative gearing rules would impact rents adversely even in the long run, in my opinion.

Andrew King is right about one thing though - the gross rental yields on properties will likely need to rise if negative gearing tax deductions are phased out. However, the manner by which this would occur would be through lower house prices, not higher rents. Anyone who has any investment experience whatsoever, or who understands simple economics, knows that capital values adjust to the level of income; income levels do not adjust to capital values (regulated monopolies are a modest exception here).

Andrew King is therefore either dumb, in failing to recognize the above, or he does understand it, but he is actively spreading lies and misinformation nonetheless to further his own self interest. It is hard to know which, because King may suffer from an all too common human affliction - a capacity for self-deception, and inability to reason from a dispassionate, non-self-interested perspective.

Most human beings believe what they want to believe; what is comfortable to believe; and/or what is in their best interests to believe. They start with a desired conclusion/belief and work backwards to find arguments to support those beliefs. Religious belief is the worst offender in this regard, but you can see shades of this mental pattern everywhere in the world if you look for it. It is a rare ability indeed - but an absolutely essential one for a successful investor - to be able to put one's self interest aside and analyse facts in a truly rational, open-minded, and dispassionate way.


PS please forgive the long delay since my last blog post. I've realized that I'm not very good at multi-tasking - I tend to immerse myself deeply in something one thing at a time. I overdid the frequency of blogging after I started and found it was adversely impacting my work productivity in terms of generating new investment ideas and finding time to read. I have also been busy working on putting together a fund structure to launch a small fund, which has also been a distraction.

As I noted at the outset of this blog, I did not wish the blog to turn into a chore, and hence I would likely only post when I felt so inclined. In the future I'll probably therefore oscillate in and out of posting with varying degrees of prolificness over time, but I do intend for the blog to continue.