Housing Mythbusters – Putting 7 Housing Myths To Bed

Few topics are as inclined to lead to arguments as housing. It seems that not a week goes by without yet another report predicting the next housing-related disaster. One week we’re reading reports on a housing affordability crisis; the next we’re seeing commentary on a housing bubble that is about to pop.

Unfortunately, all of this sheds more heat than light. In fact, reading many of the commentators, one is reminded of another topic on which we frequently write – cognitive biases. The “availability heuristic” is a mental shortcut that relies on immediate examples that come to mind when evaluating a specific topic. We are just 10 years on from the US subprime crisis, which led to the global financial crisis (GFC).

We have seen and read numerous memorable articles and movies about the shortcomings of the US housing and lending industries. Is it any wonder that we view the Australian industry through the same lens? But what if the Australian experience is different?

We consider seven of the most enduring myths about housing in Australia.

Myth #1 – Housing is an unproductive investment

The first myth that we should put away is the absurd notion that housing is unproductive. It is intellectually unsustainable, academically unsupported and contrary to basic common sense. Nevertheless, it continues to be rolled out periodically by sloppy thinkers; even those who should know better.

To see why it is a myth, we need only return to first principles. The most basic economic problem – the reason we have an economy at all – is to deploy scarce resources to meet our unlimited needs and wants. Foremost among these needs and wants are the basic material items that we all need to survive. These include food and water, clothing and shelter.

For much of human history, and for a substantial part of the world’s population even today, it has been a struggle to meet these most basic of needs. It is a major triumph of the modern economy that it managed to furnish most citizens with these needs to at least a reasonable standard. From this perspective, the provision of shelter, or housing, is a fundamental function of a productive economy.

In addition, housing provides the base from which a society can be built. When you think of the shops, offices, transport, hospitals, schools etc. that cluster around housing, you get a sense of the centrality of housing to a productive economy.

What’s more, as pointed out by a 2007 study from the Federal Reserve Bank of Chicago, household capital directly affects labour productivity. Improvement in the quality of housing has a significantly positive impact on labour productivity.

Most acutely, the national economy also benefits from what is known as the ‘multiplier effect’. For every dollar spent on construction, there is an increase in broader economic output of $2.87 (on ABS estimates). That is a genuine and tangible contribution to the Australian economy that results in increased spending, wealth and jobs.

Finally, one still reads some pundits claiming that investment in existing residential property simply drives up asset prices with no benefit to society. Interestingly, they never apply the same logic to the stock market. The reason, of course, is obvious.

A vibrant and effective secondary market is a critical function of an effective capital allocation system. Who would invest in residential construction if they could not rely on an effective secondary market to sell at a later date? That is what is known in financial circles as a ‘stranded asset’.

Myth #2 – Our policy settings encourage the use of leverage for the purchase of and investment in housing

The second myth is equally straightforward to debunk. Leverage, or borrowing, can be utilized in relation to any asset or investment. It is conceded that – for individuals – leverage is most commonly used for the purchase of a house.

But that is not because of any policy settings (we’ll come to taxation policy in a moment). It is simply because the providers of leverage, also known as lenders, generally prefer to take security over property, rather than other types of assets. The excellent performance and low volatility of residential property prices makes housing ideal collateral to support a loan. Over time, this analysis has embedded itself into the culture of credit providers and regulators.

Options to use leverage to buy other assets abound. Margin loans are a perennial feature of the Australian financial market. What’s more, it is common for investors to draw on the equity of their residential property to leverage up a share investment program. So whilst leverage is most common in relation to housing, it is a myth that this is because the asset class is somehow the beneficiary of favourable policy settings.

Myth #3 – Our taxation system unfairly favours housing at the expense of other investable assets, such as shares

Now we concede at the outset that our taxation policy settings are absurdly complex. Unpicking the tax consequences of investment decisions involves myriad complexities, carve outs and special cases. That is an issue for another time and another Investment Enews! But it is simply incorrect to state that housing benefits from favourable tax treatment.

To understand how this is the case, one can consider a few high-level issues, such as income tax (specifically, the deductibility of interest), capital gains tax (CGT), land tax and stamp duty. For completeness, one could also consider pension impacts. It should also be remembered that, in the eyes of policy makers, the purchase of a house differs to the purchase of shares in critical ways. As we have already discussed, a house can be a home, or an item of consumption, as well as an investment.

For this reason, it has long been the policies of governments across the world to treat at least owner-occupied house purchases as different to pure investment decisions, like buying shares. That has consequences in tax, both positive and negative. The table below summarizes the treatment of the purchase of a home, an investment property and a shares portfolio from a range of perspectives.

As can be seen, the sale of a home does not attract CGT. On the other hand, a homeowner does not get the benefit of a deduction for the interest that they pay. Further, unlike shares, a residential property attracts both stamp duty and – in the case of an investment property – land tax. Assessing the net result of this treatment is complex and very much dependent on the circumstances of the individual investor. But some light can be shed by considering a typical example of the tax effects:

Jill is 40 years old, lives in Melbourne, earns a salary of $120,000 and has savings of $150,000, partly earned through the sale of her previous home. She intends to use these funds and an interest only loan of $600,000 at 5% as the deposit for the purchase of an asset worth $750,000 (LVR: 80%), which she will hold for five years before selling.

She is considering the purchase of a residence, a residential investment property (legal fees: $2,000) or a portfolio of shares (brokerage: $200). Based on an 8% p.a. return, at the end of five (5) years she will sell the asset for $1,101,996.06.

The taxation implications of each are summarized in the following table:

Even this high-level analysis requires many assumptions and simplifications. We have, for example, assumed that Jill can obtain an 80% LVR loan at 5% to purchase shares, that she does not qualify for special carve-outs, such as first home buyers’ concessions and that the pre-tax returns for each of the investments is the same.

We have assumed that rent nets off against dividends and have excluded both from calculations. We have ignored the maintenance, rates and other expenses like depreciation inherent in property ownership and their deductibility (more about that below!). A longer holding period would increase the value of the CGT exemption and, assuming that principal was gradually being reduced, would reduce the value of the deductibility of interest.

On the other hand, we have not factored in the greater net present value of the interest deductibility on an annual basis, as opposed to a back-ended CGT benefit. We also have not taken into account the fact that a 5% interest rate is much lower than the historical average and that an increase in interest would increase the relative value of the deductibility benefit (as would a reduction in the relatively strong 8% p.a. capital value increase).

In any case, the table makes it absolutely clear that the notion that property is favoured under tax law is a myth. In fact, it shows that there is a case that share investing receives far more favourable treatment even than home ownership, with investment properties receiving the least favourable treatment. Indeed, investment properties have been put in an even worse position by recent changes to limit depreciation deductions.

Having said this, it should be noted that the home does benefit from exclusion from pension means testing. This can be a considerable benefit to older Australians and has been noted, along with stamp duty, as one of the policy settings that inhibits the efficient allocation of housing stock amongst population demographics. We would not be surprised to see increasing focus on this issue from policy makers in the years ahead.

Myth #4 – Negative gearing! Negative gearing! Negative gearing!

The fourth myth is that negative gearing is some sort of special strategy that relates to property investment. In fact, negative gearing is simply the normal application of the standard and straightforward rule that expenses, including interest expenses, can be deducted from a taxpayer's income. An asset – any asset – is ‘negatively geared’ when expenses – especially interest expenses – relating to the asset exceed income earned from the asset.

Whilst it is true that negative gearing is a strategy most commonly employed by property investors, this is because of the willingness of lenders to use property as a security as we have already discussed. Certainly, there is no special, favourable treatment of property under interest deductibility rules.

Myth #5 – Interest only loans are inherently dangerous

There has been much discussion in media of late about interest only loans. From the commentary, one could be forgiven for believing that interest only loans were devised so that borrowers could take on more debt than they can afford to service on a principal and interest basis.

The truth, of course, is much less dramatic. There are many rational reasons why a borrower would take an interest only loan. Tax deductibility is one of them. Cash flow management is another. But – whatever the borrower’s strategy – residential lenders in Australia operate under the National Consumer Credit Protection Act 2009, which obliges them to ensure that a loan is not unsuited to a borrower’s objectives and that a borrower can meet their obligations under the loan (including repayment of the loan), without undue hardship.

In short, lenders are required by law to review the borrower’s request for an interest only loan and take into account accelerated principal repayments that follow the ending of an interest-only period.

Myth #6 – Foreign purchasers are driving up house prices

The sixth myth is that foreign purchasers are driving up house prices. It has been repeatedly debunked by a number of commentators and industry experts, ourselves included, but continues to raise its head when house prices are discussed.

Let’s first consider a detailed analysis published by Treasury in December 2016. It considered the relationship between foreign residential real estate demand and dwelling prices, with a special focus on Melbourne and Sydney, where demand is concentrated. It sought to quantify the effect foreign demand for Australian housing had on Australian house prices.

It concluded that the effect on prices was very small indeed. In fact, it estimated that foreign demand increased dwelling prices by just $80 to $122 per quarter, compared to the average quarterly increase in Melbourne and Sydney of $12,800. Now this type of economic modelling is difficult, but even if the researchers were out by a factor of 10, the impact of foreign demand on house prices is negligible.

More recently, the press reported a research note prepared by ANZ in December 2017. Written by Senior Economist, Daniel Gradwell, it found that foreign buyers represent a small share of the total market and have not been the main cause of price growth. Using FIRB figures, Gradwell found that foreign buyers make up just 7% to 13% of total housing turnover.

In short, foreign demand for Australian housing has been increasing in recent years, particularly in Melbourne and Sydney. But when considered in the context of the extraordinary size of the Australian housing market ($7.5 trillion), its effect on price growth has been very limited. The strong price growth seen in recent years has much more to do with domestic demand and supply factors.

Myth #7 – The Australian mortgage market is full of “liar loans” and we will have a US-style sub-prime collapse

The final myth has been doing the rounds over the last twelve months or so. Global investment bank, UBS, attracted headlines across the country last year by issuing two reports with the sensational headline catchphrase “liar loans”. The net effect of the reports was to imply that the Australian mortgage market was sitting on a hidden rump of poor quality loans that would put bank balance sheets at risk.

When measured by media coverage, the two reports were notable indeed. But it’s fair to say that most informed commentators were less than impressed with the rigor of the analysis.

The reports were based on a survey of 907 borrowers who had taken a mortgage over 12 months to August 2017. The first report found that one third of the borrowers stated that they were not “completely factual and accurate” in their loan application. The second report found that around one third of borrowers with an interest only (IO) loan did not appear to know they had an IO loan.

So what to make of this? Some, such as the ANZ, have pointed to the small size of the survey relative to the Australian lending market to suggest that the results are unrepresentative. Others point to the methodological flaws inherent in such a survey. Veteran Fairfax Business Day Editor, Michael Pascoe, wrote that his own loan would be classified as a “liar loan” by UBS given that he does not know his monthly expenses with complete accuracy and instead provides estimates. He also cast doubt on other aspects of the reports, such as the claim that people were finding it easier to get a loan in 2017 than they had in 2016 (how many of the 907 had applied for a loan in each year?).

Then there is the external statistical evidence. Loans that are in real stress and arrears are running at low levels and tend to centre on geographic sectors that are experiencing economic difficulty (e.g.: the mining boom towns). For the rest of Australia, things are actually going quite well. Indeed, a Reserve Bank study at the end of 2017 focused on first home buyers and concluded that, while saving a deposit is a stretch, those who make the step are better placed to pay off their loans than prior to the crisis. Housing loan serviceability levels are in line with historical averages.

This, of course, is consistent with the experience of most lenders in Australia today. They see arrears and borrower stress at low levels. These indicators are cyclical and generally reflect economic conditions (hence elevated stress in becalmed former mining boom towns), but there is little to no objective evidence of deteriorating borrower performance. Surely “liar loans” would lead to increased mortgage defaults?

When it comes to credit quality, Australia has never had a substantial ‘subprime’ mortgage market of the type seen in the pre-GFC US. What’s more, since at least 2009, when the National Consumer Credit Protection Act was passed, Australian lenders have faced increasing, not reducing, scrutiny from regulators. Responsible lending obligations have been imposed, interest buffers increased and serviceability calculators tested and refined. It is counterintuitive, to say the very least, to argue that credit standards have systematically declined in face of these actions.

The Australian housing market is enormous, with $1.7 trillion in loans outstanding. No doubt there will be the odd case where a lender has erred. But the notion that Australia’s credit market is somehow systemically compromised… that’s a myth.


None of this should be read to suggest that the policy settings around housing and investments are perfect or that there are no issues that can be productively addressed. Indeed, there is no suggestion that there is such thing as a ‘perfect’ mix of policy settings that are appropriate to all points of the economic and social cycle.

Good policy process always involves continuous review to ensure that emerging trends and developments are being appropriately monitored and, if necessary, regulated in the best interests of society. It is clear that this has been the intention of the ‘macro-prudential regulation’ by APRA that has occasioned so much comment in recent times.

What is important, however, is that we base our market analysis and policy responses on solid grounds. We should, of course, learn the appropriate lessons from the US subprime crisis. We should be watchful of our credit market, like all of our financial markets. But we should not assume that a market failure in the US will be reflected in a similar failure in the Australian market.

We should resist the temptation to take the ‘cognitive shortcut’ of assuming that the two markets are the same. That will simply focus us on the last crisis, instead of the next. Most of all, we should be careful regularly to test our thoughts and preconceptions against the evidence. Because bad thinking will lead to bad policy.

Featured Posts
Recent Posts