Negative Gearing and Housing Supply

  How significant for housing supply are loans to investors for new construction?

 

 

 

Negative gearing is a tax policy that allows property investors to offset losses from rental properties against taxable income. Its effect on housing supply and affordability is controversial, with some arguing negative gearing encourages investment in rental properties and increases housing supply, while others argue most of that investment goes into existing properties, so negative gearing increases demand for rental properties and drives up prices, making it more expensive for first-home buyers. However, the effect of negatively geared investor loans on housing supply is not as clear as the effect on house prices. There is nothing in negative gearing to specifically act as an incentive for construction of new homes, but that does not mean it does not increase the supply of housing.  

 

The Australian Taxation Office definition of negative gearing is: ‘A rental property is negatively geared if it is purchased with borrowed funds and the net rental income, after deducting expenses, is less than the interest on the loan.’ With a negatively geared property the taxpayer makes a loss, but that loss is tax-deductible against other income, including ordinary wages and salaries, and thus other taxpayers help the property investor meet the costs. investors know rental returns are less than operating and interest costs but they expect property values will increase so losses will be more than covered by capital gains when the property is sold. The higher the income of the taxpayer the more favourable this type of gearing becomes. 

 

Two examples of arguments for increased supply are reports for the Property Council in 2014 and 2019. The 2014 report  by ACIL Allen claimed around a third of all loans for new dwelling construction were to investors and it was a myth that negative gearing does nothing to support housing supply. The later 2019 report by Deloitte Access Economics found limiting negative gearing to new housing and reducing the Capital Gains Tax (CGT) discount from 50% to 25% would lead to a decline in prices for new property of 3.6% by 2030 that ‘in turn results in a decline in dwelling commencements which is estimated to be 4.1% below baseline in 2030. The decline in commencements each year reduces the stock of dwellings over time … The stock of dwellings is estimated to be 0.4% lower by 2030.’ 

 

This post addresses the question of the significance of negative gearing for supply of new housing. It starts by looking at the data available from the Australian Bureau of Statistics on lending to investors, then compares the data on loans to investors for new construction to the building approvals data, and finally the Australian Tax Office data on deductions for rental properties is considered.  

 

Lending For Dwellings

 

Australian Bureau of Statistics’ Lending Finance data shows over half of the value of new lending is to investors, and ABS census data shows nearly a third of existing properties are owned by investors. How significant for supply of new housing are loans to investors for new construction?

 

Although a lot of lending for dwellings goes to owner occupiers in Australia, since 2019 the share of lending to investors for dwellings has been increasing. This went from 29% to 38% for the number of dwellings and from 39% to 60% for the value, in Figure 1. While these are the headline numbers often used when discussing negative gearing, they are not relevant to the supply of new housing because the great majority of this lending to investors is for established housing, not new construction. 

 

Figure1.  Investor share of total lending for dwellings

 
Source: ABS 5601.

 

Between 2019 and 2024 the shares of lending to investors changed, as the proportion of investor loans for new construction increased from around 11% to 14.5% of the number of dwellings and from about 10% to 14% of the value, while lending for newly built dwellings more than halved over the period, from around 11% to under 5%. As a result, their combined share for new dwellings of total investor lending has fallen from 22% to 19%, which is not insignificant. As Figure 2 shows, over the last two years the growth of lending for existing dwellings has been much faster than lending for new construction. 

 

Figure 2. Lending to investors for dwellings

 
Source: ABS 5601. These ABS data series begin in September 2019.

 

For housing supply the investor loan share for construction new dwellings of total lending is the important point, and that share is only 6% of the number and 8% of the value, in Figure 3. That share is very low because so much more lending goes into existing properties. However, although this suggests investor loans play a marginal role in the supply of new housing, and not all investors are negatively geared, this is not the whole story.

 

Figure 3. Lending to investors for construction of new dwellings

 
Source: ABS 5601. These ABS data series begin in September 2019.

 

Building Approvals 

 

Comparing the number and value of investor loans for new construction of dwellings to building approvals shows the role of investors in housing supply has become more important over the last few years. In 2019 the shares of investor loans for new construction were 8% of the number of private sector building approvals for dwellings and 10% of the value, but in 2024 they had increased to 16% and 21% of the number and value respectively, in Figures 4 and 5. These are more significant shares than those in the lending data. 

 

Figure 4. Investor loans for new construction and number of building approvals

 

Source: ABS 8731 and 5601.

 

The increase in the investor share of building approvals is a combination of a decline in approvals since 2021, which can be attributed to the 30-40% increase in costs since then, and the increase in investor loans noted above. The increase in the share of the value of both investor loans for new construction and the share of building approvals suggest this is funding for houses rather than apartments or medium density development. 

 

Figure 5. Investor loans for new construction and value of building approvals

 

Source: ABS 8731 and 5601.

 

 

The 16% investor share of the number of dwellings approved is significant. There are, however, two caveats to this. The first is that not all approvals become commencements, although most do eventually get started. The second is that not all investor loans are negatively geared. 

 

Australian Tax Office Data

 

The most recent ATO statistics are for the 2021-2022 financial year because of the time taken to submit and process returns, so there is no data for the last two years. The share of investors who are negatively geared rises and falls with changes in interest rates. During the financial crisis in 2008 when the cash rate was 7.25% the share of negatively geared rental properties was over 69%.  As Figure 6 shows, in the years before before 2019-20 total net rental income was negative, but as the cash rate fell to 0.1% in 2020 total deductions also decreased and the share of negatively geared rental properties fell below 50%. Table 1 has the same data going back a few more years to 2014-15.

 

Figure 6. Total rental income and deductions

 Source: ATO Taxation Statistics Individuals

 

 

Table 1. Total rental income and deductions, $ billion

Source: ATO Taxation Statistics 

 

In the ATO data going back to 1999-2000 the majority of investors have been negatively geared, and since 2002 it has been between 60% and 70%. As Figure 7 shows around 60% of rental properties were negatively geared in the six years before 2019-20. Because interest rates were at record lows in 2020-21 and 2021-22 the number of negatively geared properties fell to 47% and 42%. With the increase in the cash rate after 2022 to 4.35% in 2024 the share of negatively geared properties should be trending upward to the long-run level of over 60%.

 

Figure 7. Number of rental properties by rental outcome

 

Source: ATO Taxation Statistics 

 

What is not in the data from either the ATO or the ABS is the share of negatively geared investor loans for new construction, the question this post is addressing. The assumption can be made that the share is the same 60 to 70% for new builds as for negatively geared existing properties, but there is no way of knowing if that is the case. In all likelihood it is less, possibly much less, because investing in a new build would be seen by the typical negatively geared investor, who has one property, as more risky than an existing dwelling. The ATO data has 70% of investors with one property. 

 

Of the investor loan share of 16% of the number of building approvals, if around a third are negatively geared then the 16% becomes 5 or 6% of building approvals, if it were half then 8% of the number of approvals would be negatively geared. Even at the high range assumption of two thirds of investor loans for new construction being negatively geared, that is barely more than 10% of approvals.

 

Conclusion

 

Negative gearing is a tax incentive that allows investors to deduct rental property losses from other income. Australian Bureau of Statistics’ Lending Finance figures show about 85% of investment in rental properties is for purchase of existing properties, not building new ones. Because it increases demand for rental properties, this drives up prices for existing properties, making it more expensive for first-home buyers. However, the effect of negatively geared investor loans on housing supply is not as clear as the effect on house prices. There is nothing in negative gearing to specifically act as an incentive for construction of new homes, but that does not mean it does not increase the supply of housing.  

 

Between 2019 and 2024 the share of lending going to investors for dwellings went from 29% to 38% for the number of dwellings and from 39% to 60% for the value, The great majority of this lending is for established housing, not new construction. The proportion of investor loans for new construction increased from around 11% to 14.5% of the number of dwellings and from about 10% to 14% of the value, while lending for newly built dwellings fell from 11% to under 5%. For housing supply, the investor loan share for construction new dwellings of total lending is only 6% of the number and 8% of the value. The higher share of the value of investor loans for new construction and suggests this is funding for houses rather than apartments.

 

The role of investors in housing supply has become more important. In 2019 investor loans for new construction were 8% of the number of private sector building approvals for dwellings and 10% of the value, but by 2024 had increased to 16% and 21% of the number and value respectively. That 16% share of the number of dwellings approved is significant, but not all approvals become commencements, although most do eventually get started, and not all investor loans are negatively geared. This rise in the investor share of building approvals is due to the combination of a decline in approvals since 2021 and the increase in investor loans. 

 

Australian Tax Office data going back to 1999-2000 shows the majority of rental properties have been negatively geared, with between 60% and 70% negatively geared before 2019-20. Because interest rates were reduced to 0.1% in 2020-21 and 2021-22, negatively geared investors fell to 42% of properties. With the increase in interest rates after 2022 the share should be trending back toward the long-run level of 60% or more. 

 

The data from the ATO and the ABS does not give the share of negatively geared investor loans for new construction, the question this post addresses. An assumption has to be made. Is the share the same 60 to 70% for new builds as for existing properties? Probably less, possibly much less, because investing in a new build would be seen by the typical negatively geared investor, who has one property, as more risky than an existing dwelling. Of the investor loan share of 16% of the number of building approvals, if around a third are negatively geared then the 16% becomes 5 to 6% of building approvals, if it were half then 8% or at two thirds slightly over 10% of the number of approvals would be negatively geared. 

 

At between 5 and 10% of building approvals for new dwellings, negatively geared investor loans do not play an important role in the supply of new dwellings, and they are more likely to be for houses than apartments. To increase supply better targeted policies are needed and would be more effective. 

 

UK MMC and Manufactured Housing Failures

How not to promote Modern Methods of Construction 

In Australia, Canada, the UK and parts of the US there are problems associated with low levels of new house construction, high prices, rising rents and decreasing affordability. Although modern methods of construction (MMC) cannot solve these problems on its own, it could make a significant contribution if restrictions on its use were relaxed, and governments developed effective policies to expand the market and promote its use. 

 

The UK Government has been a leading producer of industry policies for construction since the 2011 launch of the construction industry strategy, with an updated version following in 2016. Some parts of the strategy have been successful, developing the BIM Framework and BS 19650 standards and increasing the use of BIM with a public sector mandate (discussed in a previous post here) in particular. Also, between 2019 and 2022 the Transforming Construction Challenge completed 68 projects.

 

In contrast, the UK policy to promote manufactured affordable housing has been a notable failure. Over 2022-23 MMC companies that collapsed were Ilke, House by Urban Splash and Modulous, and L&G closed its housing factory (in image above). In late 2023 the UK House of Lords Built Environment Committee started an inquiry into manufactured housing, and this post is based on the report from the inquiry and transcripts of evidence given. The report (in the form of a letter to the Secretary of State for Levelling Up, Housing and Communities) provides some insight into an agency that has not published any data on the twin policy objectives of increased supply of affordable housing and increased use of MMC. 

 

Background

 

In 2017 the Government committed to increased housing supply using MMC by supporting the growth of the industry. MMC describes a wide range of non-traditional building systems and in the UK is divided into seven categories, from completely built offsite (Category 1) to completely built onsite with some automation (Categories 6 and 7). The policy to promote MMC was supported by the Construction Innovation Hub and the Advanced Industrialised Methods for the Construction of Homes (AIMCH) project, which both ran for three years over 2020-22 funded by UK Research and Innovation through the Industrial Strategy Challenge Fund.

 

The agency responsible for increasing use of MMC was Homes England, established in 2018 to fund new affordable housing (replacing the Homes and Communities Agency set up in 2008). The Strategic Plan 2018-23 described Homes England as ‘a new non-departmental public body, sponsored by the Ministry of Housing, Communities and Local Government … to accelerate the delivery of housing across England, except in London’ and explained ‘Our mission is to intervene in the market to ensure more homes are built in areas of greatest need, to improve affordability. We’ll make this sustainable by creating a more resilient and diverse housing market.’ There were six objectives in the Strategic Plan, the third of which was to improve construction productivity by supporting MMC:

 

We must embrace change to improve productivity and reduce the impact of the declining workforce. MMC has the potential to be significantly more productive than traditional methods of construction and greatly increase the pace of delivery. It can also improve the quality of construction, address labour and materials shortages and deliver a number of additional benefits such as improved energy efficiency and health and safety. As a result, developers are already introducing MMC. However, the MMC industry is currently immature with limited production capacity and supply chains. It requires stimulus if it is to evolve further.

 

We will support the uptake and development of MMC through a range of interventions. We’ll incorporate MMC into our building lease disposals to demonstrate a range of MMC products by supporting pilot projects on Homes England land. We’ll also encourage partners to use MMC through our provision of development finance to developers. Our Local Authority Accelerated Construction programme will also encourage more widespread use of MMC to help increase the speed of construction and build out.

 

 

Inquiry Report

 

After the collapse and closure of the two major Category 1 MMC businesses, Ilke Homes and House by Urban Splash, in late 2023 the UK House of Lords Built Environment Committee started an inquiry into MMC in housing ‘to explore the potential reasons for these failures, especially considering the support provided by the Government to the industry.’ 

 

The inquiry made some pointed observations. Homes England could not provide data on the extent of MMC across its portfolio, despite that being its measure of success, and has not developed an evidence base or published research on MMC as promised. An MMC Taskforce, which was expected to work on data and standards, has never met. Some key points from the report were:

 

‘we have been told … Category 1 housing is, or could be, more expensive than homes built using traditional construction methods … we heard that MMC homes are cheaper. These two statements cannot both be true’ (p. 3).

 

‘We have limited confidence that a coherent plan to encourage the use of MMC is in place and, owing to the absence of its publication, have found it challenging to scrutinise the Governments activity and spending’ (p. 4) 

 

‘It remains unclear both how Homes England is assuring itself that Affordable Homes Programme (AHP) providers in receipt of grant are meeting the pre-manufactured value (PMV) requirements and when this data will be published’ (p. 7). PMV measures how much of a project’s gross construction cost is derived from pre-manufacturing with all seven MMC categories contributing to a higher PMV. 

 

‘The current approach taken through the AHP does not stipulate the use of Category 1 and 2 MMC. The requirement for 55 per cent of the PMV of the home to be MMC allows many housing associations to use MMC from Categories 3 to 7 … the majority of MMC delivery has a low pre-manufactured value’ (p. 8)

 

‘We were particularly disappointed by the attitude of insurance providers and the warranty providers towards MMC. The extensive time periods it can take to obtain warranties and the reticence of insurance providers to accept compliance with building regulations as sufficient is having a detrimental impact on the delivery of MMC homes’ (p. 13).

 

'Homes England made significant investments from the £4.5 billion 2015 Home Building Fund which directly supported Ilke Homes (£60mn) and House by Urban Splash (debt facility of £26.9mn and equity of £3.1mn). Homes England expects limited recovery of its investment into Ilke Homes and full recovery of its loan to House by Urban Splash, though not the equity’ …  'it is still unclear why Homes England chose these two companies and what its selection criteria and objectives were’ (p. 15).

 

‘It is also unclear why the Government is not allowing experienced international MMC companies to apply for procurement processes and stipulations. Volumetric MMC housing is successfully delivered in other countries. The Government should ensure that its procurement practices do not limit the ability of successful MMC companies from around the world in moving into the UK market’ (p. 16).

 

‘we came away from our inquiry with the impression that the Government had too easily accepted that undirected and nonstrategic investment of public money was the obvious way of providing this assistance. We say that because the Government has not set out clear objectives for the investments and funding it provided. Nor did Homes England give us any clear metrics as to how success (however defined) was to be measured and over what timescale’ (p. 18).

 

The report also pointed out that ‘MMC has been commercially successful in other sectors and blocks of flats, as illustrated by build to rent and student housing’ (p. 3). In evidence given by industry to the inquiry affordable housing is not a viable market segment for MMC because traditional methods are cheaper in some parts of the country and volume manufacturing requires an  sustained high level of demand, so for the failed companies the ‘level of investment expended relative to the demand was the fundamental flaw’. Examples given of successful MMC projects in the UK were medium and high-rise buildings, hospitals, prisons, detention centres and defence housing. 

 

Conclusion

 

What does this tell us about Homes England’s MMC policy and implementation? There are a few basic principles for industry policy. The first is to be technology agnostic, meaning the funding should be allocated on the basis of meeting the policy objectives, not on the basis of a preferred technological solution. In this case there was no good reason to prefer Category I MMC builders over Categories 2 – 5, and there was no evidence that the final cost of Category I volumetric buildings were cheaper that alternative MMC builds. 

 

The second basic principle is to avoid picking winners. If funding is to be provided it should be available to any firm that can meet the criteria set and policy objectives. Making equity investments in firms, as Homes England did, is not appropriate and has a long history of failure. Typically, industry policy funding is through either credit support or incentives, rarely a combination of both, as many studies of policies in different countries for specific industries have shown.

 

Finally, industry policy funding will be most effective when used to stimulate demand. Homes England contracted a total of £137mn to local authorities to deliver 9,969 homes using MMC in Categories 1 to 5, although the inquiry was unable to establish how many had been delivered. The Affordable Homes Programme made funding available to housing associations using MMC through strategic partnerships, long-term deals under which partners must build at least 1,500 homes and deliver 25 per cent of those homes using MMC. However, the inquiry found the majority of AHP houses had a low PMV with a lot due to Categories 6 and 7. Here the objective of increasing offsite manufacturing was undermined by accepting onsite work as MMC. 

 

UK manufactured housing provides a good example of how not to do industry policy for construction. The ‘undirected and nonstrategic investment of public money’ was both wasteful and probably ineffective (given the lack of data on outcomes). Homes England did not develop standards or provide data that would have encouraged insurance and warranty providers to support MMC, and excluded international firms with experience with MMC from entering the market that could ‘help improve the maturity of the market, and provide the data and evidence called for by warranty and insurance providers’. 

 

The concluding paragraph of the inquiry’s report pointed to the complex interplay of factors involved in unblocking supply of housing in general and increased use of MMC in particular:

 

It is possible that real barriers exist in the form of resistance by planning officers and undue risk aversion on the part of warranty providers, insurance companies and banks. Our short inquiry did not establish clear evidence to make that case, but we believe the Government should look more carefully at how these parts of the housebuilding ecology are working, as well as taking a greater interest in overseas examples of success with modular construction. 

 

This situation is not unique to the UK. Australia, Canada and parts of the US all have similar problems associated with low levels of new house construction, high prices, rising rents and decreasing affordability. Although MMC cannot solve these problems on its own, it could make a significant contribution if restrictions on its use were relaxed. Demonstration sites where examples of modular building are on show could be established. Some publicly owned sites could be recycled and reserved for modular buildings to create a market. An independent agency could collect data on costs and performance. Lending and valuation guidelines could incorporate energy savings from modular buildings. Local governments could be given incentives for allowing new modular buildings and/or extensions to existing houses. Social housing could be required to use MMC. A levy on embodied carbon in building materials would favour modular building, which typically has less waste and lower use of cement and concrete. 

 

MMC is not only Category 1 3D buildings. It includes panellised and structural systems, pre-assembled floor and wall cassettes, kitchen and bathroom pods, and manufactured components such as facades and windows. Many of these are already widely used outside residential construction, and given the opportunity can be used to increase the supply of new housing that is so urgently needed in many places. The focus in the UK on failures of manufacturers of single houses has obscured the success of MMC in medium and high-rise residential buildings and for a wide range of commercial and institutional buildings. 

 

 

Note. Homes England lost another £9mn invested in Stewart Milne, a house builder that failed in January. 

 

 See also https://gerard-de-valence.blogspot.com/2022/09/comparisons-of-construction-to.html