How tax credits can stop housing heartbreak

Posted: Thursday 30 August, 2018

Australia stands on the precipice of a major social crisis. Industry Super Australia estimates a national affordable housing shortage (mostly sub-market rentals and emergency housing) in the order of 350,000 depending on typical family size. Two thirds or more of that shortage is in New South Wales and Victoria.

The bedrock objective of housing policy was once to get families into decent homes. Apparently not any more.

A rising tide of housing distress has causal effects like homelessness, rising mental illness, family stress, domestic violence, wage stagnation and welfare dependency.

The additional economic costs of housing distress are borne by all levels of government and they will simply keep rising from now on. This is a lose-lose scenario for current and future generations. 

Housing stress is a mainstream economic problem that wastes human resources and destroys productivity.  Yet none of these social and productivity imposts are being measured; a worthy challenge for the next Intergenerational Report due by 2020.

The social dividend from fixing this problem far exceeds any other mainstream economic or fiscal reform as it deals with the fabric or ‘infrastructure’ of social cohesion. 

Listening to radio advertisements you could be forgiven for thinking the goal of Australian government housing subsidies is to give mum-and-dad investors the ability to buy multiple existing properties using debt via a self‑managed super fund.

As a result, some own multiple properties and pass wealth to the next generation in the family. Meanwhile, others face periods of homelessness and impoverishment which is also passed to subsequent generations who can’t access education or employment due to unstable housing; let alone home ownership.

The affordable housing shortage is testimony to 30 years or more of inadequate regional and national planning coupled with short-term thinking. Successive Australian governments have directed too many resources at spurring demand for existing property rather than building new homes for the most needy.

Australian governments must urgently work together to address this before the trickle becomes a flood and our nation experiences a homelessness epidemic. 

What is affordable housing?

The common definition of housing stress is spending more than 30 per cent gross pre-tax income on an ongoing basis. Families face a daily dilemma: Do I pay the rent, childcare, car repairs, food or medical bills. Depending on the city, 40 to 60 per cent of urban households in Australia will find it very difficult to pay market rents without making major sacrifices in other household spending categories.

How do we fix the social housing shortfall?

Firstly, we must identify where the need is greatest by Local Government Area, remembering that some regions are cheap because they are remote, rundown or for some other reason sub-standard. This is a job for the Office of National Housing operating within a Productivity Commission more inclined to evidence based analysis. It would be charged with annual generation and release of these analytics.

Secondly, all levels of government must pool existing housing subsidies and reprioritise them for the sole purpose of building and/ or operating housing for the disadvantaged (Federal Government will need to use carrots and sticks here).

Thirdly, all levels of government must identify underutilised public and private landholdings. The Federal Government must provide effective incentives for asset recycling and for charities, Churches and community groups to offer up any excess landholdings on long term leasing.

Lastly, governments must lever the balance sheets of long term investors such as overseas pension funds, Australian superannuation funds, insurance companies and family offices to invest into affordable housing. 

Right now, most long term portfolio investors have little interest in residential property in Sydney and Melbourne due to current yields of around 3 per cent (and falling prices). These returns are too low for funds that benchmark CPI plus 4-6 per cent. Furthermore, sub-market rental units return even less and tenants are generally even more risky.

However, more innovative industry superannuation funds are developing direct investment proposals in affordable housing, especially by targeting key workers and identifying the most reliable renters in the sub-market distribution.  But these projects are likely to be a drop in the bucket compared to the scale of the overall problem. Regrettably, so are government policy experiments in inclusionary zoning, town planning processes, bond aggregators etc. These to do not address the heart of the affordable housing crisis.

Brick-by-brick, building-by-building, the affordable housing sector is being denied access to the scale of equity capital necessary to address housing shortages. Sure, banks will lend them debt finance for a price, however that has to be repaid on commercial terms. Sustainable projects employ 70 per cent or more equity finance.  So who will provide that capital?

The missing link in this policy chain is the provision of an efficient and effective mechanism to deliver equity capital to affordable housing providers. Such a policy would provide the means to allow institutional investors to effectively write-down or write-off every dollar they ever invest in a sector with no adverse impact on their rate of return benchmarks.

The missing link in this chain is a policy such as affordable housing tax credits.

Assuming the Productivity Commission identified the location of a material housing shortage, the Federal government could authorise a statutory corporation to tender for the construction of these places.

The successful developer/operator would structure the project financing based on receipt of tradeable tax credits (the funding source for the equity capital) which they would sell to long term portfolio investors.

The portfolio investors who purchase tax credits could then write-off their tax liabilities immediately. Federal or state revenue/housing authorities would require investors to ensure projects are delivered as promised in terms of affordability, quality and quantity.  Investors entrust the management and maintenance of the housing developments to qualified community housing entities.

Over time, tax credits should trade close to face-value. The credit efficiency goal would be to ensure that 90 per cent of tax credits goes to direct housing investment.

By embedding an affordable housing tax credit into the tax code (just like negative gearing is) the program will become a self-perpetuating funding stream into affordable housing that is regulated via a statutory body to eliminate fraud and waste. It should not be subject to the vagaries of political change through the annual budget process.  This program is likely to attract significant private sector equity capital and build permanently affordable, privately owned and managed affordable housing developments as community resources.

If an Australian scheme generated $1 billion in tax credits and those credits were invested at 90 per cent efficiency at $400,000 per two bedroom unit or town house (to target 40 -60 per cent of Area Median Income Households) it would produce 2,300 units annually; nearly 23,00 units in a decade, adjusted for inflation. Yet $1 billion is a small fraction of the $20 billion in subsidies spent on superannuation with little affordable housing benefit generated. 

Has a viable tax credit scheme operated anywhere else in the world?  The United States’ Low Income Housing Tax Credit (LIHTC) program has generated 3.0 Million Units (1987-2015) in 45,900 projects. It now creates around 110,000 units per year worth $US 8.0 billion per year (FY 2016). Operators achieved a 97.8 per cent occupancy rate in 2016 and a 0.7 per cent cumulative foreclosure rate.  So, the scheme has a long successful pedigree.

The now defunct National Rental Assistance Scheme provided a good foundation for the proposed tax credit scheme. But a new scheme must incentivise and guide State-based effort and call for EOIs for very large tranches of support to attract institutions. NRAS had developed a good head of steam and should be built on.

Is this proposal an example of rent seeking by the super sector? Not at all. Maybe Australian superannuation funds will access these tax credits (perhaps to replace some taxpayer’s loss of imputation credits after the next election). However, certain portfolio investors and non-financial corporations that face higher effective tax rates will find housing tax credits an attractive policy.

Can we avert a looming housing crisis?  Put simply, we need to build more assisted houses in the right places.  We need to remove existing market distortions which muddy incentives for new building.  We need government via long term institutional investors to allocate big pools of capital to assisted housing.

In the final analysis, governments must realise that if they are not prepared to deliver affordable housing directly via public balance sheets (via public housing) they must provide equivalent subsidy to private balance sheets probably via not-for-profit community housing providers.