Pitfalls loom for vacancy taxes

We delve into the detail

Governments make token moves in the right direction

The Federal government announcement of a vacancy tax on foreign investors could be construed as pure populism.

Foreign investors constitute some 11% of all residential property purchases. Barely 3% of those purchasers are the much vaunted Chinese investor. Domestic investors are up to four times more significant. With investment borrowings hovering at around 50% of all housing loans, such statistics identify the role of investors (whether local or international) as the core issue crowding out genuine home makers.

The Federal Vacancy tax is a $5,000 per annum annual charge on foreign investors. Foreign landholders will be liable on any property not occupied for 6 months. The fee is based on the Foreign Investment Review Board’s residential land fees and will be charged annually.

Victoria’s vacancy tax flawed

The Victorian Vacant Residential Property Tax (VRPT) will utilise the council rating base, making Capital Improved Valuation (CIV) the basis for charges. This is a fundamental design flaw as CIV taxes land and buildings, penalising capital improvements such as renovations.

Vacant land will not face the full impact of the tax; empty vacant homes will. If levied on a CIV basis, marginal dwellings (e.g, ageing stock) may be demolished in order to minimise tax. This may lead to decreased marginal housing stock, with implications for affordability amongst the most vulnerable.

The State Revenue Office indicates the tax will only apply to property in the inner to middle rings.

The sprawling land banks of Melbourne will be largely overlooked by this vacancy measure, an oversight that must be addressed. Melbourne has expanded its urban growth boundaries extensively over the last 20 years, yet in terms of affordability, the outcome has been a resounding failure.

The fact the levy has been applied to inner city suburbs only further adds to the populist case that ‘reform’ is little more than a light tap on the shoulder of foreign investors.

The 1% charge on CIV values will equate to around $5,000 – $6,000 on an apartment. Will that be enough to push a property onto the rental market? Many will see it as a cost they will absorb as capital values climb.

Can the tax be passed on?

The aim of the vacancy tax is to spur vacant properties onto the market.

The vacancy tax puts pressure on holders to put dwellings to use. The longer the property is vacant, the more investors will pay. Downward pressure will be placed on rents due to the added supply coming onto the market.

It is unjust for investors to hold sites vacant. Prosper has regularly revealed such practices surrounding Melbourne University. Speculative Vacancy rates in the Carlton – Carlton South region have varied from 12.7% to 28.9% over the 9 years of our reporting. Currently, investors understand they can engage in such practices as demand is greater than supply. In a key location like Carlton, investors face little economic penalty for manufacturing scarcity and accentuating the supply crisis.

How will it work?

At this early stage it is hard to know exactly how the Victorian (or Federal) government will identify vacant property. There is some concern landlords will try to avoid the tax by claiming the property is a holiday home. A process for exemption of such properties with strict thresholds may be rolled out.

Self-reporting with a strong oversight component simplifies the process. Failure to self-report could be penalised with a significant fine. Vancouver, Canada has announced a similar vacant home tax. A significant CA$10,000 per day fine will be charged for failure to self-report. Their vacancy tax began January 2017. Melbourne’s Vacant Residential Property Tax will commence January 2018.

Oversight is critical to the program’s effectiveness. The system could be enhanced by including water consumption as a proxy for vacancy. Water utilities already have the relevant data. It takes just a few people a matter of hours to crunch the numbers for 1.2 million Melbourne households.

Prosper accepts that using water consumption as a proxy for a vacancy tax could create perverse incentives. To offset the practice of automated water-timers, additional oversight measures such as randomised audits and internet usage could be investigated.

The use of electricity meters has been offered as an alternative identifying measure. In the formative days of Prosper’s Speculative Vacancies report, we considered electricity consumption. It quickly became apparent households could change energy retailers at any point in the billing cycle. The escalating role of solar was also considered. Importantly, water utilities are limited to the region one resides in. This ensures double counting does not occur during the 12-month time frame.

Will a Vacancy Tax work?

The state- based 1% charge on a $700,000 apartment is only $7,000. On its own this would not be enough to change supply outcomes.

The $5,000 Federal vacancy charge will ensure a greater outcome. When added together, both vacancy penalties equate to about two-thirds of current annual rental income. Together these federal and state initiatives will incentivise a supply side response in the inner city.

The combination of the 7% sales tax on foreign investors, the 1.5% absentee landowner surcharge (added to current land taxes), the Federal vacancy charge and the VRPT are significant. But will they result in lower prices for purchasers – or for Australian investors?

Affordability outcomes would be further improved if the burden of the 7% state sales tax on foreign investors was shifted to a more significant absentee landlord surcharge. Such a broad-based land tax set at a higher rate will reduce the capitalisation value of vacant properties. Profitability will be curtailed and thus the incentive to speculate on rising prices.

A Step in the right direction

The combination of vacancy charges sends a signal to the market by putting a price on speculative inclinations. We expect this will lead to enhanced investment in the sprawling estates, where many families are looking to purchase.

Like Land Value Capture, we see these measures as stepping stones towards a broader Land Value Tax.

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https://prosper.org.au/2017/05/15/pitfalls-loom-for-vacancy-taxes/