How getting landlords into (heat pump) hot water can get tenants out of high gas bills

Imagine for a moment, it is Budget preparation time, and you are sitting next to the Treasurer. In front of you both is a lever. If the Treasurer pulls the lever, tenants around Australia will receive $600 tax-free each year for the next 10 years and beyond.

Would you urge the Treasurer to pull the lever? I certainly would.

Of course, this benefit has a cost. There will be no significant cost to the Treasury. The tenants will pay nothing. It is you who will bear the cost, as you will have to live with the knowledge that you have encouraged the Government to do yet one more thing for landlords.

Could you live with this knowledge?

For decades in Australia, other taxpayers have given lucky landlords silver service. In this Budget it seems their luck might be running out as the landlords’ negative gearing and capital gains benefits may be reduced. Such reductions would be a good thing – though not all landlords would agree.

Against this backdrop it seems ironic to propose a new handout for landlords. Nonetheless that is what we should do. 

In many rental properties, the hot water for the kitchen and shower is heated by gas. Typically, a tank of water is heated by a burner just as a kettle is heated by a cooktop. Hot water systems are somewhat smarter than a kettle as they have a thermostat that automatically turns down the heat when the water reaches 50°C. 

But that is as smart as these devices get. Much of the time, they do stupid things. If the water cools off on a winter night at 3am, the burner will ignite and reheat the water to 50°C. The systems will also keep heating your water while you are away on holiday. Over a year, gas tank systems use quite a bit of gas unnecessarily. 

Less wasteful are the instant gas systems that only fire up when they sense water running through the pipes. Broadly, these ‘on demand’ systems use around one third less gas.

You could argue that none of this mattered much when the cost of gas was low. Today however, gas costs have moved into the overtaking lane. Over the last 15 years, according to some estimates, the cost of gas in Victoria has doubled. We can expect gas costs to further accelerate, driven relentlessly higher by a self-reinforcing cycle of rising prices and falling demand.

It’s time to get out now. The more the cost of gas increases, the faster people will switch from gas hot water to hot water generated by a heat pump.

To see why, let us compare the indicative running costs for a household of two, that uses around 100 litres of hot water a day. 

You will find higher estimates, but I am going to suggest running costs of $600 a year for a gas-and-tank system and $400 a year for an instant gas system.

The running costs of a heat pump system are much lower. Typically, heat pumps can get the water up to temperature in a couple of hours and use only around 4 kWh a day. If you switch to a retail plan that offers several hours free in the middle of the day, your running costs for hot water will be zero. 

You can see how a rental property with a heat-pump hot-water system would be attractive to a tenant. It would be one less bill to pay – equivalent to half a week’s income on median weekly earnings and whole week of income for a single person on the pension.

For tenants to get their $600 a year, the gas hot water systems in rental properties must be switched to heat pump systems. For this discussion we will set the cost of this equipment swap at around $2,500. (You can pay less for lower quality and more for best quality. The price and rebates vary from state to state and from house to house, depending on the existing switchboard and other factors.)

This low capital cost makes the payback period quite short – around four years – and the long-term return substantial. Assuming the new equipment lasted for 10 years, you would avoid spending $6,000. 

Here, however, we run into a problem with motivation. 

The homeowner is motivated to pay to sack their gas water heater because they will enjoy the savings. The landlord currently is not motivated, as they face a capital cost with no payback. Over a 10-year tenancy it would be well worth the tenant paying for the appliance themselves. The tenant however faces the risk they will not recover their investment if they choose to move or the landlord does not renew the lease.

This knot can be untied by providing the landlord with a motivation to change the hot water service. 

It is said that many people are in hospitality or farming because they love the work and the contribution it makes. This may also be true of some landlords, people who take pride in providing a needed and worthwhile service to others. But most landlords we can assume are in the rental property game to make money – attracted by the generous tax arrangements and the promise of large capital gains.

To motivate this group, we must speak to them as investors. 

We are fortunate there is an investment motivation ready-to-hand and relatively straightforward to introduce.

Among the benefits that landlord investors receive from the Commonwealth is the uncontroversial mechanism of depreciation. This mechanism allows a landlord to claim the cost of a new hot water system against their income and thereby reduce their tax bill.

Currently however, the Tax Office requires that these claims are spread across the expected life of the unit. For a hot water system, the Tax Office sets a lifespan of 12 years. When a landlord installs a $2,500 heat pump hot water system, the Tax Office allows a depreciation claim of around $200 a year. This level of benefit provides the landlord investor with little motivation to switch out the tenant’s hot water system.

By contrast, someone who runs a business has access to an instant asset write-off. This tax reduction mechanism allows the business to claim depreciation of the full asset cost in the year of purchase. A business could, for example, install solar panels and a battery at the workplace and, through the instant depreciation mechanism, claim the full amount against their income for that year.

Now we can see the fine print underneath the label on the lever in front of you and the Treasurer. It reads ‘Permit landlords to reduce their tax through an instant and full depreciation of the total cost of the installation of a heat pump hot water system when it replaces a gas hot water system’.

We could discuss whether the wiring behind the lever should be adjusted. Perhaps the benefit should be narrowed and only available to landlords whose tenants are pensioners. Perhaps it should be broadened to include solar panels, batteries and cooktops.

My preference is to start simple and see if it works. If no landlord takes it up, no harm is done. If instant asset write-offs prove to motivate landlords, the incentive can be adjusted and expanded.

Come on Treasurer, pull that lever.

Harry Barber is a volunteer member of Electrify Yarra. He will be presenting a webinar about free hot water on 6 May. The session is jointly presented by Electrify Yarra, Electrify Boroondara and Lighter Footprints. You can register for the Zoom webinar here