How will potential negative gearing changes affect property investors?
SINCE 2016, when Bill Shorten first announced his intention to change negative gearing laws if he was elected, there has been a lot of speculation about the impact it would have on the property market and its players.
As we edge closer to the next Federal Election, which could be held any time between now and May next year, this property tax policy is at the forefront of many investors’ minds, especially with the likelihood of an ALP victory looking ever more likely as the days pass.
So what impact will it have? Let’s first take a look at what the changes are.
What is negative gearing?
Borrowing to buy an investment property is called ‘gearing’ and when the property you buy costs you more in expenses than the income you are earning from it – so you’re making a loss – it’s negatively geared. The loss from a negatively geared property can be claimed as a deduction against an investor’s taxable income, which means the tax payable is lowered.
The loss of $4,000 can be offset against an investor’s taxable income.
If a property is making a loss it may seem to be a bad investment, but investors who negatively gear are actually banking on the property experiencing higher capital growth (or increase in its value) than the loss they make over time so they can one day sell to more than cover their out of pocket expenses and make a profit. In the meantime, however, negative gearing enables investors to limit their losses.
What are the proposed changes?
The ALP’s policy on property taxes is to limit negative gearing to new properties only, with established properties no longer eligible.
While we don’t know when the policy would be implemented if the ALP wins the election – and gets the legislation through the Senate – existing investments will be grandfathered, meaning if you already own an investment property that is negatively geared, you will be able to continue with negative gearing.
The alternative to the policy being passed in its current form is that it may instead be diluted so that it will be limited on established properties to a certain dollar value, number of properties or to really high-income earners. Its introduction may even be delayed until the property market regains strength in the major capitals
The other major property tax change proposed by the ALP is to halve the capital gains tax (CGT) discount for people buying investment properties in the future, seeing it rise from being payable on 50% of the net gain for people who hold investments for more than one year to 75%.
When these policies were first proposed in 2016 the property market was in a very different place, with affordability, especially in Sydney and Melbourne, seen as a crucial issue and investors pegged as being largely responsible for creating competition, driving up prices and forcing first home buyers out of the market. The removal of negative gearing was touted as being the answer to reducing competition and hence prices, allowing more buyers to get into the market.
But since then prices have fallen significantly in those cities, with affordability issues now being trumped by homeowner concerns about falling equity in their assets. Investor numbers have also fallen, in large part due to the APRA crackdown and resultant tightening of lending restrictions and out of cycle rate hikes for these borrowers. New supply is also plentiful, with some cities having an oversupply of apartments, so incentives to build new are not necessary.
The ALP is still standing by their policy, however, with the justification, it will save the government money, increase the supply of new housing by making these properties more attractive to purchase and improve housing affordability by driving investors out of the established home market and thereby reducing competition and prices. A recent Newspoll conducted for The Australian found voter support for the policy had dropped but those in favour of it made up 47% compared to 33% those who opposed to it.
How will Labor’s policy affect property investors if brought into effect?
At this point, it’s crystal ball gazing, as no one really knows what effect it will have until the policy is legislated. But it’s likely to have a significant impact, especially since a very high proportion of investors negatively gear their properties at some level. Property investors who already own negatively geared properties will still be able to claim a loss as a tax deduction, so their return won’t be impacted, and they’ll still be able to claim the 50% CGT exemption. But the value of an investment property could fall due to a likely reduced buyer pool resulting from lower demand for property investment.
Those investors looking to buy after the legislation comes into effect will likely be drawn towards new property rather than established so they can claim the negative gearing benefits, creating a two-tiered property market. That means established properties will have less buyer competition, which can lead to a lower price. But hear’s the catch, future investors who do buy new will face the same issue when it comes time to sell, as they will then effectively have an ‘established’ property. This almost seems to go against most logic of successful property investment strategy, as investors will be encouraged to buy new property simply for the tax deductions, more often than not with a lower land value, and the reduced prospect of capital growth because it will be stifled by this new two-tiered property market.
Future investors choosing to still buy established property will have a reduced after-tax return, which will make it harder to justify buying a negatively geared property.
Positive cash flow or positively geared properties are hard to find, but yields will become more important for investment purchases, which means regional markets, such as the Sunshine Coast and Ipswich, could become more popular.
I would advise investors to be wary of buying new properties as they’re more likely to be exposed to spruikers, have lower land content, greater competition for tenants and less likely to see capital growth, as they aren’t usually in areas where there is high demand, and they can often be oversupplied.
Remember that many property investors invest with the goal of being self-funded retirees, and disallowing negative gearing in the current form may lead to lower investment and hence, more aged Australians reliant on welfare. Renters will also likely be affected as less rental stock will probably lead to higher rents.
On the other hand, this may open the door for cashed-up investors to invest in a high yielding property instead of earning 2% interest at the bank.
So what’s the verdict?
On balance, it’s possible that the ALP’s policy may not be fully implemented, and even if it is, some areas and properties will be affected, while others likely won’t. Some properties will always be sought after and hold their value no matter what.
For investors looking to buy now, look for growth markets in capital cities or seek a property in a higher yielding regional area with plenty of strong growth drivers like population/jobs growth and infrastructure spending that will increase demand, and therefore less likely to be impacted by any potential negative gearing changes.
It’s also a great time to buy now, especially if you have finance pre-approved. With some buyers sitting on the sidelines there is less competition and more opportunity to negotiate and purchase at a good price. Don’t rush into buying simply because you want to beat the introduction of the legislation, however; any purchase should always be well thought out. But bear in mind the longer you wait the higher the chances of losing substantial negative gearing benefits currently available.
And who knows, even if it is implemented, it may be scrapped shortly after, just as it was in 1987 after being introduced in 1985!