Will removing Negative Gearing help Housing Affordability?

The Reserve Bank wants the Govt. to remove negative gearing as a Tax deduction so I have been asked to give my thoughts.

The first thing I want to make clear is removing negative gearing will NOT fix the problem.

And the second is, I could write a book on this subject but I will try to be as brief as is possible to explain what is a complex and far reaching issue.

The problem that most Australians want to fix is, housing affordability, but as you will see in the following paragraphs negative gearing is only a very minor part of housing affordability and in fact its removal might make things worse for young Australians wanting to buy a home… while not slowing property investment by anything appreciable.

So let's look at it in a bit more detail...

 

There are 2 aspects to Negative Gearing to consider:

·         Financial and

·         Functional

 

Let’s look at just the numbers first because it will demonstrate that the negative gearing Tax refund that investors receive is only a very minor incentive to invest in property. In fact it helps the tenant arguably more than it helps the investor.

 

From an investment point of view, property is a good investment because it has consistent growth with low volatility. It has been quoted that on average property doubles in value every 10 years. While that is not true of all property it is reasonable to expect that sort of growth whether a particular property doubles every 7, 10, 12 or 15 years (the true nature of property growth is another subject worth discussing in another article).

 

For the sake of this exercise let’s assume that a particular property doubles in 10 years ie 7.2% per year and let’s assume that growth is consistent each year (which it is not) but for the sake of simplifying this example.

 

Let’s also assume that interest rates for the mortgage on the property are 7% (Australia’s average). Rates are currently less than 5% making negative gearing deductions almost non-existent in today’s property market anyway, and hence the ridiculousness of the argument to remove it.

 

So a property investment is costing the investor 7% per year to hold (mortgage) plus holding costs (Council Rates etc.) on average those cost would add to about 1% to the property cost.

 

So the total holding costs are about 8% of the asset value each year (based on average Bank interest rates).

 

To reduce those holding costs the investor will receive rent from a tenant of about 4.5-5.0% of the property value (in South Australia).

 

So a negative gearing deduction on such a property would be 8.0 - 4.5/5.0 = 3-3.5% as a negative gearing Tax deduction at the investors marginal Tax rate. For the average investor that would reduce the holding cost by about 1%, making the holding cost now just 2-2.5% of the purchase price.

 

But most property investment will also attract some Tax deductions for depreciation. On a new property those deductions could be as high as 2%, scaling down to maybe 0.5% for an older property.

 

So as you can see property is a good investment because for this example the investor is paying less than 1% of the property value to hold an asset that is increasing in value by about 7.2% per year.

 

If we remove negative gearing from this equation then the asset is costing the investor less than 2% to hold but still growing in value by 7.2%.

(Remember that this is based on an interest rate of 7% from the Banks not on current rates)

 

But negative gearing was introduced to justify Capital Gains Tax so the Govt. would have to remove or alter Capital Gains Tax at the same time, making all grains in property value potentially Tax free.

 

And then they would have to consider the inequality between property investment and share investment for both gearing and capital gains tax… and this would constitute a huge loss of Tax to the Govt.

 

Additionally the flow on effect from investors would also put pressure on increasing rents to offset that loss of cash-flow. Increased rents would make it harder for young Australians to save for the deposit needed to get into their first home. We saw this in the 80’s when the Hawke/Keating Govt. removed negative gearing. As much as you might hear on TV that rents did not increase, that is just not true. I increased the rents (as did everyone I know) on my properties by nearly 20% over a 3 year period without the loss of a single tenant.

 

So that is the financial side of the equation. Let’s now look at the functional side.

 

Negative Gearing has been around for about 30 years or more and during that time we have had what the media call "booms" and "busts" regularly, about every 7 years. So if negative gearing is the cause of this so called “boom” then why hasn't it been the cause previously?

 

As mentioned earlier, in today low interest rate environment most investors would not be claiming negative gearing deductions because their property would be positive in cash-flow so removing negative gearing to help affordability would have no effect at all.

 

Now let's talk about this so called “boom”...

 

Only Sydney is experiencing higher than average growth, but even there the current growth is less than it was in 2002-2004, in fact it is about half the growth of that period… so not really over the top.

 

Other states are growing at differing, but at reasonable rates, slightly higher than inflation which is “situation normal”.  In fact, the real growth rate is less than real inflation because the Govt. have fiddle with how they measure and report inflation to make the numbers look better.

 

So we are NOT in a “boom”...

 

The real problem for affordability is the lack of available land to keep up with demand.

 

Now the current demand is being made slightly worse by foreign investment but again removing negative gearing won’t help that situation because they don’t get to claim it.

 

For a moment let’s look at why Chinese investors like Australian property as an investment. Clean air, clean water and a stable economy, plus an exchange rate (Dollar to Yuan) that gives them about a 25% discount on the property… plus they can borrow money in China at an almost zero interest rate. That is a pretty healthy incentive to invest here.

 

So what happens if our dollar recovers and goes back from 75c to 90c or even $1 then many Chinese will sell their properties making a substantial profit just on the change in the exchange rate. And all that has happened is some Chinese investors paid the Australian Govt. a lot of Stamp Duty.

 

(We did much the same thing with USA property when our dollar was at $1.05 against the US $1. Our clients bought US property paying with the inflated Australian dollar and now that the rate has dropped to $0.75 our clients are selling at a 30% profit plus any growth. That is how capitalism works)

 

Affordable housing is a problem all over the world and possibly worse in Australia because we have such large areas of land that are under developed.

 

In Australia, lack of infrastructure spending by past Governments has become a real problem. Plus we have among the world’s highest costs of entry, Stamp Duty, Council development costs etc.

 

In years past there were still areas of land that could be developed without the need for expensive roads and services but that land has now mostly been developed and hence we are having to look up (to high density housing) and out (to green fields developments).

 

That is a Govt. problem that we need to either accept or be prepared to pay higher Taxes.

 

There are more reasons for the property affordability question like Australia’s employment centralisation (the sand pile effect) that could be discussed but I think you get the idea. It is not about negative gearing.

 

I hope that helps with your understanding of what you see on television when they talk about removing negative gearing to help affordability but feel free to call me if you would like to discuss it or any other issue around property investment.

 

 

Graeme Clark

www.InvestmentPropertyFinders.com.au

Tel 1300 131099