Why The Government Won’t Kill Negative Gearing

Below is an article I came across published on www.buyside.com.au, seems to explain a few things that most of us don't think about this subject and how it could effect the Australian housing market. Interseting read...

Why The Government Won’t Kill Negative Gearing
Given the posturing from both political parties over negative gearing over the last few days, it’s important to make comment, however, my personal opinion is that there are more important economic scenarios on the horizon for the property market, which I will discuss in coming weeks.
Before I start, I do want to emphasise the below is written with no political affiliations and is merely an analysis of what could happen in the residential market, should a policy similar to the one the Labor party proposes, gets introduced.

The details of Labor’s policy announcement are a bit scant at present, but essentially you would think the proposed policy change would mean that if you purchased an established property after July 1, 2017, then any net loss you make on that property [rent – (interest + costs)…say $8,000 a year], could not be offset against your personal income, and you would not be entitled to a tax refund on that property. That is, you would have to wear the loss.
Whereas, if you bought a new property, the cost of holding the property (say $8,000/year) and any allowable deductions (say another $8,000/year), would then be allowed to be offset against your personal income tax (as is the case now). This can be quite a sizeable chunk of money, and could certainly sway the average property investor to include some “developed” property in their portfolio.
Economic forces will go to work however, with the below scenarios likely to eventuate should this policy be put in place by any party.

New property will be priced at a premium to established property.

This may be done through forces of supply and demand (more buyers attracted to new property). However, the developer is not an irrational person! He sees that his product now has extra value to a property investor… say $5,000 a year in tax refunds to the average Australian. The developer calculates a value of these tax deductions to the ‘average investor’ over the long term (say 10 years), and prices his product at that premium to an established property! In this case, the value of the $5000/year deductions in today’s terms (the Net Present Value), is $42,651. The property developer could theoretically price his product at a $40,000 premium to an established property of the same type, and the average Australian would still be getting value!

Rational property investors will unlikely purchase a new property at a premium, knowing as soon as they bought it, its capital value would fall IMMEDIATELY once they have purchased it(new car showroom anyone?). That’s right!! Once a property investor purchases a new property, it’s not new anymore and the next person they sell it to, cannot take advantage of ANY negative gearing incentive. Thus the premium disappears!

How a bank finances a new property will likely be impacted, a bigger deposit will be required…maybe 30-40%! The bank knows if they get caught as mortgagee in possession when a borrower defaults at anytime, that property will also be worth less in the secondary market than what the buyer paid. With such a high deposit required, a new property is unlikely to be the domain of the first home buyer!

Yields on established properties will rise as negative gearing is no longer allowed, and the market adjusts to this policy change. This happens in 2 ways: either property prices go down, or rents go up. It may end up being a combination of the two, but my best logic says that rents will rise as investors demand a greater return for their purchased product. Long term investors are unlikely to sell their properties at a discount if the effect of this policy is to keep prices low in the near term. Thus, there will be less established stock on the market to buy (established property is cheaper don’t forget), and thus there will be more demand for rental accommodation until the right properties come along.

The rising rent makes it harder for the first home buyer to save for their deposit. No explanation required here.

My take on this policy is it is very difficult to allow negative gearing on one type of property and not the other. For mine it needs to be available across the board, or you get rid of it completely to maintain some sort of status quo, otherwise the result will merely be a transfer of wealth from taxpayers to developers at the initial sale of the new property.
The Liberal party has made some comment in the last 24 hours that they will either look at one of 2 things:
1. Reduce the number of properties a taxpayer can negatively gear;
2. To cap the amount of investment losses that taxpayers can offset.

At present, there is probably even less clarity on how this would be implemented, so I will off until it is a little more transparent. I will say though that my initial thoughts are it is unlikely to create a two-tier market like a ‘New Property Negative Gearing’ policy is likely to do.

There are several arguments that negative gearing in its current form does not promote enough new housing. It is true, more established properties are purchased and offset using negative gearing, but the reality is, we do have more established properties than new properties! What negative gearing does do is reduces the burden (cost) on the Government to provide housing by allowing the more efficient private sector to take on the risks. It has been very well described in a piece back in 2012 by RP Data’s Cameron Kusher. http://goo.gl/FNYv5q

With the awareness that it is intended to add a more light on the superficial one-liners the media reports on, and throw out some thoughts, that as of yet, I haven’t seen from the press or right wing proponents of either side of the fence.
Written by Ben Weeding.
Full article can be viewed at https://buyside.com.au/17190-2/