What's Negative Gearing Got To Do With It?

This is Part 3 of a 4 part series on what the experts we’ve interviewed on The Elephant in the Room property podcast think is really going to happen in 2019.

No commentary would be complete without looking at Labor party’s negative gearing policy. It looks like they have an excellent chance of winning the federal election and they’re not backing down on the plan they hatched back in 2016, when the market in Sydney and Melbourne was red hot. What will be the intended and unintended consequences of this policy and what does it mean for property investors?

This is a very emotive issue - largely because it is so misunderstood. Labor are pitching it as a solution to housing affordability. What’s clear from our interviews is that, as with most things in life, it’s not so cut and dried.

Will removing negative gearing really help first home buyers?

Property advisor Ben Kingsley talks about this in episode 32. According to him, the message that “greedy property investors” deserve to have their benefits cut is a vote winner. Yet 73% of property investors only hold one property, so have they really created the housing affordability crisis?

Ben says the affordability story is misleading because removing negative gearing for established properties will affect prices everywhere other than the inner areas of Sydney & Melbourne. He suggests that it will encourage land banking in areas where
land is most valuable and this will certainly not free up property for first home buyers. While second-hand apartments will become cheaper, houses in good areas are unlikely to.

Another potential impact on future supply will come about if the capital gains tax discount is reduced from 50% down to 25%, which is part of the policy. Investors holding quality property will be less inclined to sell because they’ll have to pay more tax. This will limit the amount of good assets that could come onto the market for homebuyers.

What is rarely mentioned is the number of first home buyers who use negative gearing in order to get onto the property ladder by rentvesting. These buyers will be shunted to new builds, which is the riskiest segment of the market - about to be made even riskier due to the evaporation of the secondary market.

But negative gearing will be available for investors buying new property, so what’s the problem?

This, I believe, is the true danger of this policy, for it will encourage unsophisticated investors to buy poor assets that will trap them financially. Why? Because there will be no secondary market for these new apartments and houses. Investors who are worried about cashflow simply won’t buy second hand.

A two tiered market has already to been created to a certain extent by changes to depreciation allowances that were introduced by the Liberal government in 2017. We discussed this with quantity surveyor and depreciation expert Tyron Hyde in episode

15. He explained that, as with Labor’s proposed legislation, the existing rules don’t apply fairly, as there are different treatments depending on whether you own a property in your own name, a trust, a company or your SMSF. High income earners can afford to get advice and “work the system”. Lower income earners are already disadvantaged and will this disparity will continue.

If the policy is meant to deliver tax savings to the Labor government, then Noel Whittaker makes the point in episode 45 that this is the ultimate in short term thinking. If the average investment takes 5 years to become cashflow neutral, they might cost the Aussie tax payer around $25K, which in itself is an investment by the government because that person is working towards being a self funded retiree. Number crunchers have calculated that the true cost of a pensioner is something like $800K, and that is a poor trade-off to grab back the $25K and forfeit $775K.

Pete Wargent has done a lot of research in this area and produced a report with Riskwise which contains warnings for Labor about the consequences of pushing forward with this policy. We discussed this with him in episode 24 and he makes the case for less of a sledgehammer approach, along the lines of what Ben Kingsley had also suggested.

The Kouk explained Labor’s policy intentions in episode 43. Now, as distinct from most of our guests, he certainly seems in favour of this policy, however even he has highlighted one of the unintended consequences, and I think it’s a biggie - the opportunity for spruikers to go to town.

Probably the biggest elephant in the room was explained by Noel Whittaker: the wealthy will still be able to use negative gearing by offsetting it against other investment income because they are likely to have other assets. The real people it will hurt the most are those who NEED negative gearing in order to be able to afford to invest in quality property.

So what does this mean for investors in 2019?

Remember that buying an investment property just so you can reduce your tax is a poor idea. On its own, negative gearing is a terrible reason to buy a property. It means you have to lose money to save tax. At best, for every dollar you lose, you get 47c back. There is no justification for that unless you buy a quality asset that will go up in value.

For buyers who were wanting to invest in property and are ready to do so, I’d encourage you to get in sooner rather than later. But remember the mantra: quality, investment grade property only! If you wait until the last minute, you’ll be following the herd and run the risk of buying a poor quality asset and/or paying too much. In Part 4 of this series, I’ll cover interest rates and my podcast co-host, Chris Bates outlines what you’ll need to do in order to get finance approval in 2019.