Will property prices will crash under Labor? How scared should you be?

Will Labor’s policies kill the property market?

With a federal election expected to be called within the next 6 months and Labor proposing some controversial reforms to negative gearing and the capital gains tax discount, the jockeying for position in the negative gearing debate has started.

Recently Prime Minister Scott Morrison warned Labor’s proposed policy to make housing more affordable could actually “invite a housing market crash.”

This echos a report by RiskWise which advised that Sydney and Melbourne’s house prices could slide by up to 9 per cent if Labor gets into power and introduces its planned property tax changes.

Similarly, CoreLogic’s head of research Tim Lawless was reported in the Australian Financial Review as saying:

“There’s no doubt Labor’s policies are adversely affecting housing demand right now as current and prospective investors fret about not being able to negatively gear and being subject to much higher capital gains tax.”

To better understand what this all about and what’s likely to be ahead for our property markets, let’s do a Q&A:

What do we know about Labor’s proposed reforms if they are elected into government next year?

Labor plans to limit negative gearing to new rental dwellings.

This will only apply to new purchases after a yet to be announced date.

Those who currently own properties won’t be affected.

They also propose to halve the Capital Gains Tax (CGT) discount from the current 50% to 25% when investors sell their property.

What was Labor’s reasons behind proposing these reforms?

The stated intention was to level the playing field for first homebuyers competing with ugly greedy property investors (my words), improve housing affordability and strengthen the Commonwealth Budget position through limiting these subsidies.

These reforms were first proposed before the last election — are they still appropriate today?

It makes no sense to me to implement a housing policy that was developed at the peak of a last boom when property prices Sydney and Melbourne prices were skyrocketing, investors were buying emotionally and first home buyers were having difficulty getting into the market.

The landscape of the Australian property market has changed significantly since these proposals were first made and this needs to be taken into consideration.

APRA’s credit restrictions, tighter lending standards by the banks in part because of the findings of the Hayne’s Royal Commission into Banking, have significantly reduced investor, as well as home owner, lending and as a result dwelling prices in Sydney and Melbourne have been falling for the last 18 months.

And the other property markets around Australia have softened.

At the same time first home buyers’ activity is back to or above long term averages in all States other than in NSW.

So there’s really no need for Labor to introduce a policy to reduce investor activity.

However, earlier this year the shadow treasurer Chris Bowen shrugged off suggestions the proposed tax amendments should now be scrapped.

Bowen said that the negative gearing and CGT changes are about making long-term structural adjustments rather than addressing the short-term property cycle.

The problem is there is a delicate balance between orchestrating a soft landing for our two big property markets (which APRA seems to have achieved) and a more significant downturn which would have flow on effects to the economy at large.

If the aim is for the soft landing to run its course and house prices to gently drop a little further before stabilising, it makes no sense to scare off investors more than they already are.

However these proposals would obviously make the tax concessions available to investors far less attractive.

And if investors withdraw from the housing market, it will remove a big chunk of demand and that’s going to have an ongoing negative impact on prices.

Just so we’re all on the same page, let’s make sure you understand exactly what negative gearing is and why a property investor would consider it

Negative gearing means that the interest you are paying on your loan and all other associated costs with your investment property is more than the income you earn and as a result you are making a cash flow loss.

What makes negative gearing particularly useful when it comes to personal tax is that any net loss from investment properties can be offset against other income that would otherwise be included in your assessable income.

This means the amount of tax that you need to pay is potentially reduced.

Negative gearing was originally introduced in Australia in 1936 to encourage investors to invest and help the economy get going after the Great Depression

More recently negative gearing has been a way of encouraging the private sector — investors with a little money, and probably paying more tax than they’d like — to invest in residential real estate and become landlords providing accommodation for those Australians who can’t afford to or who chose not to buy their own homes.

In many other countries this type of rental accomodation is provided by the government — but the fact that 30% of properties in Australia are owned by private invetsors — mums and dads — let’s the government off the hook.

If you look back in the past the Australian government provided more public housing — remember all those housing commision projects which were expensive for their budgets and in many cases were disastrous social experiments

However, it’s important to understand that negative gearing is available for other investments as well, such as shares or businesses. And on the other side of the tax equation, property investors have to pay Capital Gain Tax when they dispose of the asset.

Unfortunately, negative gearing is also a political football, which is often mistakenly blamed for increasing house prices.

The problem is that many people with only a hazy idea of what it actually is, blame negative gearing for virtually everything from locking first home buyers out of the market, to causing high property price rises, to investors rorting the tax system and driving the National Budget into deficit.

The truth of the matter is that negative gearing not an investment strategy — it never has been.

It is a funding model that is usually only used for a short period of time.

And the proposed changes will not affect sophisticated investors who have other investment income (from properties, shares or businesses) to write off their future negative gearing against.

This will still be allowed — the restriction will be that negative gearing losses from investments (like property) won’t be able to be offset against personal exertion income (wages.)

So while more sophisticated, wealth and established investors probably won’t be affected much by the proposed changes, they will be detrimental to mum and dad investors who won’t be able to write it off against their personal exertion income.

How many property investors use negative gearing?

ATO statistics suggest there are just over 2 million property investors and 1.8 million (just over 60%) are negatively geared.

If Labor did come in to government next year and did introduce their proposed measures, what impact would they have on our property markets?

Sydney and Melbourne’s house prices could drop even further if Labor gets into power and introduces its planned property tax changes.

Doron Peleg, CEO of RiskWise Property Research explained that one of the key findings of his recent detailed study on this issue is that a blanket introduction of the reforms across the country would have unintended consequences, and some local government areas, especially those with weak or fragile property markets, would be adversely impacted more than others.

His report identifies the Top 10 Local Government areas that would be most impacted if the changes went ahead as currently proposed.

These include Darwin, Mackay, inner-city Perth and Townsville.

Source: Riskwise.com.au

According to the report another unintended consequence would occur in the Sydney unit market where the proposed changes would be the equivalent to a sudden 1–1.5 % increase in interest rates.

Source: Riskwise.com.au

Declining dwelling prices, or price deceleration in some regions, would lead to a reduction in dwelling commencements and deteriorating rental affordability in some locations.

What does this mean for property investors?

There will be no change to the tax situation for those who currently own investment properties, but if there is a general fall in property prices some may choose to, or have to, sell up and suddenly their property could be seen as a secondary property to future buyers who will not be able to negatively gear it as it is an established property.

And some investors will also avoid these second hand properties because they will pay higher CGT when they sell.

It seems to me that the proposed changes would create primary and secondary markets for investor stock.

You see…investors will be driven to buy new properties, both apartments (which will generally be in the CBD) and houses (which are likely to be in the outer suburbs.)

But history shows us that both these types of property make poor investments because of their locations and will make even worse investments as, once purchased, will instantly be established properties with a thinner potential resale market.

Now we know that around 50% of investors sell up in the first 5 years, because they buy the wrong property or get the wrong finance, or their circumstances change but the proposed taxation changes will only further increase the risk of investing in new dwellings.

So these poor investors lose out in 2 ways — poorly located properties that won’t appreciate in value and difficulty selling their second hand properties.

Another factor to consider is that in time investors will require a better return is they lose the tax benefits of negative gearing.

This is the situation in many other countries who don’t offer investors negative gearing.

And this extra return will come int he way of higher rentals.

Won’t the proposed changes increase the stock of new houses and therefore affordability?

Contrary to Labor’s claims, its policies on negative gearing and capital gains tax will not increase the supply of new housing or create new jobs in the building industry according to independent economic modelling commissioned by Master Builders Australia.

They suggest up to 42,000 fewer new homes would be built over the five years following the implementation of Labor’s policies, resulting in a reduction in the value of residential building activity of between $2.8 billion and $11.8 billion.

The bottom line:

The odds are shortening for a Shorten government and in the short term this will dampen investor confidence. (See how many “shorts” I squeezed in this short sentenceJ)

The unintended consequences will also affect home owners who won’t be happy to see the value of their home falling.

And rents will rise as the supply of rental properties diminishes at a time of strong population growth.

This will mean a cash flow windfall for property investors and further harm the people the Labor party is trying to protect.

By the way…If this policy allows more first home buyers in the market do you think they’ll want the value of their home to keep falling. Certainly NOT!

Having invested for well over 40 years now, as I look back I’ve noticed that I’ve had my best years in property during Labor’s reign in government.

Their policies tend to lead to inflation which is a powerful driver of property values.

If property values drop in some locations as is likely to occur, I have no doubt there would be a significant economic flow on effect due to falling consumer confidence as they see property values falling.

This will lead to a round of government led incentives that will be the making of the next property boom.

The lessons for investors is to think long term and not to change their strategy based on short term factors.

Originally published at propertyupdate.com.au on December 5, 2018.