In the lead up to the federal budget, word has leaked out that the government is considering limiting negative gearing for residential property.
At the moment, this looks like a ‘kite flying’ exercise, which governments use to take the temperature of the electorate. But if it comes to pass, it will be the most significant change to the tax treatment of property in 12 years.
It could be the most significant change to the tax treatment of property in 12 years
What’s being talked about?
The leak said that cabinet was looking at retaining gearing benefits for newly built property, and keeping all existing arrangements in place – known as ‘grandfathering’.
But the proposal would prevent investors claiming new gearing benefits for established property after a certain date.
Why would they stop it?
The thinking behind this proposal is that it will direct investors towards new housing, which will encourage more construction and create jobs and business for the building industry.
Will this direct investors towards new housing which will encourage more construction, creating jobs and business for the building industry?
Investors play a significant role in the housing market, buying around 40% of all property on the market last year. But more than 90% of their purchasing power is directed towards established housing.
If negative gearing is removed, will investors abandon the market?
It’s true that negative gearing encourages people to invest in residential property, but it’s not the only factor.
The reason so many invest in property is because it has a record of strong capital growth and stable rental earnings, and because it is a market that most Australians understand.
Hasn’t this happened before?
In July 1985, the government quarantined negative gearing, provoking many predictions that house prices would slump and rents would explode.
But it didn’t work out that way.
During the two years the quarantine was in place, ABS figures show rents rose 22%, but in the two years after the quarantine was lifted they rose by 21%.
Similarly, data from the Valuers General shows house prices in most cities continued to rise more or less in line with the trends in place before the quarantine.
If it happens, will house prices fall this time?
If this proposal comes to pass there will be plenty of commentary in the media that house prices are about to fall, but that is very unlikely.
House prices are unlikely to fall
For one thing, the grandfathering of existing arrangements means investors are less likely to sell their property because they will lose the after-tax benefits. And those investors who have held their property for many years typically don’t receive gearing benefits anyway, because their rent exceeds their payments.
Therefore, it is highly unlikely there will be a rush of investor-owned properties onto the market.
The other prediction made by some economists is that this measure would lead to a dramatic rise in new housing construction.
That’s also highly unlikely. Housing construction in Australia has been stuck at same levels since the 1970s.
Housing construction in Australia has been stuck at same levels since the 1970s
The main factors hobbling new housing construction are limited land release for development (particularly in Sydney), high development charges and tight planning restrictions in inner and middle-ring suburbs.
It is this last factor which has proven the most potent, as it is the inner and middle suburbs – where most home buyers want to live and most investors want to invest – which have had the biggest price rises over the past 30 years. With development restrictions continuing, supply of housing in these areas will continue to be limited.
So will a restriction on negative gearing have an impact?
Yes, over time it will play its part, but other factors like the strength of the economy, interest rates and the development of housing in areas buyers want to live in will be much more important.
originally posted on realestate.com.au