The impact of removing negative gearing from the economy

The impact of removing negative gearing from the economy

There has been some fierce debate on what impact negative gearing has had on property prices over the past 40 years and whether or not it is a good thing for the economy to leave the policy intact, in its current form into the future. Many Australians are questioning whether it has been the reason property has become unaffordable and whether it is keeping first home owners out of the market. I am going to break down and analyse what the potential impact of removing negative gearing might be in order to attempt to provide a balanced review of the long term outcomes:

I believe there are 5 key factors at play here that politicians need to fully consider before making a decision to introduce the negative gearing tax reform, and these are:

1. Property Investment Isn’t just for the Super Rich

There has been a lot of media commentary around the idea that property investment is a strategy used by the rich to reduce their taxable income significantly at the expense of the government. A look at the 2011 census data shows us the breakdown of how many investment properties individuals in Australia own:

 

From the data above, there are 1.76 million Australians who own at least 1 investment property and under 30,000 individuals that own 5 or more. Based on what someone’s definition of rich is, it is a long bow to draw that 1.73 million Australians who own investment property could be defined as rich and are using negative gearing and the tax concessions issued by the government to make the “rich, richer” at the expense of the everyday tax payers of Australia. 

Having been an investor for nearly 20 years, and an investment advisor for the past 3, my observation is that property investment in Australia is a strategy adopted by everyday PAYG employees, some of whom are on higher incomes (above $150,000 per annum, and of course they get a higher taxation benefit), but primarily people that are on average incomes of between $75,000 and $90,000 per annum who are looking to use property investment to get ahead and give themselves a self-funded retirement.  Australians fundamentally feel as though property as an investment vehicle is safe as it is far less volatile than other options such as shares or futures and it is also very heavily engrained into our psyche as we feel as though we know the sector well because nearly all of us live in a property. My opinion is that the government should be encouraging investment as it will ultimately save them many billions in pension and health benefit payments as our population ages in the next 10-50 years. 

2. Is Negative Gearing Really Inflating the Property Market?

If we have a look at property prices in Australia historically over the past 45 years, despite what the economy was doing, property prices have risen by around 12.62%* p.a.* compounding annually (See Graph below)

In the 70’s we had single income families where generally the male would work and the female would stay at home and raise children. In the 80’s we had an environment where interest rates reached levels of 18% per annum for home and investment loans. This was a point in time where the females were beginning to work a part time job and/or the males would work a second job to assist in paying off the mortgage. As time went on and we got into the 90’s, women started to become full time professionals within the work force and the “Recession we had to have” forced interest rates down from the historical highs we had to now, in 2016 the lowest rates we have seen in the past 55 years. The fact that households were at their highest earning capacities they had been in decades, bank interest rates were at their lowest and banks appetites for lending money against home equity started to gather serious momentum in the mid 90’s, 25 years of economic prosperity and an eternal optimism by Australians thinking things will always be good is what has been the real driver of housing prices. Sydney for example, had a median house price of $160,000 in 1990 and in December 2015 had a median house price of $1,040,000. Is negative gearing to blame for these price increases? It is very difficult to pin the blame on that policy being the cause of the housing market price growth rates over the past 25 years. 

3. If Negative Gearing is Removed or Reduced, The Government Will Have to Provide Public Housing to Accommodate “Renters” 

Something the government will have to seriously consider is what the cost of supplying ample accommodation to accommodate people who are left homeless if negative gearing is abolished as a result of investors fleeing to sell property before the cut off dates the government would introduce before the policy is wound back or removed. As was seen in 1985 when negative gearing was abolished the first time, investors exited the market en-mass prior to the cutoff date. This had a significant upward inflationary impact on rental prices as the number of investors supplying rental accommodation diminished. This policy was quickly abolished around 8 months after it was introduced as it put a real halt on property transactions occurring, which not only effected the rental market by putting severe upward pressure on rental prices, but it also put a significant black hole in the state government's stamp duty incomes that are payable when properties are transacted. Assuming investors would react in a similar way if negative gearing was abolished in 2016, how would each state accommodate for the lost revenue through stamp duty and how long would it take to implement and build the required government accommodation to suit the increased demand the loss of rental accommodation creates? Where would the government get the funding to build this accommodation and what would the impact be on rental stock that remained in the market? The big argument in the press is that abolishing negative gearing is a prudent measure as it would make housing more affordable for entry level home owners and lower income earners. If we look at all of the factors that could impact the housing market if it is removed again in 2016, it is highly probable that the cost to the government to deliver this infrastructure would far outweigh the cost of the current negative gearing concessions private investors currently receive and would have the reverse effect of keeping rents affordable for people who aren’t able to afford a home of their own. 

By allowing the private sector to provide rental accommodation as they currently do, it takes the burden off the government in having to supply rental accommodation, having to manage that supply of accommodation and also allow for individuals to provide for their own self-funded retirement in the future. 

4. What is the Multiplier Effect on Industries and Employees within those Industries as a Result of Abolishing Negative Gearing?

A major consideration for the government will be the impact on the employment of people who have jobs that directly and indirectly affect the various industries that support owners of exiting investment properties. These include professions such as:

Property Managers

Property Maintenance Service Providers

Conveyancers and Legal Services

Accountants and Financial Advisors

Suppliers of white goods and property fixtures and fittings

Real Estate Agents

Mortgage Brokers

Insurers

Building and Pest Report providers

Whilst applying negative gearing to new property is positive in the fact it provides work for building companies, tradesmen and raw material suppliers to build the new homes, on the flip side it has the ability to create a bigger problem. There would likely be a situation where many people who are currently employed full time to provide these services that are created as a direct result of the investment homes and rental accommodation supplied by private investors are no longer required or may have their roles reduced to a part time positions. 

This also has the ability to impact the government’s budget in a negative manner via the additional requirement for training of these people looking for new professions, the reduction in tax collected by these people reducing their incomes and increased unemployment benefits that would be required to be paid whilst they are looking for work. 

5. Negative Gearing Becomes Positive Income that is Taxed

If we look at the number of what the Government provides as a tax incentive based on the current taxation rules with negative gearing concessions in place, we can see that the negatively geared property turns from negatively cash-flowed to positively cash flowed in year 5 and the government begins to collect tax in year 13, (based on some very conservative estimates). The cost to the government over a 15-year period is $33,000 and as I have discussed prior, this allows individuals the chance to self-fund their own retirements, support the broader economy and job market and will ensure the government’s key sources of revenue like stamp duty do not adversely affect the state budgets.

The figure below outlines the details:

$400k Investment Financial Model

Modelling Assumptions

  • Individual's Income is assumed to be $80,000 per year with an annual increase of 3.00%
  • Property Purchase Price is assumed to be $400,000 and increases in value 5.00% per annum
  • The Purchaser borrows 90.00% of the purchase price and pays 6.00% per annum interest on an interest only loan
  • Rental Income is Calculated at $400 per Week with a vacancy rate of 8.00% per annum and a rental increase of 5.00% per annum
  • Council Rates Are Calculated at $1,650 per annum
  • Water Rates Are Calculated at $650 per annum
  • Property Maintenance is Calculated at $400 per annum
  • Property Insurances Are Calculated at $600 per annum

Conclusion

I don't believe the introduction of negative gearing reform will achieve the desired effect of reducing the entry cost of accommodation for the average Australian wage earner or first home buyer. I believe that if the government was to introduce this reform, the rich that the labor government is trying to stop from taking advantage of this strategy would use their resources and ability to pay for professional guidance to find an alternative way through another means of investment to reach the same outcome, whilst the average wage earner would then have their ability to create a self-funded retirement significantly limited. If the policy is to change, I think it would be a similar story to 1985 when the reform was introduced, in that it would be a very short time before the new policy was abolished. 

Time will tell on what the government decides to do in regards to this hotly debated reform in 2016 and beyond. 

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