Expert Advice with Simon Buckingham 01/04/2019
The Labor Party has just announced its intention to change the way negative gearing and capital gains tax work for property investments from January 1st, 2020.
Now, before I get started, my intent is not to begin a political bunfight in an election year - or offend the sizeable segment of readers who will likely vote Labor at the upcoming election.
For the record, I'm also not an advocate of negative gearing as a wealth-building strategy.
My purpose is simply to explore the likely effects of the stated Labor policies that target investors.
These new policies targeting investors are well-meaning - however, they present some risks to property investors, renters, the wider property market and even to general economic confidence.
To this end it's important to be aware of and prepared for the policies and their potential impact.
Let's begin at the top.
Way back, on the 12th of February 2016, Bill Shorten announced an Australian Labor Party policy targeting property investors (as well as hitting stock market investors too).
Labor was unsuccessful at the last election, but has held onto this policy leading into the election this year.
Recently it was announced (on March 29th, 2019) that - if elected – Labor intends to implement the new policy from January 1st, 2020.
The policy stands to:
1. Restrict negative gearing to newly constructed homes only, and;
2. Reduce the Capital Gains Discount on investments (including shares) from a 50% discount to a 25% discount.
Here's the long-form policy, taken from the ALP website:
Labor will reform negative gearing and the capital gains tax discount to ensure that our tax system is fair, sustainable and targets jobs and growth.
Labor will limit negative gearing to new housing from a yet-to-be-determined date [now known to be January 1st, 2020] after the next election. All investments made before this date will not be affected by this change and will be fully grandfathered.
This will mean that taxpayers will continue to be able to deduct net rental losses against their wage income, providing the losses come from newly constructed housing.
From a yet-to-be-determined date [now known to be January 1st, 2020] after the next election losses from new investments in shares and existing properties can still be used to offset investment income tax liabilities. These losses can also continue to be carried forward to offset the final capital gain on the investment.
Capital gains tax
Labor will halve the capital gains discount for all assets purchased after a yet-to-be-determined date [now known to be January 1st, 2020] after the next election. This will reduce the capital gains tax discount for assets that are held longer than 12 months from the current 50 per cent to 25 per cent.
All investments made before this date will not be affected by this change and will be fully grandfathered.
This policy change will also not affect investments made by superannuation funds. The CGT discount will not change for small business assets."
The stated goals of this policy are to:
- Potentially generate $32.1 billion dollars in extra tax receipts for the Australian Government over the next 10 years;
- Increase the supply of new housing;
- Improve housing affordability for young people and middle-income-earners;
- Increase employment in the construction industry by 25,000 jobs.
These sound like noble aims, but how well does the policy stack up to these goals?
The Short Term Effects of Shorten's Gambit:
If it is implemented, Bill Shorten's new policy is likely to create a surge of investment ahead of January 2020 if Labor is elected...
...but ironically this WON'T be investment in new housing, despite the intentions of the policy.
Experiences like the introduction of the First Home Owners Grant in 2000 and the First Home Owner Boost in 2008 have clearly demonstrated that people will bring forward property buying decisions when given a financial incentive to do so.
We can therefore expect investors to race to secure tax concessions on established properties ahead of the implementation of the new policy.
This is because any investment property purchased before January 2020 would still be entitled to claim full negative gearing benefits and the 50% CGT discount into the future.
Just like the introduction of First Home Owners grants, the effect of this in the lead-up to the implementation of the policy will be to increase prices, and actually reduce affordability - while raising no new tax revenue.
(The exact opposite of what Labor wants to achieve.)
Incidentally, this would create an opportunity for investors who already hold property to "cash-in" on the feeding frenzy, by selling their properties at a premium in the lead-up to January 2020.
The Post-January 2020 Effect
In Part 1 we covered the likelihood of a potential surge in house prices preceding the introduction of the Labor's new property tax policies ahead of January 2020, as investors rush to secure existing negative gearing and CGT benefits on established housing.
But what's likely to happen after January 2020?
For one thing, if investors bring forward purchasing decisions to get in ahead of the change, then this could result in a "vacuum" in demand immediately following the introduction of the change.
While this might cause some short-term volatility for house prices in some areas, it's unlikely to "crash" the property market.
History provides similar examples where First Home Owner incentives were cut back on established housing, leading to a rush of activity before the cut-off date, followed by a short-term lull in activity before the market normalised again.
However, investors entering the market after January 1st 2020 would experience higher after-tax expenses on established properties that they acquire, and reduced CGT concessions on any future sale of those properties.
In other words, the cost of ownership for property investors would be higher - as many previously deductible expenses that could be paid in pre-tax income would need to be paid from after-tax income.
What does this mean in real terms?
Here are the numbers...
As of November 2018, the ABS estimated the average adult in full-time employment was earning around $83,000 per year - placing them in the 32.5% marginal tax bracket.
Meanwhile, a recent study ("A Snapshot of the Australian Taxpayer", published in the December 2018 Australian Accounting Review) found that the average negative gearing loss reported to the ATO based on data from the 2013/14 reporting year was $8,604.
Taking these figures, the cost of owning a typical negatively geared investment property stands to rise by $2,796.30 per year under Labor's proposal to abolish negative gearing on established rental properties.
That's $53.78 per week.
Or around 3.4% of the average full-time employee's weekly budget.
Although it may seem like a relatively minor amount of money - and that "rich landlords" are an easy target - landlords aren't a bottomless pit of money.
The extra $53.78 per week has to come from somewhere...
The "Push" Effect On Rents from Landlords
Since property investors only have limited amount of income with which to pay property ownership expenses, the likely effect of property investors under pressure may be a "push" factor on rental prices - where investors put pressure on rental managers to increase rents, and attempt to recover these higher ownership costs.
This stands to affect both potential home owners who are currently renting - reducing the amount of income they can save towards the all-important home deposit (which is perhaps the BIGGEST factor affecting affordability - not the actual repayments on a property).
Plus, it stands to affect those who can LEAST afford it - those who are on low incomes and currently renting.
…And The "Pull" Effect On Rents from Renters Themselves
The majority of property sold or rented in the market isn't newly built.
Instead, it's established property.
People who rent typically want to live somewhere convenient - close to where they work, where the kids go to school, and near the amenities and activities they enjoy (cafes, shops, sports etc.)
They don't want to rent in new housing estates on the outer fringe(something Labor’s policy makers somehow consistently fail to comprehend).
And this tax plan provides a disincentive for investors to buy established houses and make those properties available for rent.
Over time, the effect of this policy will be fewer houses available for rent where renters actually want to live - hitting family homes in established suburbs the hardest (and possibly directing investment towards already oversupplied new apartments in capital city CBDs and new housing estate developments in outer suburbs).
This stands to create a lack of "rental supply" in established areas.
As Economics 101 tells us, low availability (low supply) and strong demand means high prices, as tenants will have to compete for increasingly scarce housing stock.
And this competition for the limited supply of nicer family homes in established areas stands to further increase rental prices.
Impact on Established Property Values
At the same time rents are rising, it's possible that prices may fall for these established properties. Especially in areas where a high portion of properties are owned by investors, when those investors attempt to resell their properties but other investors might not be so willing to buy.
These drops would not just affect investors - but also existing home owners in these areas too.
This is the flip-side of the affordability debate… Making established property more affordable to new home buyers means making it less valuable for existing home owners and investors.
It's worth noting here that for most Australians, their home is their single biggest asset and contains most of their wealth. The potential impact on established home owners' property values seems to have been glossed over in Labor's policy, but could be a grave concern to many voters.
While prices might fall to some extent, for the record I'm certainly not suggesting that this would burst any imagined property “bubble” or that property prices would go into free-fall and drop 30%-50% as some sensationalist articles have claimed recently.
A more likely scenario in most established areas would be a levelling out of prices or more modest falls.
And if values do drop in established areas, the combination of lower prices and higher rents will mean higher rental returns.
This will mean better cash flow from landlording – which would make the idea of investing in established property more attractive for investors, over time encouraging investors back into those markets (competing with first home buyers and defeating one of the claimed purposes of Labor's policy).
Eventually an equilibrium would be reached and prices would be likely to begin rising once again.
Let's get into Part 3, where we'll examine the realism (or otherwise) of the purported benefits of Labor's proposed policy for first home buyers, jobs and government tax revenues.
As you'll discover, these benefits may be questionable at best...
"Putting The Brakes On Australia's Economy"
Imagine an Australia where taxes are higher, rents are higher, and home values are lower.
Would you be likely to spend more? Or spend less?
It should come as no surprise that when taxes and rents are high, and the asset value of property is low, people are left feeling poorer.
The consequences of this are:
- Consumer sentiment turns negative
- People are reluctant to spend or invest in the wider economy
- And economic growth slows down.
Now, I'm no fan of negative gearing as an investing strategy, but experimenting with the tax regime in a way that can adversely impact economic growth is best left for times when the economy is growing strongly, not times when the economy is struggling as it is today.
At a time when there are heightened concerns about the outlook for major sectors of the economy such as the construction and retail industries, it is extraordinarily dangerous and economically irresponsible to introduce a policy designed to make people feel poorer.
This policy actually risks having an adverse impact on the economy, rather than the intended improvement in affordability for first home buyers, boost to jobs, or collection of more tax revenue from investors.
Will This Policy Actually Benefit First Home Buyers?
Even if we ignore the issues raised above, the question remains: "Will this policy actually result in an increase in the number of first home buyers getting into the market?"
The Affordability Fallacy
It has been suggested that directing investment away from established housing and into new housing will somehow make established housing more accessible to first home buyers.
However, this notion is based on a fantasy that the majority of renters could suddenly afford to become home buyers overnight, if only established properties were cheaper.
With rents likely to rise following the implementation of Labor's proposed policy as discussed previously (in Part 2), it will only become harder for renters to save the deposit for their first home.
Furthermore, Labor's policy assumes that if an investor sells an established property, it will most likely be bought by someone who previously rented.
But this ignores other market segments - upgraders, downsizers, location-changers - who actually form a far greater segment of the market than first home buyers or investors.
Even if investors were to buy fewer established homes, first home buyers would still have to compete with these other segments to buy properties in these established areas (where most people want to live).
Failure to Deal with the Root Cause
Attempting to stifle one element of demand to create a "quick-fix" for affordability is fundamentally flawed.
The real issue for housing affordability is not (and never has been) demand from investors due to tax breaks or low interest rates.
Instead, the fundamental problem has always been a persistent LACK OF SUPPLY in established areas where people actually want to live.
The average household size in Australia has been growing - not because families are having more children, but because their children are staying at home longer - and the number of empty properties (for rent or for sale) is about as low as you could possibly get right now.
EVERY Federal and State Government over the last several decades has failed to grapple with the supply-side issues of the housing affordability debate, and it is only by addressing SUPPLY that any long-term fix for housing affordability will be found.
Vilifying investors and accusing them of driving up prices is a convenient political football to kick around in an election year...
...But it once again shows that politicians are looking for a band-aid solution, rather than grappling with the hard task of creating any kind of genuine housing policy or reforming the bloated and cumbersome red-tape that bogs-down town planning in this country.
Ask any developer - the costs and red-tape involved in developing new housing in ESTABLISHED areas (where people actually want to live) are horrendous! (Not just developing apartments - but liveable housing.)
In large part, this is due to the multiple inefficient layers of policy, planning and regulation between Local, State and Federal Government, and substantial taxes that raise the cost of development – including GST, stamp duties, land taxes and developer contribution levies.
This is perhaps the biggest factor affecting supply - and pricing - and keeping first home buyers out of the market.
Will Labor's Property Tax Policies Actually Create More Construction Jobs?
The idea that pushing investors towards new developments will both increase affordability and create jobs through a resulting construction industry boom is also deeply flawed.
It assumes investors will gravitate to new housing...
...That the market won't adjust - with prices dropping, and rents rising - to create an equilibrium point where investors still prefer established areas, and;
...That investors are so short-sighted that they don't realise new housing becomes "established" housing the moment it's resold, losing all of its concessions.
This stands to make re-selling more difficult if fewer investors are interested in buying established properties, which actually provides a DISINCENTIVE for building or buying brand new homes in the first place.
Rather than encouraging investment in new housing developments, this awkward paradox within the policy (that new housing becomes established housing and loses its concessions on resale) could actually turn investors off new housing -undermining the construction industry, employment, and economic growth.
The Extra Tax Revenue from Labor's Policies May Be a 'Pipe-Dream'
Labor argues that the greatest benefit of its policy is the higher tax revenue it hopes to gain as a result of the reduction in CGT concessions.
But it seems likely that this too is based on a flawed assumption - an expectation that investors will continue to resell properties at a similar rate to today even after the proposed change...
If investors stand to pay more capital gains tax on properties sold, and higher holding costs (through lack of tax exemptions) on housing purchases after January 2020 - then this policy encourages investors to hold onto their properties FOREVER!
And if a property is never sold, the government earns no capital gains tax at ANY rate.
So the purported tax revenues from this policy change may never actually eventuate.
At the time of writing, the pollsters are predicting a Labor win at the next election.
This means it is entirely possible that Labor's tax changes for property investment could be implemented from January 2020.
Although it's a poorly-thought-out and economically irresponsible policy...
...Although it alienates property owners and share investors alike (millions of "swinging voters" in the suburban middle class)...
It IS a big possible change to the property market.
But will it cause property prices to fall substantially as some commentators are suggesting?
More likely it will cause established property prices to rise in the run up to January 2020, as investors with a longer-term outlook fight to secure the existing negative gearing and CGT concessions on established homes.
Ironically, we may actually see a mini property boom in the second half of 2019 if Labor is elected!
Investors looking to bank a quick gain should be positioning themselves now to take advantage of such a "feeding frenzy".
Then, once the dust settles after January 2020, property investors will likely adjust to the new regime over the medium term, perhaps by simply deferring potential future sales of properties to offset reduced CGT discounting and higher after-tax expenses, through holding their properties for longer.
While house prices might fall a little post-January as a result, it wouldn't be long before the market normalised with values levelling off and even rising again in many areas.
Alternatively, if the Coalition survives the next election then there would be no change to the existing tax regime for now. Removal of uncertainty would then likely result in house prices stabilising more quickly.
But even then, change is probably inevitable at some point in the future - whether it's in the next term of government or a subsequent one.
Sophisticated property investors therefore need to be mindful of the risk of change, the potential impact on the property market, and prepare themselves by proactively adapting their strategies rather than 'reacting' after the fact.
With all that said, there are far better ways of profiting from property investment than through negative gearing or tax concessions in any case.
Now, more than ever, it's critical for smart investors to revisit their existing portfolios and position themselves to capitalise on new opportunities for maximising profits in the years ahead - before the playing field changes.
- Simon Buckingham
For more valuable insights from Australia’s most respected property mentors and market analysts, download your free report on “How NOT to ‘Stuff-Up’ Your Property Investing!” - designed to help you invest smarter and avoid common property investing mistakes.
Simon Buckingham is Director of Results Mentoring and a highly experienced investor. Simon has been investing in property for over 15 years using a broad range of strategies including positive cash flow, renovations, property development and commercial properties, both within Australia and overseas.
Holding university degrees in Commerce and Law, and with over 10 years' experience as a business consultant, Simon turned his back on corporate life forever following the births of his two children and now spends his time investing, developing property, supporting multiple charities, and building businesses - while teaching others how they can do the same. He has personally coached hundreds of investors in techniques that can be used to profit from property in any market conditions, regularly facilitates public workshops and provides other free resources for property investors through ResultsMentoring.com, and has presented to thousands of people at property conferences and seminars around Australia and New Zealand.
Simon writes the highly regarded Sophisticated Property Investor e-newsletter and his opinions on the property market and real-world investing strategies have featured in Your Investment Property magazine, Smart Property Investment, Channel7 News at 6, Kevin Turner's Real Estate Talk, and Property Observer. He is co-author of the critically acclaimed property book The Real Deal: Property Invest Your Way to Financial Freedom, and a founding Mentor in Australia's award-winning personal mentoring service for property investors: the RESULTS Mentoring Program.
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.