Anna Porter, a former valuer and property investment expert tells us how the market will be impacted if the negative gearing reform comes to fruition.
As many know the opposition leader, Bill Shorten has proposed significant changes to negative gearing in Australia. He proposes to remove investors’ ability to claim on negative gearing for established properties, and only claim on new properties. This will have a grandfather clause so that people with existing properties that have purchased prior to the budget coming into effect (proposed 2017 budget) will retain the negative gearing functionality. So if you have been thinking about investing for some time and not made a move, I would suggest you start now to get ahead of any changes.
The current Liberal government has said they will not be taking such an extreme line on negative gearing, but has alluded to the fact that they will likely tinker with the negative gearing tax structure to some extent. The exact plan is yet to be unveiled by the Liberal Government.
So the big questions are, how will this impact the property market if it does occur and what could the Liberal Government be planning to do?
Firstly, it is important to note that the more severe changes are being proposed by the opposition leader and not the current government. So the first big hurdle is for them to be voted in before any changes can take effect. So if you don’t like what they are proposing, vote for the other guy!
Secondly, the grandfather clause will protect existing investors. So the focus remains on how it will impact on the property market once the reforms are implemented – assuming it even gets that far along the political agenda.
Market Fall Out
Assuming Labor get into power, the first thing we will see is a frenzy of investors hitting the market to invest before the cut off date. This will create a short-lived boost to the property market, where buyers will have to pay a premium to get into the market, which is why you shouldn’t wait until the few months before any changes to invest. This will be reminiscent of when the Government reduced the first-home owners grants of stamp duty exemptions coupled with up to $14,000 grants, down to just a smaller grant for buying a new property. This occurred around 2005 in NSW and varies from state to state, but all have seen significant decline in this scheme over the past few years.
Cast your mind back and there was a big frenzy in the lead up to the cut off and all the talk of how it would make the market crash once the incentives were stripped away.
But that did not happen. The market just slowed for 6-12 months, which was a welcomed relief after the frenzy in the lead up.
At Suburbanite, we expect a similar phenomenon to occur. A slowing of the market in general while buyers and investors gather themselves and get used to the new ‘norm’. From there we will see some equilibrium return to the market. You need to remember, that investors do not make up the entire market and they only account for a small proportion of the property buyers.
Another example of how the market fares major economical change is the GFC. If you cast your mind back to the GFC, that impacted the property market but not as dramatically as many think. At Suburbanite we sit at the forefront of the data and corelogic reports show that the average declined in values during the GFC was 5%-10% across the capital cities. Admittedly, in our experience we saw some outlying markets get hit harder. But in the instances where the property owner got the fundamentals of buying a quality property right, they weathered the storm and didn’t see too much fall out in pricing.
Interestingly, in 2010 the Melbourne market recorded a 25% increase in values. This was just after the GFC! So Melbourne investors were thinking, “what GFC”.
Do we really think that this proposed change in government policy will hit the market harder than the GFC? I think not.
Markets That Will Get Hit Hard
The market sectors that will get hit hard are the markets that are driven solely by investors. For example,
- tourism hubs where investors often flock,
- serviced apartments or holiday letting style properties that do not achieve a positively geared ratio,
- oversupplied unit markets that are often investor heavy, especially in locations like the Gold Coast or Tropical North East Queensland,
- newer housing estates that are not established and have high investor activity, typically where the supply outstrips demand within the local market.
Markets that do not appeal to home-buyers will be the problem. So this is where you have to go back to your fundamentals of investing. If you buy a good quality property, in a location positioned for growth and tap in to multiple market demographics then you will push through the pain and still have a property that will perform well over a mid to long-term strategy.
What Will Liberal Do?
The Liberal Government still has to unveil their firm position on the matter, but it has been insinuated that they will likely tinker with the tax structure also.
Some speculation around what they might do includes, limiting the number of properties you can claim negative gearing on. They may limit it to 3,4 or 5 properties within a portfolio. This is not such a bad move really. Why should the rest of the tax payers have to subsidize investors with 20 or even 200 strong properties in their portfolios through the tax system?
This could create a good balance within the system. Still allowing the Mum and Dad investors that are trying to get ahead continue to build wealth for their future, so long as they build a modest portfolio. Which is typically what most of our Mum and Dad investors want to do, buy just one or two quality properties that will perform rather than fill their portfolio with a whole heap of regional properties.
If Labor gets its way, there is another market sector that this will impact more significantly. This is first home buyers. We are seeing a phenomenon whereby first time home-buyers that can not afford to buy a property to live in are redeploying their money and buying a more affordable investment to get onto the property ladder. We call this the stepping stone strategy at Suburbanite. We help them get closer to their dream home step by step with smaller investments that build wealth for them along the way, thus adding to their deposit power for them to eventually buy a dream home to live in.
Negative gearing is a big part of this strategy as it allows them the affordability to build a small portfolio and makes is more achievable for them to get there sooner. If it were to be limited to 4 or 5 properties this will still be a great strategy for first home-buyers to get into the market, but with no negative gearing it may become unattainable.
The oppositions proposal will stifle first home buyers trying to get into the market through investing in more affordable locations, as the areas they live such as Sydney, Melbourne and Perth are typically too expensive for first home buyers to get into these days. But they need to live there for work.
“It would be a shame to see the opposition put in place a policy that creates more hurdles for first home-buyers.”
Making Developers Rich and Mum’s and Dad’s Poor
The bad news is that if the reform includes new property still having negative gearing concessions and established property not having any, this will mean a lot of investors will go for new properties over established ones just for the tax benefits. They will overlook the quality of the investment and the market in which it is located and in many cases buy a property that will have no growth because they were distracted by the negative gearing.
Typically the new unit markets get quickly oversupplied and they significantly under-perform as over supply is the single biggest risk to the performance of any investment. This is also the case with many newer housing estates, they are over supplied with new house and land packages resulting in downward pressure on growth and rental returns. If investors converge on the same market, the rental market will become oversupplied in that sector resulting in low rental returns and high vacancy rates for new stock.
For example, according to Australian Property Monitors data new units in Brisbane CBD saw a decline in values by 5.9% for the 12 months to October 30, 2015. This is the exact type of property that would attract investors if they are focused on negative gearing but due to the overwhelming supply of units to the market, this type of investment is exactly what will not return good capital growth for many years to come.
Resulting in developers getting rich, and the associated investment firms will also get rich – some firms only source new and off the plan investments through developers, taking a hefty kick-back from the developer on the way through – typically about $50,000 per property. They too will reap the rewards as investors will focus on these types of properties. All the while the Mum’s and Dad’s are not seeing any growth and their rentals are declining. This will stop every day Australians from securing the financial security they deserve and can achieve through strategic property investment as the distraction of negative gearing will leave investors making bad decisions.
Investors Will Need To Be More Savvy
If the reforms come through, investors will need to really look at what their investing for. Are they looking to build wealth and achieve strong capital growth for their future, or are they chasing rental returns? Property will still be able to build wealth for investors but they will need to really employ the fundamentals of getting into the right markets and buying properties that appeal to a market that is far broader than just investors. This is something we always do for our clients at Suburbanite irrelevant of the tax reforms looming. We also ensure that if we are buying a negatively geared property, they have the capacity to hold the property on a before tax basis so that they never feel financially stretched. The tax deductions are not the entire strategy, they are the icing on the cake. First we must get the cake right!
If they are chasing a rental style strategy then this should not even be a concern. You will be buying a neutrally geared or positively geared property from the outset and the negative gearing will not impact you.
If negative gearing is limited to a certain number of properties, and not scrapped all together investors will have to be more savvy with their purchases and make sure they buy fewer quality properties rather than lots of average ones and hope for the best. This will also wind down the overly aggressive investment strategies that some firms promote and is often just an over leveraged, under preforming house of cards waiting to topple over. So I am not opposed to that occurring in all honesty.
Secondly, if clients are only able to negatively gear a limited number of properties, this will make investors become savvy with how they build their portfolios. At Suburbanite we typically build a portfolio as a one for one strategy, where by we secure a good growth property to anchor the portfolio and that is typically negatively geared, then the second one is a strong income property to protect the investors cash flow. We then repeat this until we have a good balance of growth properties and income properties. Then when the investor wants to step back from work or retire they sell down the growth properties, use that equity to pay off or pay down the debt on the remaining income properties and those properties are their cash cows for retirement. They retain a few properties with low to no debt levels.
At the end of the day, investors generally go into investing with the goal of building wealth. This will still be achievable with the proposed reforms and the impact to the property market will be short lived. We just caution investors not to be distracted by negative gearing if they limit it to new properties, and ensure that you focus on the fundamentals of investing.
Invest NOW to secure your negative gearing
Given the proposed changes will most likely have a grandfather clause, if you have ben thinking about investing and want to get the best of both worlds – a great property AND get in before any changes occur, then time to stop thinking about it and start your investment journey. You can book in for a complimentary strategy session with us at Suburbanite by calling 1300 245 490 or emailing team@dev.webbird.info/suburbanite. We can help investors Australia wide.
Don’t wait until a few months before any changes come through to invest or you might be left paying a premium for the property, which is a false economy.
Want to know more about negative gearing – see Kochie discuss it here