As Labor party announces its plans to do away with negative gearing on existing houses, the idea has stirred controversy about the future of the rental market and the impact on mum and dad investors.
The policy aims to make property buying more accessible for first home buyers, especially the youngsters. While it is easy to judge that negative gearing is the evil leading to the rich investors getting richer, read on to understand what negative gearing actually means and how the proposed reforms may affect you.
What is negative gearing?If you own an investment property whose costs overrun the rental return, the ATO allows you to offset the losses against your taxable income. This principle of negative gearing applies to other investments as well, but is most widely used in terms of investment properties.
Owning an investment property has associated cash costs in the form of interest payments, insurance premiums and maintenance costs, and non-cash costs in the form of depreciation costs.
If you add both these costs and they exceed the rental income, then you can claim the net loss against your other taxable income.
However, negative gearing is not an investment strategy but an incentive to encourage investors in the market. A negatively geared property can be a good investment only if its value rises significantly, which is unlikely if the property cannot even make good its costs with rental returns.
According to latest statistics released by the ATO, about 1.3 million Australian investors use negative gearing for tax concessions. 70% of these investors earn less than $80,000 a year.
Negative gearing has definitely encouraged people in the lower and middle income groups to invest in property. However, there is another side of the statistics that cannot be ignored. While 70% of the investors fall under the $80,000 slab, most people in Australia also fall under the same slab. This means that 30% of the investors who negatively gear belong to the very small group of high earning individuals in the country. Thus, the proportion of high-income investors taking advantage of negative gearing is much more than the group this strategy aims to serve.
The proposed changes to negative gearing
The Labor party proposes to confine negative gearing to new constructions from July 2017 onwards. Further, capital tax discount would be reduced to 25% from 50%. The policy aims at raising $32 billion in 10 years. This move plans to leave the current 1.3 million negatively geared investors untouched.
How will these changes affect the property market?
Existing dwellings – Given the grandfathering provisions for existing investors, it is possible that investors would be in hurry to add an established property to their portfolio before the reforms kick in. This can mean a potential hike in the prices of established properties for the nine-month period leading to the reforms if Labor has its way.
New constructions – As negative gearing stays in place for new dwellings, it is hoped that there will be a surge in housing construction adding more houses to the market that would finally lead to leveling of property prices. As the housing market is quite short on supply end, new constructions can fulfill the demands of first time buyers.
Labor expects to create more supply and bring down property prices by almost 10 per cent. However, with negative gearing in place for new constructions, it could have a reverse impact with both first home buyers and investors competing in the same market.
Rental rates – Investing in property is lucrative as negative gearing makes it a win-win situation. However, if landlords are no longer able to claim concessions for their losses, they may drive up rents to make good their losses. However, rental rates are mostly dependant on demand and supply and negative gearing does not really impact these. As landlords of positively geared properties are not affected, even if the affected investors decide to hike rates, tenants opting to move out can be a deterrent.
The final word
Negative gearing was aimed at creating more supply in the market by encouraging investors to borrow and invest in property. It is also true that most investors borrow to fund existing property purchases, which defeats the purpose of any new houses being added to the market. Labor party aims to resolve this parity and make the property market a fairer jungle. However, unless the changes actually get implemented, the announcement is only going to spark off endless debates shrouding the real estate industry in more myths and speculations.
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By Vidhu Bajaj