My generation has been very vocal about the struggle they have with the high cost of property in Australia. The argument is not without merit with our 2 largest cities often ranking in the top 10 most expensive places in the world to live. Indeed in the past I’ve said that Australian property is out of reach for an average person on a single income although I did conclude that this wasn’t representative of how most Australians buy their homes. Still one target that almost always comes up in discussions around housing affordability is that negative gearing isn’t doing anything to help the situation and its abolishment would lead to cheaper housing everywhere. Whilst I’m sure my vested interest in this topic (I have a negatively geared property, soon to be 2) will likely have most tuning out before this paragraph is over I’d urge you to read on as getting rid of negative gearing, or modifying it in a way you think appropriate, won’t bring prices down like you think they would.
Taken by themselves the numbers around negative gearing do appear to be quite damning. Every year the government doles out about $4 billion worth of tax cuts to people who own negatively geared property, amounting to about 1% of total tax revenue. At the same time data would seem to indicate that investors almost exclusively target established properties something which is at odds with the arguments that investors fund new property development. All this would seem to add up to a situation where investors are locking up existing property stocks which forces potential buyers out of the market. Whilst I’ll admit that negative gearing is a factor in all this it’s by no means the major contributor and making changes to it will likely not have the effects that many desire.
One proposed changes is to limit the number of properties that can be negatively geared to 1, putting a cap on the number of properties investors can draw benefits from. It sounds good in theory as it would put the kibosh on property barons snapping up large swaths of property however the fact is that the vast majority of property investors in Australia, to the tune of 72.8%, own only a single investment property. They in turn account for just over half the total number of investment properties in Australia. So whilst limiting negative gearing to a single property sounds like a good idea it would only affect half of the investment properties in Australia leaving the rest in the same situation as before.
Limiting negative gearing to new construction is an idea I’m on board with as it will more directly address the issue of housing supply rather than pushing investors away from property as an investment class. The one caveat I’d have to put on top of that would be the curtailing of the land agencies from charging exorbitant amounts for new land releases as that could easily erase any gains made from quarantining negative gearing in this fashion. Indeed if you look at just the land prices here in the nationals capital a small, 400m2 block will usually go for $400,000 meaning that even a modest house built there will cost upwards of $550,000. If you want to attract investors to building new properties then this is most certainly an issue that needs to be addressed prior to quarantining negative gearing.
However all of these ideas are flawed when you consider that there’s a much bigger tax break at work here that’s inflating property prices. As I’ve stated many times in the past Australian housing investors are something of a minority, accounting for around 20% of the housing market. Therefore it’s hard to believe that negative gearing is solely responsible for Australia’s house prices as the majority of the market is because of owner occupiers. What I didn’t mention in that previous post is the tax breaks that owner-occupiers receive in the form of exemptions from capital gains tax. Essentially when you sell your primary place of residence you don’t pay any tax on any gains that property may have made while you owned it which puts a strong upward pressure on prices (people want to maximise gains), enabling them to trade up to bigger and better houses.
That sounds fine in principle but it costs taxpayers a staggering $36 billion a year, 9 times that of negative gearing. You wouldn’t even have to abolish this to see savings far in excess of what getting rid of negative gearing would achieve. Instituting a 50% reduction in the capital gains tax payable (like is done currently with shares) for the sale of your primary place of residence would generate $18 billion a year and put a heavy downward pressure on property prices. Hell you could even apply the new construction only exception to this as well, giving people who build new houses something like 5 years worth of capital gains tax free whilst ensuring everyone else paid up. Of course this solution is a little less palatable since it targets everyone and no just those dirty investors but it would be far more effective.
Many will argue that abolishing negative gearing is a good first step towards solving the problem but in all honesty I don’t feel it will have the impact that it’s advocates think it will. Australian investors, whilst being a factor in housing prices, aren’t the major contributor with that responsibility falling to the Australian dream of owning ever bigger and better homes. Fixing the supply issue is a multi-faceted affair and if you want to attract investor dollars to it the solution has to be much more nuanced than simply removing one piece of legislation. You might not like it, hell I don’t like limiting things to new construction but I’ll agree it would work, but we have to face the fact that targeting Australian property investors likely won’t get us very far.
Before I dig my hooks into the reasons why negative gearing isn’t to blame for high house prices (a seemingly controversial view these days) I will tell you, in the interests of full disclosure, that I’ve been negatively gearing property for the past 5 years or so. Back when we first bought our property I lamented the dearth of good properties that were available in our price range, focusing much of my anger of the property boom that took place mere years before we went into buy. However we found something that we could just afford if we played our cards right, even though it was out in the sticks of Canberra. During that time though I never once blamed the negative gearers for this predicament but the more I talk about it the more it seems my generation blames investors for it when they should really be looking elsewhere.
Depending on what figures you’ve read though I’d find it hard to blame you like the table above (from this ATO document) that has been doing the rounds lately. On the surface it seems pretty hefty with some $7.8 billion in total losses being claimed by investors with negatively geared property. Realistically though the total cost to the government is far less than that as even if everyone was on the top marginal rate (which they aren’t, most are on $80,000 per year or less) the total tax revenue loss is closer to $3.5 billion. Out of context that sounds like a lot of dosh, especially when this year’s budget came in at a deficit of $18 billion, but it’s like 0.9% of total tax revenue which is significantly dwarfed by other incentives and exemptions. If your first argument is that it costs the government too much then you’re unfortunately in the wrong there, but that’s not the reason I’m writing this article.
The typical narrative against negative gearing usually tells a story of investors competing against homebuyers (usually first timers), driving up the price because they are more able to afford the property thanks to negative gearing and the higher amount of capital that they have. Whilst I won’t argue that this never happens it fails to take into account the primary driver for upward trending house prices: owner occupiers. Initially this idea sounds ludicrous, since homeowners aren’t taking advantage of negative gearing gains nor are they in the market for new property, but the thing is that the vast majority of capital gains in Australia are held by just such people, to the tune of 84% of the total property market.
In Australia the primary mechanism which drove house prices up, with most of the increase occurring between 1994~2004, was current home owners upgrading their houses. For a current homeowner especially ones that own their property outright, the cost of upgrading to a larger property is a fraction of what it would cost to buy it outright. However anyone looking to upgrade will also try to extract the maximum amount of value out of their house in order to reduce the resulting loan and thus the cheaper priced houses get pushed up as well. Couple that with the fact that the majority of Australian owner/occupiers move at least once every 15 years and that selling your primary place of residence is exempt from capital gains tax and you have a recipe for house prices going up that’s not predicated on negative gearing’s influence.
Indeed the ABS Household Wealth and Wealth Distribution supports this theory as the average value of an owner occupied property is $531,000 which is drastically higher than the Australian average (which includes all investor properties) at $365,000. Considering that the bulk of the Australian property market is dominated by owner-occupiers (since investors only make up 16% of it) then its hard to see how they could be solely responsible for the dramatic increases that many seem to blame them for. Most will retort that investors are snapping up all the properties that would be first home owners would get which is something I can’t find any evidence for (believe me, I’ve been looking) and the best I could come up with was the distribution of investment property among the 5 sections shown here which would lead you to believe that the investors are normally distributed and not heavily weighted towards the lower end.
The final salvo shot across the negative gearing bow usually comes in the form of it providing no benefit to Australia and only helps to line the pockets of wealthy investors. The counter argument is that negative gearing helps keeps rent costs down as otherwise investors would be forced to pass on the majority of the cost of the mortgage onto renters, something we did see when negative gearing was temporarily removed. Indeed the government actually comes off quite well for this investment as using that revenue to instead build houses would result in a net loss of rentable dwellings which would put an upward pressure on rents.
I completely understand the frustration that aspiring home buyers go through, I went through it myself not too long ago when I was in a position that wasn’t too different from average Australian. But levelling the blame at investors and those who negatively gear their property for the current state of the Australian property market is at best misguided and at worse could lead to policy decisions that will leave Australia, as a whole, worse off. You may believe to the contrary, and if you do I encourage you to express that view in the comments, as the current Australian property market is a product of the Great Australian Dream, not negative gearing.