Negative Gearing: The future of property investment

So many investors have been asking me worried questions about the future of negative gearing. Here is my take on it:

Let’s start by looking at some key numbers:

Investors? How many are amongst us? Are we the rich one?

According to the ATO, there are approximately 13 million individual taxpayers of which about 2 million (15.4%) own one or more investment properties. Of these 2 million property investors, 1.5 million own 1 property and only about 80,000 own more than 4 properties. So negative gearing does not primarily benefits the wealthy. Owning one or two properties will not make someone rich but it will very probably help supplement superannuation.

Materiality for government budgeting

By allowing negative gearing on investment properties, the government forgoes about $2 billion in taxes every year. Compare this to other taxes forgone by government (latest Government Tax Expenditure Statement published in Jan 2014):

  1. Superannuation concessional taxation : $32 billion
  2. Capital Gains exemption on owner occupier property : $30 billion
  3. GST on uncooked and unprepared food : $6.2 billion

The $2 billion forgone because of negative gearing is further reduced by the fact that for every dollar interest deduction claimed, there is a corresponding dollar of taxable income for the banks. So Government is only marginally impacted by this tax concession.

Understanding the numbers

Property investor are expecting to create wealth by anticipating capital growth on their investment. They need to hold this investment for the longer term and must be able to afford the cash flow requirements that goes with it. This is very much like investing in shares or any leveraged investment.

Investors are using taxation to help them with their cash flow, so that the investment risk is worth undertaking. In countries where negative gearing does not exist, properties tend to have higher yields or lower expenses so that the return to investors is reasonable. No-one in their right mind would invest in a venture that did not provide market returns. In Australia, negative gearing is part and parcel of the equation. If this is removed, the only logical outcome is that investors will have to raise rent to compensate or simply sell. In effect property prices would decline, and construction of new dwelling would slow down dramatically, creating a huge economic downturn as the construction industry employs a sizeable workforce in Australia. Last time negative gearing was removed in 1985, the effect was so severe that the very same government that removed it reintroduced it two years later. Given the reluctance of politicians to back down on their policies, it is a clear admission that it was a major mistake!

There are many more questions being asked about negative gearing:

Does it help provide public housing for people who can’t afford to buy?
Property investors certainly help with the provision of rental accommodation. It is their business! If this slows down by removing negative gearing, Government will have to start building more public housing , which will be quite expensive and troublesome.

Does it push property prices up?
There is no evidence of this whatsoever. Investors tend to think about numbers and will not over pay for a property. Owner occupiers still represent about 70% of the market are the ones making emotional buys and are more inclined to pay more. Upgraders are more likely the one pushing prices up. Also this is mainly localised around Sydney and Melbourne.

Does it prevent First Home Buyers from entering the market?
Statistics from the ABS certainly show a reduction in first home buyer activity over the last few years but by their own admission these numbers are wrong. They have been counting people applying for the First Home Owner Grant in various states, and as these have been mostly wound back, numbers naturally decrease.

Tinkering with negative gearing has only got downsides for everyone. Supply of properties will reduce, rents will go up, unemployment will go up and create a downward spiral such as the one that rocked Australia last time government removed it. Property investment is an effective tool that helps two million mostly ordinary Australians bolster their retirement and, at the same time, provides much needed rental accommodation that the government does not need to supply. What is wrong with that?