There has been so much press lately on negative gearing and the potential changes that could be made and what sort of impact that would have on property investment, I have decide to devote this newsletter solely to negative gearing and the possible changes that could occur.

What is negative gearing?

When the expenses of holding a property are higher than the income coming in, the property is negatively geared. Most people believe that it is when the interest repayments are higher than the rent the property is negatively geared. This is not the case. There are many other expenses that are incurred when holding an investment property that need to be included. Some of these extra expenses can be either “cash” expenses or “non-cash” expenses. The difference between the two is that “cash” expenses actually take money out of our pockets while “non-cash” are just book entries. The biggest and most important of these “non-cash expenses” being depreciation. It doesn’t actually cost us anything but we are still allowed to claim it as an expense. It can be in the vicinity of $10,000 per year on a new house.
The “loss” that is created by the difference between income and expenses can then be used to reduce our taxable incomes.

Example:

Rent $20,000

Expenses
Cash $18,000
Non Cash (depn) $10,000
Total Expenses $28,000
Loss $8,000

If my tax rate is 30% overall then I would save myself the equivalent of $8,000 x 30% = $2,400

When you take into account the tax refund of $2,400 it actually makes the property cash flow positive by $400!

You can see why negative gearing is such an important thing to a property investor. It enables you to hold property at little or no cost and still get the capital growth.

What are the various political parties are proposing and the impacts.

Liberals

The liberals are very much opposed to abolishing negative gearing altogether or even limiting it to new houses. No one is really sure about what they intend to do but they are looking at some sort of limiting factor being either the amount you can claim or the number of property investments you can claim on.

Hopefully they have taken into account that an investor needs to have at least 4 properties owned outright with no debt to be able to live comfortably in retirement. If they were to limit it to any less then say 6 houses, this would be a pain but I think this would affect a minority of people. But I can’t really see that helping either revenue raised or housing supply. A clever investor will just buy property under different entities to avoid those issues.

Labour

While I am sure the leader of the Labour party Bill Shorten would like to abolish negative gearing all together, he would be happy to settle for at least to reduce it to new property only.

Negative Gearing abolished altogether

If it was reduced all together, this would have a significant impact on the housing market. Firstly, there would be a lot less new houses coming onto the market which would mean a reduction in supply. This would increase rents significantly because there would be less to select from for tenants. Whenever there is a reduction in supply of a product and demand remains consistent, there will be an increase in price.

It is hard to say whether there would also be an increase or decrease in values. Although supply would be greatly reduced, so would demand because of the increased cost of owning an investment property. I think initially prices would drop with nervous sellers flooding the market but later it would reach an equilibrium and price would hold steady. I think the increase in rents would eventually see holding an investment property costing about the same as it is now.

Negative Gearing Reduced to new houses only

If this was to happen it would negatively affect the value of a second hand property. It would instantly remove the majority of investors from that market thus reducing the values. Conversely it would make it easier for those looking to buy a home to get into the market with the reduction in price which is a good thing.

New houses would attract a premium and builders would do very well and I think the construction industry would benefit. However, it would definitely make it a two tiered market of old vs. new houses.

Summary

The Liberals idea of reducing the amount claimed or the number of properties able to be claimed on, while it will only affect a very small number of people, it would not really serve any benefit. It would not raise much revenue nor would it help increase housing supply. I don’t think it is a good solution.

While I don’t think Labour will abolish negative gearing altogether the proposed plans to limit it to new housing only is not a bad thing. It would help home buyers get into the market, it would stimulate the construction sector and bring a lot of new supply onto the market.