A very narrow gap between gross rental yields and mortgage interest rates is a buy signal for investors.
Too much negativity regarding possible gearing and capital gains changes
(Originally published in The Australian Financial Review 15 October 2018)
Bill Shorten may be prime minister by December. He will be odds on for the Lodge should the government lose the Wentworth by-election and its parliamentary majority this weekend.
Labor’s policy to change the rules on negative gearing and capital gains tax for residential property will then become government plans, to be enacted perhaps as soon as budget night in May 2019.
Property investors therefore need to understand the detail and implications of these changes. But it must be done in a clear-eyed manner. Put aside your personal politics or your like or dislike of this politician or that politician. Be wary of the pronouncements of those who claim the outcome will be a disaster for property prices or those who say it will be wonderful for affordability. It is likely they are conflicted.
As investors, we’re simply interested in understanding whether we can still make a sufficient return on our property assets or whether we should switch our funds elsewhere. If we can conclude we can make money, then it’s likely most other participants can as well, and the market will adapt without too much fuss.
Labor plans to abolish negative gearing from a yet-to-be-announced date for purchases of established property. New property will be exempt from the rule changes. Labor also intends to pare back the capital gains discount for investors from 50 per cent to 25 per cent. Current arrangements will be grandfathered.
The doomsday scenario is that there will be a rush to the exit by investors and that property values will slump before enough buyers are brave enough to take up a glut of supply.
This scenario simply isn’t credible. It supposes a collective leave of senses. We know the grandfathering provisions means that current investors won’t suffer any change in their cash flow costs when the new rules commence and they will keep their 50 per cent capital gains tax discount for when they eventually want to sell. The vast majority of this group will sit sensibly on the sidelines.
We also have the ‘death-by-attrition’ scenario. This is where the property market enters an unending Narnia-type winter, as Labor’s policy commencement tolls the death of new investors. The market limps on, barely sustained by home buyer-driven transactions, so never again having the vitality and capital growth of the last 20 years.
No, that’s not going to happen either. I calculate that the end of negative gearing will increase out-of-pocket costs for most new investors by around $200 to $300 month. That will be an unwelcome shock, and arguably an excessively draconian move to do in one fell swoop. But some of the loss of tax benefits will be offset by higher rents, as landlords take advantage of low vacancy rates in most markets to share the burden with tenants. It is also likely that property managers will be squeezed on their fees a little as part of the pain sharing process.
Ultimately, the negative gearing issue is mostly a temporal cash flow one. Under the Labor plan, the gearing losses that could previously be claimed back in the same tax year will now have to be stored up and set against future investment income or capital gains. Sure, the present day value of a claim in say ten years is worth less than the same nominal amount secured today. But it underlines that the impact of Labor’s policy would be less severe than many suggest – but it is a point the policy’s proponents need to do a better job at explaining.
Finally, I believe the reduction in the capital gain tax discount is irrelevant to medium-term market dynamics. Put simply, rationale individuals aren’t going to stop investing in property just because they are only receiving a 25 per cent discount on their capital gains tax bill. It will be sad not to obtain 50 per cent, but it is still a discount. Saying that, we may see a boom in investor activity – and prices – in advance of the introduction of the new rules.
Also available: TV interview on this subject by Your Money with Jarrod McCabe, here.