Bye-bye negative gearing and reduced capital gains tax? Likely impacts
Both major parties are making passionate claims and counter claims about the likely impact of the opposition's proposed policies for negative gearing and capital gains tax.
We want to take some of the heat out of the debate and disspationately consider the detail of Labor's plans, the implications for investors and for the market in coming months and years, should the policies be enacted.
The video features Jarrod McCabe, director, Wakelin Property and Stuart Wemyss, director, ProSolution Private Clients.
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Chart 1 – Cash flow impact of negative gearing in today’s dollars
Chart 2 – Impact of negative gearing versus after tax capital growth in today’s dollars
Article by Stuart Wemyss published by The Australian newspaper.
- Thanks Stuart.
- Thank you very much for joining us on this presentation about the negative gearing changes in particular but broadly I guess lots of the tax changes that might affect property investors directly. Our aim with this presentation is really just sort of cut through the noise. So certainly from my business perspective we're independent but we certainly do have a mortgage business so I guess there is some connection there with the property market and obviously Wakelin buy property for property investors. But what we've tried to do is take those hats off and put ourselves in your shoes and with our knowledge and experience share exactly what we think are the pros and cons and the potential consequences and opportunities of these different changes without any political rhetoric and so forth. Because obviously there's a lot of noise around these issues and what we really wanna do is just put all that aside and say okay what's really going to happen? Also I've got a few charts and referenced a few articles and I've included the links to those below so if they're not legible on the video you can certainly click underneath and have a look at them. And we've got some questions from our clients that we will address at the end as well and we do apologize if we haven't had a chance to address everyone's question.
- Okay, let's get into it. Let's start really with, go through all the proposed changes by the Australian Labor Party that direct impact property. There's quite a few so certain bear with me. I'll talk about a few or at least name a few that have less impact and I will probably spend most of my focus on the capital gains tax and negative gearing changes which is the reason why you're watching this presentation. About six different changes that could affect property investors, the first on is that the ALP's proposed to cap tax advice fees at $3,000 a year. So if you've got a particular tax issue and you need to get advice on that and it's very specific and potentially costly the ALP is essentially saying we'll only give a $3,000 deduction even if you might have spent $10,000 on getting that advice. They're gonna increase the top marginal tax rate to 49%. It's currently 47% so a 2% increase there. They're mooting tax changing the way that discretionary trust are taxed and gonna apply a 30% tax rate there. That's to try and prevent people from distributing income to various beneficiaries to reduce their taxes. I must say on that one there's been commentary from both side of politics about making that change over the last two maybe three decades and nothing has been changed yet and that's a pretty significant legal change so we could probably put that one aside for now. The ALP have said that they're going to ban super funds from borrowing to invest in property so you can still do that as the law stands but certainly the pool of lenders that will lend you money for that purpose have reduced so it's a lot more difficult but still doable today. And the last two which are really the purpose of our conversation today is the capital gains tax discount reduction. So this discount will fall from 50% to 25% and I'll certainly talk about that and its impact. But essentially it'll increase the amount of tax that you pay when you sell an asset by about 50% depending on your marginal tax rate and tax position but circle 50%. And that increase in capital gains tax applies to all assets so shares and property so it's across the board there. And lastly, negative gearing. The ALP has said that it will ban negative gearing but I think this is a really key point to make Jarrod a ban isn't really a good way to describe it, it's a delay of negative gearing benefit. So they've said that if you purchase an asset on 1 January 2020 or after that you will no longer be able to offset the income loss that that asset generates against your income in that particular year. And instead what you need to do is carry forward that loss until that particular asset makes a profit. So for property that can take what? 10, 15 years or so?
- Around that sorts of levels, yeah that's right.
- Also it depends on your borrowings, what interest rates are doing in the particular time, how much money in offset you've got all these sorts of things play into it. But you will get the gearing benefits it's just gonna take a lot longer to enjoy them and so obviously there is a cost there which I'll go through is the time value of money. Because we would much rather have $1 tax deduction today than a dollar tax deduction in 20 years time. And if you sold the property, we haven't seen the legislation so we don't know the particulars. But as they've worded when you sell the property if you've still got some carried forward losses you can reduce your capital gain, use them to reduce your capital gain. The interesting thing to note though is that this banning of negative gearing or delaying of negative gearing after 1 January 2020 only applies to established property. So there's no change for new build properties. So if you're the first owner of that property then you still get negative gearing impacts which is gonna create a bit of two-tiered market and we'll certainly talk about that. They've also said that negative gearing will be banned for listed shares as well but not many share investors certainly borrow to levels that property investors do. So I think that the amount of share investors that are negatively gearing would be a significantly smaller number than property investors. So let's start with our first question Jarrod. I like to ask you, it's a question in two parts really how do you think the impact of these changes will have on the market firstly in the shorter term so obviously if the ALP wins on 18 May between then and 1 January so end of this calendar year prior to those changes coming to place and then after 1 January what do you think will happen?
Impact on market: initially
- [Jarrod] Sure look it's likely to create an increase in activity during that time. Now whether that leads to an increase in prices I think that's going to be more property and market specific. So I don't think you're likely to see an increase across the board of property prices between now and the end of 2019 but there is likely to be an increase in activity. I mean the other interesting components to it is that we're coming into the backend of August, September when the property market really starts to spike in terms of interest levels. There's a lot more activity happening and you combine that with the fact that talk at the moment is that our potentially mixed moving interest rates is likely to be down. That would could draw a few people out of the marketplace. And so you combine that with the risk or the likelihood that negative gearing is no longer going to be available you're likely to see some investors coming out of the marketplace. And so there's potential to see some prices increases in those sectors where investment property are attractive to investors or properties that are considered to be investment property. And that is likely to then probably lead to perhaps first time buyers for the remainder of 2019 perhaps taking a step back from the marketplace.
- So I think there's likely to be some increase in prices between now and the end of the year but I think any increase we do see in that specific sector is likely to disappear as soon as the 1st of January 2020 hits because there's not going to be that same level of competition from buyers across the board. There'll be still some investors who will be prepared to say yes, I'm still going to move on this because I know it's a good quality asset. But I think there will be many that will say okay if I don't get it before the end of the year I'm going to step back. You might then see the first time buyers come back into the market from there and I think then we'll probably find the market will revert back to what we're seeing at the present time.
- Yeah. Yeah.
- [Stuart] Yeah, and are you seeing increased inquiry from investors that are saying to you hey Jarrod I wanna buy an investment property before the--
- Yeah, we are starting to now. So I would say in the past probably month or two it just gradually started to trickle through. There's been more and more activity in people wanting to make inquiries whether they're prepared to commit to that process yet. Some have been but others are just making the initial inquiries. I would expect that to pick up again if we do get a change of government on the 18th of May.
Longer term impacts
- [Stuart] Yeah, yeah. And what about longer term like if we take a very long term lens let's say looking at sort of 10 or 15 years or even beyond that. What impact do you think these changes might have on the market?
- [Jarrod] Well, it depends on the sector of the market again that you're looking in. If you're very smart with your investment and you're selecting the right type of property, the type of property should never be wholly reliant on one type of buyer profile. So you can't be just purchasing properties that are focused for investors. If you did that you'd be looking at student accommodation and serviced apartments and that sort of thing where it's only an investor that's going to buy that and that should never be the case. So if you're going about it with the right manner and you're getting that multifaceted demand from the buyer profile so getting investors, getting first time buyers, getting downsizers or upsizers from the second or third type home but still a property that's got low maintenance so it's not needed to be upgraded and needing as much accommodation as possible which is more traditionally what family homes are looking for then having that multi-faceted demand means that the market is going to continue to work in your favor. You and I have spoken to the past but back in 2016 when APRA really started to clump down on investor lending and making sure that it was making it a lot more difficult we certainly noticed that investor started to leave the market considerably at that point in time. So the fact they did that, the market still continued to move fairly strongly driven predominantly by other occupiers from 2016 until early last year. So I think that there are still other factors that are going to drive that market along the term. It's not going to just be that investors but investors will get the benefit. So I think what we'll do what we'll see is that the market will probably take a plateau for a period of time and not a lot of activity and then once the new norm becomes apparent, the no longer achieving or being able to benefit from negative gearing with established property becomes the norm interest rates might increase, sorry rental of returns might increase a little bit over that time. And once people find that balance then the market will start to find its level again. I still think for good quality property there'll be certainly a place for it in a good quality rounded investment portfolio.
- [Stuart] Yeah, I tend to agree and I explain it to clients to say look notionally you want to invest in a property that notionally has say 20 potential purchasers for every one seller and those 20 purchases they could be as you say first buyers, upgraders, pure investors, owner occupiers, downgraders from lots of different industries and backgrounds and ages and so forth. So if you've got a really diverse buying group and then something changes in the economy or with legislation and so forth that maybe that 20 will drop to 15 for example. But as long as you've got an imbalance between supply and demand you're always gonna have pretty good performance.
- [Jarrod] And first time buyers will go as well at some point in time have no doubt there'll be another alteration to the incentives that are given to first time buyers whether that's increased or decreased depending on the government at the time that will change as well. And so that might take first time buyers out in the market place or it might alter where they're the most active in the marketplace. So then you'll be reliant as a home buyer on a different sector that's going to drive value for your property so having that multifaceted demand is really important.
- [Stuart] And then the other thing I would remind people about properties really over the last 40 years we've seen you know the property markets had to endure GST, recessions, share market crashes, interest rates at 18 or 19%, different governments, a different regulatory approach over the exchange rate and interest rates and so forth. It's seen a lot of changes and it's weathered the storm--
- It does.
- [Stuart] The longterm returns are still there and it really comes back to the old law of supply and demand that you can't argue against. If there's excess demand there's always gonna be price appreciation.
- That law of supply, sure.
- Alright, my turn for a question for you. So--
- Stuart, how will these proposed changes impact on new investors after the 1st of January?
- [Stuart] Yeah, so there's probably two things or two implications I guess. So I mean the first one is purely from a cashflow perspective. So as I said that is there delay enjoying the tax benefits of borrowing to invest in property and so I'll go through that in a second. I've got a couple of charts to sort of share with you to sort of put some numbers around that--
- [Stuart] And put that in context and the second thing which is a really only dawned on me over the last 48 hours and I'm actually just about to submit an article to the Australian about it is that it will reduce your borrowing capacity. So want start with that one--
- [Stuart] While I talk about it. So when the lenders calculate an the investor's borrowing capacity they obviously look at lots of different things. The amount of equity you have, your job stability, how much you spend on living expenses. And there's been a lot of commentary around how ridiculous the whole loan application processes has become. There was a story another broker was telling about the lender picked up in the valuation report for their property, there was a photo of the kitchen. On the kitchen was a photo of the child and the lender came back and said hang on, you said you didn't have any dependents. Prove to me that you don't have children. How do you do that? Anyway, what are these people doing that they're looking at the photos that that closely. That's just one of many stories and it's certainly an extreme example but the oddly other daily examples that we have aren't that much less ridiculous than that to be honest. So anyway going back to how lenders calculate borrowing capacity what they'll do is they'll calculate your cashflow position and there's one major issue is that when you go and apply for a new loan they'll make sure that you can make the repayments at an interest rate of 7.25% on a principal interest basis. Whereas if you compare if you're borrowing on an interest only basis today at a much lower rate that repayment that they calculate it on their benchmark interest rate is more than double what your actual repayments so that's a bit silly is it is.
- [Jarrod] But you've always told me though and explains to clients is my understanding is that you should always run your numbers around those sorts of levels for your own sake to ensure that it's viable from your perspective.
- [Stuart] Absolutely, you wanna make sure that you can afford the repayments but if you're borrowing an asset maybe your strategy's never to really repay the debt or at least maybe the strategy isn't reliant on your ability to repay your debt. You might choose to and so looking at it on an interest only basis I think it would be much fairer rather than the principal interest basis. But then the second thing they do is then they take into account the negative gearing benefit so that if you're applying for a loan and you're gonna use that loan to buy an investment property the bank knows that the rent's gonna be less than the interest so you're going to get a negative gearing benefits. So they'll reduce the amount of tax that you have to pay your tax liability when they calculate your ability to service the loans. So that's what I currently do at the moment and they've really I mean I started, there was a few lenders that were doing it probably 20 years ago and then about 15 years ago they all jumped on board including negative hearing benefit. Now if that law changes the bank's gonna have to obviously change their calculation. And I did some calculations last night. It'll reduce an investor's borrowing capacity by about 15 to 20%.
- [Stuart] So not only have we just been through probably, well the most severe credit tightening that I've ever seen I think probably in Australia's history. And certainly there's a lot of people commentating that the pendulum swung the completely the wrong way.
- True fact, yeah.
- [Stuart] You know maybe it was too, I mean arguably I would agree it was too loose, the lenders weren't doing enough checks and so forth but it's certainly gone the other way. Well if we then take these policy into account, that'll tighten lending even further. So it could mean, I mean if you're sitting there wondering should I buy an investment property before 1 January? There's the impact of the market and those sorts of things to consider but maybe also, maybe if you don't buy before 1 January maybe you won't be able to afford to be able to borrow the required loans so you might be locked out of the property market thereafter. No, I'm not saying that to incite fear and get everyone to jump on board but it's really just something we need to consider. But let's look at the cashflow impact because as I said I think it's been missold as the banning of negative gearing rather than delay of enjoying those tax benefits. So I'll bring up a chart for you now and I'll just sort of explain the chart. So the gray line is what a property is projected after tax cash flow will be over a 30 year period and you can see the gray line is above the green line. And the reason for that obviously is that if we don't get to utilize the income losses from the property in the year that they're crystallized we have to carry them forward then the after tax cost of holding onto a property increases. And that's the shaded, the sort of gray shaded area is the cost, the cashflow cost of the difference between having negative gearing in and no negative gearing. And if you express that in a value in today's dollars it's about 82, $83,000 over the first 20 year period. But after 20 years once the property starts turning positive cash flow we'll be able to utilize the losses and therefore we won't have to pay tax on that income for many, many years. And so the remaining 10 years actually gives us a tax benefit, a better tax benefit than what we otherwise would have with negative gearing so that's a positive $25,000. So as you can see there is a significant impact. I mean I'm not gonna sit here and say it's no big deal but what we then need to do is look at in context how much impact does it have on our overall investment returns. So I'll bring up another chart now and what I've done on this chart is I've, the red line has graphed the cumulative negative cashflow. So how much money have you really put in to the investment property? And the green line, what that tracks is the after tax capital gains. So that's assuming that on each of those years if you sold the property, paid for selling costs, repay the loan, paid for capital gains tax, how much cash would you walk away with? And what I've done is taken year 19 which is the height of the negative cash flow. That's when you've put as much money and the property's just about to start giving you money back. And as you can see and as it mirrors back to the first chart is it's costs you $83,000 in today's dollars but in context of the capital gain and this is again after paying capital gains tax at the proposed higher rate that's nearly $750,000. So in context then the changes to negative gearing are significant less alarming and have significant less impact than the changes to capital gains tax. And I would say that if you continue to focus on astute assets selection so that you're positioning yourself to really maximize your capital gain that could more than offset, well I mean it should, you can see it wouldn't be difficult to more than offset the cashflow cost.
- So I mean you mentioned before that the capital gains tax changes are not just for property they're for shares and things as well.
- Is it the same concerns around capital gains tax for shares as they would be for property?
- [Stuart] Yeah I mean essentially it's gonna retard people's ability to build wealth. You know the more the, I mean it's great to build wealth but you don't wanna lose the wealth that you build through inefficient tax structures and paying too much tax and so forth. So I'm glad, I'm really pleased that if they're going to make a change don't make it for one asset class, let's make it broad based, that's fair. But we should be, as investors that we're trying to build independent wealth. You know it's a concern that capital gains tax increase is a significant tax increase and I think the reason why it hasn't garnished to a lot of attention is because it's long dated, right? As humans we tend to overweight short term consequences and underweight the longer term consequences. Even the longer term consequences are significantly more concerning than the shorter term and I think that's exactly what's played out here but we're all long term investors, right?
- Yeah, we are.
- So we're gonna pay the capital gains tax at some point.
- [Jarrod] That probably and then we'll go into more details down the track but your point around the fact that it's good that the capital gains tax is not just for property probably brings me back to one of the other issues that I've got with the proposed changes. Which is around the fact that the changes aren't just for all types of property, it's focusing more on more of that established property and that's one of the great issues that I've got which we'll obviously expand on a little bit further down the track.
- Yeah and I've I mean I've got a massive problem with it.
- Not just from a, well I mean it's probably a good juncture to talking about it--
New property implications
- [Jarrod] So the negative gearing obviously changes are proposed to focus or to be taken away from those investing in established property. But it will be retained for those that are looking to purchase off the plan or a brand new property. So whether that's a high density, high rise type building or whether it's a house land package out in the state and whether it's regional Victoria or the fringes of the capital city. Investors in that space will still be entitled to continue to claim negative gearing. Now my issue with that is that it's encouraging investors to buy an asset that's got very minimal potential for capital growth because it's in an asset class that what we refer to as an infinite asset class. There is more and more of the same thing being built. You only have to look at the high rise, buildings around inner city Melbourne, Sydney, Perth, Adelaide, Brisbane that there's more and more of these type of construction going ahead and that's what leads to the of lack of capital growth because of that lack of scarcity value. And if you go out to what might be perceived as a growth corridor of one of these cities more than likely there's a huge amount of land to choose from it from a developer's perspective. So all that does is as soon as demand remotely gets close to meeting supply there's another land release and there's more development that continues on. So the potential for capital growth is very limited in that space and it really concerns me that that's still where you can go to. And that's where investors will say well I can get the capital gains, oh sorry I can get the negative gearing benefits there, that's what I'll investing. It's almost taking a step back and Stuart you can probably elaborate on this greater than me but when the changes were made a year or two ago around depreciation benefits that the fact that you actually have to do the work or buy the property brand new yourself to be entitled to them as opposed to having someone having done those works two years ago but you could still claim them. That was taken away. The stamp duty savings that were taken away from those that bought off the plan. If the property hadn't been constructive that you were entitled to whatever your property was worth at the time of purchase. You could save on stamp duty, that was taken away. So what I felt that did was it led us to be focusing more on the merits of the property itself rather than the depreciation on the stamp duty benefits. What I feel as though we're doing now is going back to that or another form of that and I just don't think that's smart from an investor's perspective.
- [Stuart] Yeah and so I certainly share those concerns but I think the other thing that I'm really worried about and if you're watching this presentation it's probably not gonna impact the people who are watching this presentation but I'm really concerned about is the amount of property spruikers that will come out that would work. That will start espousing tax benefits or don't worry about it established property, you can't negatively gear it. Here are all the tax benefits. Oh by the way we've got a development to sell you too and all you need to do is just sign here and all the hard work is done.
- [Jarrod] And these are our projections of what the growth will be going forward and these are your guaranteed rental returns and all that sort of thing and 100% in growth.
- [Stuart] And here's the gross story because you know this is a new build area and they're building these arterial roads and look there's gonna be an ALDI didn't around the corner and all those sorts of things. I've never seen a report around a development that was that was negative. They tell you all the good things but you and I know during this last 20 years that it's just never gonna work for investors. So unfortunately I think less educated people are gonna get fooled, tricked really into investing in what will be poor quality assets on the back of tax benefits. And it's really akin to you know if anyone's old enough to sort of remember those agriculture investments that accountants used to sell. You know by this investment and you get a massive tax deduction this year and they all blew up and people will lost a lot of money. You never buy an investment because of the tax benefits. If that's the only good thing about the investment it's a bad thing.
- [Jarrod] It's a red flag so if that's the key to the investment in the first place, because of those tax saving benefits then that should be your automatic red flag that there's something wrong with this because it's not the reason that you would do it. You'd be doing it for any number of other reasons.
- [Stuart] It's smoke and mirrors. You've got nothing else good to say about the asset other than the tax benefits.
- The tax savings, yes.
- Yep, yeah.
- Yeah, yeah.
What should established investors do?
- [Jarrod] Okay, I guess it depends on the stage that they're at with their investment. As we said if they're only five, 10 years into the investment journey and this is always planned to be 20, 25 year journey then they should be doing nothing. They should be returning those properties. Yes, they'll more than likely as we said earlier be a bit of a plateau for a period of time but we have that in the property market anyway. There's always going to be ups and downs and you should expect that to continue to happen. If though you're a little further advanced and perhaps getting to the point of considering where we are we were looking to sell one if not both of our investments or it's getting to that point where we need to realize assets and perhaps having them invested in a more income generating assets as opposed to a wealth creating. And you were looking to do that perhaps in the next 12 months or so then it may be an idea to consider doing that now. Just because if we do have the change of government you can potentially take advantage of those that may well be coming into the market to try and secure assets before the grand final indited early next year. I wouldn't be rushing things. If you're still two, five years down the track of when you were planning to do it then don't bring it forward just for that sake. It's more a matter of if you were looking at it for the next 12 to 18 months. If you've got what might be perceived as a poor performing asset or an asset that perhaps is going to compete more in that off the plan or modern type space then again I would be seriously considering doing that before really before you get too far into the spring market. Because if you're going to be competing directly with say a modern high rise type apartment and you are looking to resell that, you're not going to or anyone buying your property is not going to be entitled to those negative gearing benefits. So that's what as you mentioned before Stuart, that's where we get to that two tiered marketing. In that buyers who are looking at even though they might be relatively similar, they might only be one or two years age different you're not going to get new investors looking at that property because they won't be able to get those negative gearing benefits. So I would certainly poor performing assets and they are likely to be attractive to another investor it would be worth considering attending to those between now and the end of the year.
- Yup, yup good advice.
Will the changes actually happen?
- [Jarrod] Alright so I'll switch back to you. So I guess do you think that the negative gearing is definitely going to be banned if the ALP wins? Is it going to be watered down? I guess that's sort of an extent going to depend on how the election plays out.
- [Stuart] Yeah, it will and I guess that's you know the reason I wanna sort of talk about this is that we can tend to sort of jump at shadows very quickly and start to panic and end up allowing that to shape our decisions. So they are either defer or enter into a decision based on this sort of short term feeling and obviously we've talked about whether there's some longer term implications if they do come to fall. But obviously and it was interesting to know that the retired senator Graham Richardson was quoted yesterday saying that he thinks there's Buckley's chance of these changes getting through the senate. So you know he's close to the Labor Party so I don't know what he knows that maybe you and I don't know but--
- Probably a lot in that space.
- Yeah probably and some of it I probably don't wanna know. So you know obviously it depends on lots of different things. It depends on if the ALP win buy a massive majority.
- Large margin, yeah.
- [Stuart] Yeah and how much control they have and then it really depends, yeah the other thing too we need to be cognizant of is oppositions rarely win government, governments lose governments. So I don't think you know if the ALP gets votes I suspect and I don't wanna turn into a political commentator, it's not about this it's really about sort of framing what's the likelihood. But it's probably a vote against the coalition rather than for the ALP's policies. If the ALP wins I don't know if I'd be standing back and thinking they won because they had such great policies and everyone loved the idea of banning negative gearing. I think it's more because of how the coalition's behaved over the last few years. So look I think we're actually a long way from it getting enacted. Don't forget they've got to draft the legislation and they gonna put it out for comment. They've got to do that in a very compressed time--
- There's a timeframe, yeah.
- [Stuart] If there's problems they then got to negotiate and so forth. And you know when there was a talk a few years back about changes to negative gearing the decision was pretty close to being made and the decision at that point was to limit rather than ban. So I think even if the, I'm guessing here right it's crystal ball but if the ALP wins will they get their policies across as exactly proposed? I think there's a pretty, I would put it as a quite a low probability but if they win government maybe there's some changes but just not as that.
- [Jarrod] And I guess that lead us probably to having a discussion around whether or not people need to be careful at jumping at shadows too and jumping in to just buy a property for the sake of buying a property because they're concerned about it. Because as you said it rather than it being just a flat negative gearing's being removed perhaps there'll be caps put on in certain spots so that I guess it's fairer across the board and that might be a bit of compromise that gets made. So be careful if you are looking to buying property that A, you select the right asset which is always what we talk about but B, that you do it in the right manner and that it is the right time for you to do it going forward.
- [Stuart] 100%, I would caution anyone from just jumping on board because they have fear you know fear of FOMO, fear of missing out on the negative gearing benefits. Run your own race, forget about, there's always gonna be tax change. Tax changes monthly.
- Yeah it does.
- [Stuart] It's constant and what the ATO is doing and what they're focusing on it's always changing. I wouldn't worry about it, it will continue to change. Just run your own race and invest as you see fit and as appropriate for you. So Jarrod probably quick one but one of the reasons that the ALP has sided for banning negative gearing is housing affordability. So they think by allowing it on new build but not established properties that it'll mean that the new build market will attract a lot more investments and therefore generate more housing supply and therefore reduce prices and so forth. What do you think? Do you think it's going to achieve that policy aim?
Housing affordability impact
- [Jarrod] Well in the established market I think if it comes in again in its current form that it's likely to reduce the buying power of investors as you've just illustrated with the graphs and the commentary earlier so that's likely to happen. And it's no secret that in some sectors of the market investors do compete with first home buyers just to it, particularly with you in the say sub $750,000 bracket which is where the first time buyer savings are most acute or actually exist. So there's certainly a place there but don't forget that it's not just investors that compete with first time buyers in that market place. If you look in, particularly in the inner city areas and you're looking at low maintenance type property first, sorry downsizers love that type of asset too because they don't have to worry about saying maintaining the family home. They don't need three or four bedrooms. There's a lot less requirements and then first time buyers might also be competing against other upsizers who perhaps have been in a much smaller here. So I think that we get a little bit too caught up in that investors that have been driving the market. I come back to my points earlier about the fact that investors left the market fairly significantly not totally but fairly significantly in our space back in 2016 when Apple reinforced a few changes and made it quite difficult. We saw some actual interest rate increases for investors at the time so they've left and the market still continued to go forward and that was driven predominantly by owner occupier. So by making these changes just to investors it shouldn't be seen as a panacea to affordability and all of a sudden it's going to make it a lot easier for first time buyers. Investors haven't been in the marketplace significantly for two or three years now and yes we've seen some reductions in the last 12 months but that hasn't been the removal of investors. That's been the overall royal commission and the contraction around investors, sorry of how difficult it's been for all borrowers to be able to get asset to money, access to money sorry.
- [Stuart] Actually I've looked up some figures recently 'cause the ATO releases statistics on what property investors are doing and so forth. So for the last 15 years the amount of new property investors in each year has ranged between 20 and 90,000. So pretty big range but--
- That's Australia wide?
- That's Australia wide.
- Yup. So then we've got to look at what is that in context of the overall market. So the housing turnover rate kind of ranges between four and 7% so four to 7% of dwellings are bought and sold each year. So that puts the investor's market share it's somewhere between five to 15% depending obviously on how well the market's doing and so forth.
- Doing at the time, yeah. The statistics only go to 2016 and in 2016 there was 40,000 investors. If there's 40,000 investors in 2016, in 2018 or '19 I reckon it's probably towards the lower end of that long term range so probably 20,000 investors. So then you got to think about will it go to one or zero investors? It's not gonna go to nothing.
- So how much further can it fall and how much impact are investors really having in this current market? I imagine it's to lower end of the range that maybe there's 5% of investors out there.
- And if that does continue to drop like you've said I mean will that eventually lead to that increase in rents. Now, I don't see that as being a significant thing that will happen in the short term but I think the longer that there's less investors entering that established market then that's when it's more likely to see that increasing rents. It's being discussed around this is being an issue. I don't think it's a major issue, we've discussed this before but I think it's something that needs to be kept in mind.
- A market will always find a new equilibrium over the long run.
- Correct. So over the long run if there's a increased cost to investors that will always be passed on, maybe not in full but in the fullness of time. And I know people revert back to 1985 and '87 when negative gearing was banned then and to look at the data but the data's just, it's not a long enough data set to really draw anything meaningful. I mean there's already problems really with the reliability of meeting property data anyway but you really do need a length of time. And you also need because as you said quite correctly, that existing investors won't be impacted immediately but those existing investors will eventually probably buy another asset one day or sell an asset and that asset will turn over. So after a decade the impact of this policy would be a lot wider than say in the first year.
- First couple of years, yeah.
- And that's why it will take a while to filter through so. You know if capital growth comes off a little bit as a result of these changes investors we will be compensated through a higher income yield.
- Higher income yield. And you certainly see that in the Australian share market versus the US share market for example. Much higher yield but lower growth in Australia and much lower yield but higher growth internationally but the total returns are broadly the same. Yeah so investors demand a certain return and they'll get it.
How to adjust to negative gearing changes
- Yeah so I've thought about sort of five different ideas on what you might be able to do and obviously I make these lists in the context of you know if you're an existing investor and you're not making any changes to your assets then you don't really need doing anything, nothing changes. But if you're thinking about making further investments you know what do you do to sort of accommodate these changes? And so that might be an existing investor making further investments or brand new investors so someone that doesn't have investments yet. I think the first one is you can start thinking about sort of asset allocations so maybe what you need to do is balance out income and capital growth at a portfolio level. So if you're gonna go and buy an investment grade property maybe also you wanna invest in high income yielding assets like Australian shares, or bonds or so forth at a portfolio level to try and even add that income so that it's neutral rather than you creating a loss. The second thing you could do is be a little bit more aggressive in debt reduction. So maybe instead of setting a budget of 1.2 million and buying a house, buy a two bedroom apartment for 850 and therefore because of the lower cash flow cost you can more aggressively reduce debt. And so what you're trying to do then is reduce the cash outflows as quickly as possible so that you get it to neutral as quickly as possible. Buying property, ironically buying property in Super starts to become even more attractive even though the ALP said they'll ban that too. Because instead of claiming the negative gearing benefits of buying property what you'll do is instead of say contributing $15,000 towards the property in your personal name, put the $15,000 in Super and buy it inside your super fund and you'll get a tax deduction for the personal contributions of the 15,000. Obviously you got to make sure you're under the contribution caps and whether that's appropriate as an overall holistic plan, you know that's obviously subject to that. But it's certainly in the absence of negative gearing certainly borrowing inside Super starts to become more attractive. What existing investors could possibly do is shift money in offsets. So if anyone's listened to me prattle on for the last seven, eight years I've always banged on about never repaying alone. Instead of putting surplus cash in offset accounts and even if you get to a point where you've got a bunch of loans and an equal amount in the offset account and those numbers are quite big even in that situation I would still say just leave it there. You never know what's going to happen. So if you are in that situation where you've got some existing investment loans and you do have a reasonable amount of monies in the offsets attached to those investment loans what you could do is go and buy yourself a brand new property, take all the money out of the offsets against the existing properties 'cause they're the ones that still continue to get the negative gearing benefits and put it all in the new property's offset. So what you're trying to do is notionally reduce the gearing on the new asset and increase the gearing on the existing assets. And then at a portfolio level depending on the numbers you might not actually lose anything in tax benefits and you're still able then to invest in another property. And lastly in '85 what some people started to do is buy property through a unit trust and this is gonna depend on what the legislation says but back then it said if you borrow to buy property or a listed share you can't get a negative gearing benefit. But if you borrowed to buy an unlisted unit in a trust, that is your unit trust you can't get the negative gearing benefit. So it doesn't create a lot of extra cost and complexity to do that and maybe that's a way to as a kind of work around these negative gearing changes. So there's just five things that I'd be thinking about but as I said I went through in the numbers it's really about asset quality and capital growth rather than getting distracted by anything that's gonna be a kind of a bit of a magic bullet.
- Jarrod, here's a bit of a loaded question for you. If we can't get negative gearing should we be investing in assets primarily for yield so that is rental income so that we try and get something if not neutrally or positively geared at least minimize the short fall. Should that be our focus moving forward?
Focus on high yield properties?
- Yeah, very much a loaded question and I know your thoughts on this as well and we're fairly well aligned. Look it's certainly not something that I would be advising clients to do. The higher yield focused assets as we've always said the reason that they get that high yield also is the reason that they're not going to get this capital growth levels that we would want them to get. In that most of your value and an asset like that is going to be in the improvements rather than being in that underlying land component. And that's going to prevent it from achieving the capital growth and building that equity up that you wanted to do to be able to then leverage off and continue to build a portfolio whether that be from a property perspective or for other investment asset classes. So no, I still wouldn't be doing that. I would still be focusing on that growth focused asset, getting that scarcity value, getting a property that's got a good strong underlying land component to it so that longer term it will continue to perform and build wealth for you that way.
- Cool. I've always said investing is a little bit like playing golf to some, I'm not a golf player but you know it's all choosing the right club for the right shot.
- So you're not going to tee off with a putter I mean it will work but it's a lot harder and very inefficient and the same thing for property. Property is a growth asset, that's why you're buying it so that it doubles in value every seven to 12 years or whatever it might be depending on the inflation. And that will do all the heavy lifting in terms of helping you build wealth and build your asset base and so forth. If you want income there are far better investments than residential property for that so agreed.
- Okay, so you wrote a piece a couple weeks ago for the Australian about some of the impact of the ALP's negative gearing capital gains tax policies and what it will have on investment returns. So what conclusions did you draw from that end?
Capital gains implications
- Yeah, I've got the article here Jarrod and what I might do is actually provide a link below the video so people can have a read of that. And so you can read it at your own leisure so I won't bore you to death but essentially what I did is I did a sort of financial model on what is the longer term impact on your internal rate of return. Which is really if I'm putting cashflow into an investment what overall return am I getting after tax. So it's a way of kind of measuring different returns depending on their different gear in rates and so forth. And essentially what I concluded is that currently property is giving you an internal rate of return of about 12.6% and that reduces by about 26% to about 9.3% assuming that both the negative gearing and the capital gains tax changes get implemented as proposed. So a 26% reduction in after tax return it's a problem, it's a worry. You wouldn't certainly invite it but having said that a headline return of 9.3% isn't shabby either. It's still going to help you. It's high enough to allow you to build a strategy around it to help you build--
- And still justify doing it, yeah.
- Build wealth. So I think the kind of theme of the article was that it has an impact. As I said, most of that impact is because of the capital gains not the negative gearing. So it has an impact but properties weather a lot of storms and it's still giving you a good gearing rate and you can still borrow more aggressively with the same risk profile inter property than you would share and it's not a property versus shares debate. I never wanna get into that 'cause it's ridiculous. It's like arguing what your favorite club in the golf bag is, that's a bit silly too 'cause they're all doing different things. But we can't get away from the fact that the banks are gonna let you go and borrow 100% if you got other equity of a property value but for shares the limit's sort of between 50 and 70%. So that high level of gearing just mathematically putting the asset classes aside is gonna help you build a lot more wealth in the long run and a lot sooner. So they're the numbers around it. Jarrod I think with every change potentially creates opportunity if you're looking for them you'll see what you're looking for typically. If you're gonna see a whole bunch of problems then that's all you're gonna see so if we put our kind of opportunity hats on do you think there's any opportunities potentially either in the shorter or longer term as a result of these changes?
Are there opportunities?
- Look there is and particularly in the short term. I mean you've still got the opportunity to be able to get in and maintain the status quo and then get in before the changes are made so there's certainly opportunities there. The market at the moment is still quite advantageous from a buyer's perspective. The stock levels are quite limited so that's probably the one difficulty but there's certainly this is the buying market that the purchase has been crying out for for a number of years where the activity's being a lot stronger. Now we're in a market where it's very much in the buyer's favor and you can take advantage of that. So there's opportunities there and that flatter market is likely to present itself again probably even potentially even more so early next year. Now you're less likely to be able to get, well you're not gonna be potentially able to get the negative gearing benefits and that will be a consequence of that. But perhaps the values will be at a better level too so there might be an advantage to be taken there too. So there's certainly opportunities and things to be open minded about going forward.
- I was watching an auction on Saturday morning on the TV you know that real estate show?
- You need to get out more.
- Yeah, I know. I was as an excuse doing something else. It was on in the background I don't know if that's, but anyway it caught my eye and it was a two bedroom apartment in South Yarra. This is probably going back two or three weeks ago now so it would have been April and a two bedroom. I mean it looked good on the face of it in terms of location, street size, type of property. I'm not saying that I concluded it was investment grade but it passed in for for 450,000 and I just thought I mean in 10 or 20 years time we'll be looking back at that. Will someone would be watching this video in 10 or 20 years time, probably not but if they do will they look back and go oh my God should have bought 10.
- Yep and that's the thing. I mean everyone's an expert in hindsight and we always look back and say I should have held that or should have but there are still really good opportunities to be had but even for say the first time buyer market. There's some great opportunities to be had to be buying some really good quality assets in the inner city areas enabling people to be able to maintain a lifestyle that they've become accustomed to if inner city lifestyle is what you're after. There's some great one bedroom apartments around that perhaps you might not look at purely from an investment perspective but from an owner occupiers perspective they're fantastic. And there's some that are sort of sitting around the high three's to early 400 mark in suburbs like South Yarra or Richmond which would be fantastic opportunities for people to buy. So it comes back to that point I made earlier about affordability. I think relatively speaking there's still some good affordable properties in those inner city suburbs. But if you're expecting to have a bit more accommodation on a larger land parcel then you've got to be realistic around where that's going to be.
- And the thing is that the best time to buy it's never gonna feel like the best time, the best time to buy is when it actually feels the most risky time to buy. So I remember one of your guys purchased a property for me in Paran in 2008. It was two weeks after Bear Stearns crashed in the US so right in the heart of the GFC when most of the commentary and I was watching a lot of it . Most of the commentary was the world is over, business is never gonna be done like business has done, you know it's all you know no more leverage, no more of this, everything's bad. We don't know the extent of it. So it was just the world was ending really. I've never seen media coverage like that. Anyway it was a pretty tumultuous time and certainly you wouldn't conclude oh now's a good time investment, let's go and borrow some more money and put it into the property market. And anyway I went to this auction and I almost was gonna call Sean who was representing me on the day to say look don't worry about it. I'm never gonna pick it up. We're all wasting our time. I thought oh look I'll go along for the fun anyway. I end up picking the property up for a lot less than I thought it's intrinsic value was and that subsequently was shown to be the case. So the only reason I share that story is that if you're really nervous and you're really worried about the market that's typically a good signal that it's actually a good buying opportunity--
- Good in your favor.
- If you're taking a long term. So if we're all waiting to feel comfortable--
- Yeah, you could have waited a long time. You know that's--
- You're almost too late to the party as a result of that. We've got a few questions so we might address some of them and if we've sort of covered them we can just sort of brush over them but if some other thoughts might sort of flesh out. So Jarrod, Michael's asking, I'll just read it. Some commentators have claimed that the effective increase in taxation will lead to some degree to the increase in rental income.
Will rents increase?
- We've done this, yep.
- How would this work given the same property, if the same property is owned by different owners? You know they're going to, you know if it's an existing investor they're gonna have a different tax position than a new investor so how is that really gonna work through the market? And is this change in negative gearing likely to lead to reduction in interest rate premium by the banks that they apply to investment loans over unoccupied loans?
- [Jarrod] Well I think the second part, that'll be a good one for you to answer but in terms of the first parts of that question Michael, I would suggest that, it's a very good point in that and that's why in the short term and the discussion around rental increases is highly likely to be inaccurate. Because there is such a large pool of existing investors who aren't going to, nothing's going to change for them subject to if there is a change in government. So expecting rents to all of a sudden increase to offset the loss of negative gearing is just not going to happen. You know the longer term that we look as we discussed earlier, the greater potential if that is to happen is some existing investors leave the market for whatever reason and new investors potentially come in or lack of new investors potentially coming to the market then that's more likely when we potentially will see some rental increases. I don't see it as being a big thing in the short term maybe medium term but then that will be subject to a lot of other influences in the market place as well. What are interest rates doing? What are the costs associated with it? So it won't just be about the fact that there's a lack of negative gearing. There'll be other associations. If there's a lack of stock in that rental market put aside the negative gearing just not as many properties being built then that would push up rental returns and things as well. So there's a few things that would come into play in that space.
- And particularly in Melbourne I mean you look at new approved projects like high rise projects I mean they're dropping off of the face of a cliff in terms of volume coming out to the market.
- The thing to factor in there is that's not necessarily what a lot of tenants want. Not every tenant wants to living in a high rise building right on the inner city areas. They perhaps want to be in a middle ring suburb in an established property and that's where you're more likely to see some potential increases in rents.
Will interest rate margins be squeezed?
- [Stuart] Yup, yup. In response to Michael's question about interest rates and the differential between owner occupier and investment you'd be joking wouldn't you? I mean the bank's not gonna reduce the margin. If some of the other banks do I'm sure they'll follow suit but I don't think given the lower level of volume that they're writing in terms of loans, I think that'd be pretty reluctant to reduce the margin that's already in place but who knows. If the government starts really paying closer attention and wanting to get them to lend more investment monies into the market maybe they'll use interest rate as a means of doing that.
- I've got a question for you Stuart, asks if you currently have an existing investment property and you make improvements so for example you install an air conditioner or carry out substantial renovations after the January deadline would the new improvements continue to be eligible when you're gearing or is there insufficient information from politicians to decide this at the moment?
How will improvements be treated?
- [Stuart] Insufficient information is probably the quick answer because we need to see the policy however I think it would be very likely that if you're making capital improvements and so what she's suggesting there is your changing the original nature of the assets, you're improving it so that's a capital expenditure. If I was a betting man I would say that you'd be able to continue to borrow if it's an existing asset, a pre 1 January 2020 assets you'd be able to continue to borrow in order to do that. Because that's not really an acquisition of an asset that's a really improvement to an existing assets but we'd need to really, the devil's in the detail and would need to see the detail on that. I think they'd probably like to keep them completely separate and don't mix it all up. You know if you do it to an existing asset and they'd probably like to keep it simple but then again the government doesn't always do that, do they?
- Okay, there's a question here from Chris and how asking how do the impacts on investment property in Melbourne but let's just say just generally with the proposed changes to negative gearing, how will they be compared to the changes in the share market with the dividend imputation changes? So I guess it's sort of which is gonna have a greater impact?
Property or shares given various tax changes to both asset classes?
- Yeah so I think that's again from the imputation credits perspective that's probably more your so if we put it back to you, what do you think?
- [Stuart] So the imputation credits I think is probably winning or losing more votes than it is really having impact on the market. A bit large super funds it's not gonna affect them because they've got a complete mix of members and asset classes. It's really only gonna really impact people with self managed super funds and the amount the self managed super funds hold as investments and this would be direct to Australian shares compared to the market as a whole like all the participants in the market which has institutions and every single really investor around the world it's a drop in the ocean. So even if all self managed super funds went and sold their Telstra shares for example because of the imputation changes I mean it might have a small impact on the market but nothing substantial. And also self managed super fund, people that run their own self managed super funds the statistics show us that it typically relatively apathetic like they're not, of course there's investors out there that are on top of things and taking a very proactive approach but I suspect looking at the statistics they're in the minority rather than the majority. So it's probably a lot of people are just gonna go oh it's just noise, won't change my investments. It'll just hang in there. Whereas I think what we've sort of spoken about the changes to negative gearing and so forth not only do they create a lot more commentary but they probably create a lot more consequences market and individually.
Sell an underperforming asset?
- Okay, Kate has a question Jarrod and she says we've got a home and an investment blocking Footscray which I take to be a some vacant land. Would it be better to sell this in the market and purchase a property to rent so get rid of the vacant land and go and buy an established property or develop on that property? And I guess what we could maybe change the question to is really if you've got an asset that you need to do something with or you think is underperforming and I know we sort of talked a little bit about this how does these changes impact what we should do with that asset and should those changes impact?
- [Jarrod] Yeah, look I mean as we said earlier if you do have an asset that you feel is underperforming and you think that it needs to be addressed and subject to that asset not potentially being all that enticing post the 1st of January 2020 then it is a time to move on that asset prior to the end of the year. So I'd be seriously looking to do that and then potentially reinvesting it in something that's going to perform longer term and have that multifaceted demand that we've always discussed. That is going to consistently show good levels of growth and have demand from multiple buyer groups rather than just singly focused. And perhaps if it is that example and you've got a vacant block of land and you're really heavily relying on a developer or someone who wants to build their own property to be your buyer profile. It's less likely though that type of property to be influenced by the changes or be it the developer it's subject to how large the land size is. A developer and they're more likely to be coming into play again once the market starts to show that because whatever they built on there, if they put a couple of townhouses and things on there they might even be able to sell those to an investor who is looking to buy something off the plan and be able to claim those negative gear benefits next year. It's a fairly long winded answer but it's probably something that would need to be addressed specifically rather than having a general discussion.
- Because the other thing too there if EFK it's gonna actually construct a dwelling on the property well then she's actually spent the money on the asset she can depreciate that as well.
- Well, there you go.
- So not only does she hold the negative gearing potentially substance of legislation but then she gets those tax benefits that she wouldn't get from an established property. But as you say it depends on the nature and the split between building and land value. So I think we're coming to the end of our hour. So I certainly hope you've enjoyed the discussion and we've certainly tried to be as impartial as possible. We obviously have our own views and we enjoy talking about property but putting that aside. If you have any further questions or you'd like to have a discussion with myself or Jarrod and our teams feel free to reach out. Certainly contact details are just below the video and as I said the links to any of the charts and articles that we've referenced are also there so hope you take time to check the amount as well. Until next time, thanks very much Jarrod and--
- Thanks for having me Stuart, it's been great.
- See you next time.