Pete Wargent blogspot

Co-founder & CEO of AllenWargent property advisory & buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

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Tuesday, 21 May 2013

Lomas predicts tax changes "would leave 600,000 homeless"

A flurry of excitement in the real estate world following an article on Property Observer in which:

“…property investment adviser Margaret Lomas slammed ‘Barefoot’ investment adviser Scott Pape following his comments that the government didn’t have the “ticker” to abolish negative gearing tax rules. 

Lomas warned that removing negative gearing would cause a “sudden market crash” leave 600,000 homeless and a “government unable to house them under public housing programs”. 

Lomas said in response that Pape wasn’t a property investor and “does not consider the full picture”. “I like Scott but he needs to stick to his specialty,” she said.

Bank of America economist and former ANZ chief economist Saul Eslake was one of the first to wade in and criticise Lomas, but the Twitterverse went gangbusters. Matt Cowgill of the ACTU mused:

Leith van Onselen of Macrobusiness was more blunt and a raft of other prominent journalists made their views known:

How to we get to 600,000 homeless?

The question which everyone seems to wants to know the answer to is how Lomas came up with the figure of 600,000 homeless people?

The question hasn’t been answered by Lomas but my best guess is that her key statement is this one:

“Contrary to popular belief, removing it means you can still make tax claims for everything but the interest and probably more than half of them would sell,” she said.”

It was recently reported by RP Data that in Australia that there are 1,213,595 negatively geared investors in Australia in the 2010/11 tax year, so perhaps Lomas has taken this figure and estimated that as "more than half of them would sell" if negative gearing rules were quarantined there would be 600,000 homeless people.

If that is the case then the number is wrong on two counts: firstly because a large number of negatively geared investors have more than one property and secondly because Australia has, on average at least, more than one person per household.

Far more pertinently, even if a change in the tax laws did cause a stampede for the exits, all applicable properties would not be transacted instantly and we would not see more than half a million homeless people. It didn’t happen when the rules were quarantined by Keating in 1985 and it wouldn’t happen now.

Why hasn’t NG been scrapped?

It is presently fashionable to blame high capital city property prices in Australia squarely upon the practice of negative gearing. The theory is that the prevailing laws should be scrapped, speculators would exit the property market and the values of properties would decline markedly. 

So why hasn't the Government simply pressed ahead with this course of action? Well, in 1985, the Labor Government quarantined the negative gearing tax laws (as well as addressing the iniquitous double-taxation of dividend income through the franking credits tax law) and yet it was forced to reintroduce them less than two years later in 1987, with Labor then suggesting that the new capital gains tax rules should instead act as a deterrent to speculators.

Booming rents

The main problem facing the Government, so the argument goes, was a shortage of available rental properties. Some commentators point out that in some cities rents did not increase between 1985 and 1987. That may indeed be true, but in some cities (namely Perth and Sydney, which had low vacancy rates) rents jumped very sharply, which would not be a popular outcome today, when renting is already expensive in the capital cities.

It is easy today at a distance of nearly three decades to blame incessant lobbying from the real estate industry for the re-introduction of the negative gearing incentives, but the counter-argument, which was put forward at the time by author Jan Somers among others, is that as much of the backlash actually came from tenants in those cities who were shocked by the spiralling cost of renting.

Government housing funding

The other argument for scrapping negative gearing rules is that the Government could save itself billions in tax revenues. Again, this is partly true, but there is a flip side, and this is that social housing funding would increase.

Between 1985 and 1987 the numbers on the NSW housing waiting list increased alarmingly by more than a third from fewer than 110,000 up to 140,000 in only 18 months, a trend which was immediately reversed upon the re-introduction of the previous ruling on interest deductions.

Of course, many other countries do not have equivalent negative gearing tax laws, but in some cases this may equate to a higher percentage of the population (particularly in certain socialist countries) becoming reliant upon the state for social housing, an outcome which brings with it its own hefty costs.

Why don't property investors fear the gear more?

I’ve written a little before about why property investors aren’t more fearful when it comes to potential amendments to negative gearing tax laws, and here are four reasons:

1 – Lack of retrospective application - in 1985, the new laws were not made retrospective so existing property investors were not impacted.

2 - Compensating laws? At the time of the scrapping of the negative gearing rules, the Government was seemingly aware of a need to introduce other incentives and thus introduced a 4% capital allowance on the construction cost of new buildings to be offset against new income. The idea was to encourage investors to invest in new properties to alleviate the rental property shortage, but overall the allowance was ineffective.

3 – Lower interest rates - negative gearing in property became popular in the 1980s when interest rates were significantly higher than they are today. However, the cash rate today is at a record low of only 2.75% so investment properties need not be generating a significant negative cashflow.

4 – Increasing rents - if negative gearing laws are abolished, it is probable that rents would increase sharply in the supply-constrained capital city suburbs with low vacancy rates, which would act as some compensation for property investors. In my opinion it is a near-certainty that landlords in Sydney, Perth and Darwin, for example, would immediately be angling to jack up rents sharply.

Summing up

Periodically, the negative gearing tax laws will come under the media spotlight. It seems unlikely that they would be scrapped outright and overnight although they may theoretically be phased out over time. The trouble for the Government is that rocking the boat could cause a huge amount of instability and therefore politicians remain unwilling to tinker with the prevailing tax law and therefore both major political parties have discounted changes.

For those barracking for lower property prices, other reforms seem more likely to be addressed first: increasing the supply of appropriate dwellings and improvements to public transport and infrastructure.