Welcome to Finance and Fury – This episode we will be looking at the debate over negative gearing

  1. Saw a news article recently – Robert Kiyosaki – Author of Rich Dad Poor Dad came out saying that the Australian government should axe negative gearing to provide an incentive for property buyers to choose wisely rather than “reward them for bad decisions”
    1. This has also been a hot topic over the years as part of the property affordability conversation
    2. Has been an issue for the past few elections – and may come back in the upcoming federal election
  2. Want to look at this in today’s episode – so we will cover what negative gearing is? What is the point and does it help investors and has it led to price increases in property?

To start with – What is negative gearing – Gearing in investment terms is when you borrow money to invest in assets such as property and shares

  1. Property can be in three types of gearing – based on whether the investment income is more or less than the investment-related expenses
    1. Positive – i.e. the income is more than deductible expense – so you pay tax on the net income
    2. Neutral – i.e. the income is the same as the deductible expense – so you pay no tax
    3. Negative – where the income is less than the deductible expenses
  2. Negative gearing is defined by the ATO as making an investment that’s running at a loss – that is where the income or profit is less than the deductible expenses
  3. As an example – say you purchase an investment property – this generates you $31,200 of rental income – but costs you $2.5k in Rates, $2k in insurance, and $30k of property interest expenses – your total deductible outgoings are $3,300 p.a. more than what your income is –
    1. This allows you to offset other income generated by this deductible loss
    2. Note that it doesn’t include non-deductible expenses – such as principal repayments – so you actually be spending $50k on this property, but $15,500 is on principal repayments which are not deductible – as it is principal repayments
  4. Negative gearing helps to compensate for any losses at tax time by getting your marginal tax rate back
    1. If you outlay $10k – then you get your MTR back – if you are on $120k, then this would result in $3,900 back at tax time – but you are still in a negative $6,100 cashflow position
  5. Where this strategy has worked is when the growth of the property is greater than the negative cashflow over time
    1. but the risks can be magnified by having a higher LVR to get negative gearing if interest rates go up – making it impossible to cover the losses if prices slump

Let’s look at Robert’s comments on the subject –

  1. He is urging that the debate over negative gearing be renewed and take centre stage during the upcoming 2022 election campaign – this is nothing new – has been a hot political topic that has come up at most Federal elections for the past 10 years – more on this later
    1. But in this news article – Robert states: “I’ve bought several billion dollars’ worth of property and I’ve never negatively geared”
      1. So, he owns homes in Sydney’s Bondi Beach, Kings Cross and Rushcutters Bay, as well as in Brisbane – these are part of the 8000-strong property portfolio that he claims to hold
      2. Robert – net worth reported at $100m – This is fantastic – he has done great things and made a lot of money through his education programs and selling his books – but the claim that he has 8,000 properties at a net worth of $100m – means that there is only $12,500 of equity in each of these on average – I might be missing something – The net worth reporting may be incorrect – Let’s be generous and say that his net worth is 3x higher – this still only means $37,500 in equity per property
  • I’m sure that many of you out there live in Sydney – what is the average price of property in Bondi Beach, Kings Cross – These are around $1m for small apartments
  1. It is hard to imagine that in this instance these properties are not negatively geared – maybe not in current economic environments with record low interest rates – which we will come back to
  1. Also – the concept of negative gearing isn’t a thing in other countries like the US and UK–
    1. Ronald Reagan ceased the US equivalent of negative gearing in 1986 and in the UK this was done in 2015 by British Prime Minister David Cameron – So Australia is one of the last western countries to still have this law in place – similar to franking credits
    2. A side note – how has housing affordability gone in the UK or the US since 1986 – has it got better? No, it hasn’t in major cities –

Where do we stand – The proportion of property investors who are negatively geared has been falling for the last few decades as per the latest data from the ATO and Treasury show –

  1. In 2000 – the earliest figure provided by the ATO – 54% of landlords were claiming more back on losses on properties then they were generating in income – Interest rates were 7-8% back in 2000
  2. As of the 2016/2017 FY – the latest data – there were around 13.3m properties that were investments – of these 1.2m were making a loss – or around 9.5% of these – Interest rates were around 5%% back in 2017
    1. This data was well before the latest reduction in interest rates – So the number of investment properties that are negatively geared would have likely diminished even further since interest rates have fallen.
  3. Also – This strategy has become less viable since they changed depreciation rules that came into effect on 1 July 2017 – changes were made to the tax law in relation to the claiming of depreciation
    1. Depreciation on properties used to provide a massive boost to negative gearing – The property could depreciate by a % per year for a number of years which you could claim a deduction against – even though you didn’t have to outlay this cash – Since then, investors in residential rental properties have not been able to claim decline in value deductions in relation to the acquisition of second-hand properties
    2. Depreciation used to create opportunities for successive investors to ‘refresh’ the deductible value of properties through repurchasing a new investment property every 5 years – you can still do this, but only for newly constructed properties
  4. For purchasing an investment property that is not a newly built property – this made depreciation negative gearing far less attractive – as you actually have to outlay the cashflow to get the benefits – so newly purchased investment properties that qualify for negative gearing will be far and few between when combined with interest rates

 

This brings up the question – what impacts would getting rid of negative gearing have on the property market now when most properties out there are unlikely to be negatively geared?

  1. Some economists say negative gearing plays a central role in hiking up prices – as it incentivises investors to borrow more to invest – makes sense in theory
    1. But would any invest simply over bid on a property to borrow more to negatively gear? Investors still want to get the best price for a property they can get
  2. The fact that investors back in the 2000s when the majority of properties were negatively geared could claim money back on their losses may have had some impact on property price growth – but in the current economic environment – a single percentage figure are negatively geared – and interest rates and borrowing capacity for everyone increasing is the culprit for price growth in my opinion

 

The arguments against negative gearing

  1. Going back to Robert Kiyosaki – provides many points against this – these include:
    1. “It just doesn’t make any sense to do so. Negative gearing only works as long as the price of property continues to go up and when it slumps, like we saw in the crash of 2008, it’s a terrible strategy.”
    2. “I have another name for negative gearing: stupidity,” “It gives you a tax break for losing money, which makes no sense at all to me. I invest to make If you’re choosing a property because you can then negatively gear it, that’s an absolutely crazy investment decision. The government should be looking instead at giving tax breaks to people making good decisions.”
    3. He does make valid points – you want to invest to make money – from his point of view it is all about cashflow
  2. Getting rid of negative gearing – what would the potential pros and cons be
    1. The main focuses would be on property prices and rental costs – Based on statistics from SQM Research – getting rid of negative gearing – rents could rise anywhere between 7 and 15% while dwelling prices could decline anywhere from 4 to 12% over 3 years – but this study was completed back in 2019
      1. This may not be as drastic as may be thought due to current interest rates – at higher interest rates – this could be more accurate
    2. Changing the tax system may end up doing more harm than good
      1. senior fellow in economics Robert Carling (ex IMF, World Bank and federal and state treasuries) says negative gearings contribution to price rises has been exaggerated – I would agree – This policy was introduced back in 1987 – and since then with the decline in interest rates, the tax revenue loss from negative gearing has declined because when interest rates are so low it’s much harder for people to negatively gear as it’s harder to make a loss
    3. Removing negative gearing today would more or less be business as usual for many property investors –
      1. Any changes on negative gearing may not be as colossal as most people expect – as long as interest rates remain low
      2. But at the core of investing – tax policy is nowhere near the biggest influencing force over most people’s investment decisions

I have no dog in this fight – But Personally – I’m not a fan of negative gearing as a strategy to willing go into – but to change the law now for those that have already purchased under this decision may have many unintended consequences –

  1. What is the end goal of getting rid of this policy? To reduce property prices to help increase affordability –
    1. It does sound good in theory – But does this really play a massive role in prices of property – and will getting rid of it help decrease property prices?
    2. Depends on how the policy is conducted – in my guess this would be a grandfathered situation – where any new properties purchased would no longer attract negative gearing status – but all existing properties may still be eligible – how the government has operated for many property related tax changes – changes to depreciation, CGT –
  2. So getting rid of negative gearing wouldn’t do much in the current low interest rate environment to drop prices –
    1. There is a correlation between interest rates, property prices and negative gearing
      1. Interest rates go up – property prices go down – and negative gearing goes up – negative correlation
    2. If interest rates were 10% p.a. – then many property investors would be negatively geared – as more interest expense is deductible – but property prices at that level of interest expense – based around the RBAs modelling would decline – So if this were the case, would getting rid of negative gearing really help make property more affordable?
    3. Negative gearing in the current economic environment provides more or less a failsafe to investors – if interest rates rise significantly – then the losses can be offset through getting tax back – helps to avoid someone selling the property – and creating a market crash in property prices
      1. In getting rid of this policy – it could increase volatility further if interest rates were to increase – but this is speculation
    4. So in summary – getting rid of negative gearing probably wont help property prices – just remove a fail safe for current property investors if interest rates were to rise 

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