Just exactly what is Labor going to do..?
I wanted to look at the impact Labor’s negative gearing reforms might have on the property market again.
Ultimately, I don’t think it’s as scary as people make out. But do you like my title? I just wanted to show that I could be sensationalist too. I used to be a copy-writer. I get how the game works.
Its just my way of making the point that when the Coalition says that it will take a ‘sledgehammer’ to the property market, and Labor says that it’s going to be nothing but happy days for everybody everywhere, know that they both have an axe to grind, and the truth is probably somewhere in between.
… but where exactly?
That’s what Steve wanted to know. After I wrote this piece a few weeks back, he wrote in and asked:
I can't see how you think the Labour Government's proposed negative gearing reforms would not have a huge impact on the property market.
Given most investors have 1-3 negatively geared properties, if the Labour Government takes away the tax deductibility on existing properties, there will be panic as thousands and perhaps tens of thousands of properties will be put on the market in a short period of time which will drive down prices and potentially return significant losses to these investors plus it will return potential losses to property developers who are currently renovating properties or have them on the market (me being one of them).
Yes there'll be bargains for savvy investors who are cashed up who can buy cheap property which will transform the same properties into positive cashflow but I believe it WOULD have a significant effect on the property market.
I'd love your thoughts on this Jon.
Good questions Steve. You’ve got your finger on the pulse and this is exactly what we should be thinking about.
I’ll try step through it. The first point I’d make though is there is very little evidence out there, or even any theoretical modelling about what impact these reforms are going to have.
There’s reference to one piece by RiskWise and Pete Wargent, that talks about a 10% fall in prices, but I couldn’t find the actual modelling anywhere, and I suspect that they just made it up (which, tbh, is what most ‘economic modelling’ does).
This is interesting – I actually thought there’d be more out there. I think what it tells you is that in a complex and inter-connected market like the property market, it’s never clear cut. There’s all sorts of balancing and competing currents, and the end results are very hard to predict.
Ok, given that it’s hard to know what it is, let’s have a think about what it isn’t.
1. Panic Selling
This is a reasonable concern. Given so many investors are currently negatively geared, if it was suddenly scrapped, as Steve says, they’d all be looking to off-load the loss-making asset as quickly as possible.
But this isn’t what is proposed. Labor is going to ‘grandfather’ the reforms. That means that if you are negatively gearing a property now, you can keep negatively gearing it until you sell.
So the economics facing existing property investors doesn’t change. There’s not going to be a rush for the exits.
2. Cost of Carry
The challenge though comes when you go to sell a negatively geared property in to a market where negative gearing is no longer allowed.
The economics that made sense to you – the balance of rent to price (i.e yield)– won’t make sense to the next investor coming along.
Other things being equal, they would either want more rent, or a lower price, or both. Given that the market sets rents, that might suggest you’re going to get a lower price.
But it’s not clear how much of an impact it will actually have. First of all, no two investors are the same. The reason yields vary from property to property and across the country is because every investor sees the equation differently. The have different priorities.
And the thing to remember here is that negative gearing has two uses.
The first is that some investors are willing to pay to own an asset, because they think the price of the asset is going to go up. This is called the cost of carry.
Negative gearing helps you manage the cost of carry. Typically, I’d think of this as motivating your mum and dad investors.
However, what you’re willing to pay on the carry in large part depends on where you think prices are going. If you don’t think prices are going to go up very quickly, or even at all, then you are willing to pay much less.
That is, it varies with the cycle.
The other uses for negative gearing is as a ‘tax dodge’ (as Malcolm Turnbull once put it), working in concert with the capital gains tax discount.
So how much you are willing to ‘lose’ on a property each year really depends on your financial situation. That is, can vary wildly from investor to investor.
So the point is, yes, the removal of negative gearing does change the incentives facing investors, but not in a uniform way and definitely not in a predictable way.
The point I would make here is, be careful extrapolating from your own personal situation. So if you own a property, that’d be losing money on it’s current valuation, you might think that the price would need to fall, say, 10%, for the numbers to stack up.
But that’s just from your perspective. It’s totally possible that prices fall just 2%, and the property becomes attractive to an entirely different investor, with a totally different perspective.
And that’s before we even get to the question of owner-occupiers, who have an entirely different set of motivations again.
3. Pivot to New Builds
As I noted last time, Labor’s policy is for negative gearing to remain in place for new builds, and this confuses the picture further.
Now if every investor who wants to use negative gearing now piles into the new home market, prices are going to launch. As Stockland CEO Mark Steinert says, it’s going to put a rocket under their business.
But this is the thing. The existing and new home segments exist in the same market. There’s no firewall between them. One is a pretty close substitute for the other.
And so you can’t have the price of new builds rocketing without that having an impact on the existing market. Buyers who miss out on the new (especially owner-occupiers) are forced back into the existing market.
How does that balance out? I’ve got no idea. But it is possible that a rising market overall, driven by new builds, offsets partially or completely the falls facing individual properties.
Not a one-way street
So this is what I mean when I say that I don’t see the reforms having a huge impact.
I think when you look at your own situation and how it changes your own numbers, it is tempting to think that it will have a large impact on the market overall.
But your situation is unique, and there will be other investors and owner-occupiers looking at your property through a totally different lens.
The impact on the overall market isn’t clear cut either, with a run up in new build prices likely to offset any loses, at least to some extent.
And this all assumes the market is static, which it’s not.
For many people, their appetite for negative gearing is going to be largely dependent on the future outlook for property prices.
With prices already falling at a national level, it’s likely that that appetite was waning already.
Removing negative gearing now may just accelerate something that was going to happen at this stage of the cycle anyway.
So none of this is property positive, but I just don’t see it having huge impact. Very happy to see some modelling or hear some arguments that suggests otherwise.
Is there are silver lining?
So… Is there a possible positive in this whole story?
For me, when I look at it, I see the market potentially rebalancing away from investors and back to owner-occupiers. Not in a huge way, but to some extent.
Owner occupiers make up about a third of the market now. Maybe that goes to 35%, maybe 40% in the long run.
For me, personally, that’s a positive. Owner-occupiers tend to be more driven by emotion, and more willing to pay a premium for the features they like.
As an investor who likes to get active with his properties, and as a developer, I’d much rather be selling to owner occupiers than investors. There’s much more upside.
Now I’m not every investor. Some people are more of your ‘buy and pray’ type investor.
But for me, there is something of a silver lining to all this.
Hit me up
Anyway, that’s my thoughts. What do you think? Always keen to hear your thoughts.
And if you’ve seen any modelling that’s actually serious, very keen to see it. Send it through.
And thanks Steve for the questions. Always nice to know I’ve got the ear of vigilant investors.