Negative gearing is back with a vengeance

From Business

August 19, 2022

Negative gearing – the tax break loved by property investors and detested by just about everybody else – is back with a bang.

A rapid upsurge in mortgage rates is triggering an explosion of activity from current levels as millions of Australian’s rediscover the biggest tax deduction available to salaried workers.

New figures just released from the Australian Taxation Office indicate the total cost of negative gearing in our market evaporated during the recent period of rock bottom rates – for the year to June 2020 it hit a minuscule $167m. In contrast, the all-time high for negative gearing was a bumper $9bn in 2007.

But industry analysts suggest the total this year has already risen more than tenfold and could ultimately rise to somewhere beyond $6bn annually.

While the wider residential sector monitors the market’s steady – but moderate – drop in house prices, investors have swarmed into the market attracted by the double lure of strong cash income and negative gearing tax breaks.

Aggressive investors are betting the housing price downturn will be shorter and shallower than the current consensus suggests.

The investment lending numbers speak for themselves. The current lending to residential property investors – at $12bn per month – has already risen above the volumes we saw at the peak of the last cycle in 2015

For the investor, the swelling tax write-offs offered by negative gearing can be counterbalanced by the prospect of rising cash income coming through from higher rents.

The average rent across Australia grew by 12 per cent over the last year – that’s twice the pace of inflation.

“I would not be surprised to see the total negative gearing loses move up beyond $6bn a year – they might even test that record set back in 2007,” says Shane Oliver, chief economist at AMP Capital.

With top personal tax rates at 45 per cent, well over one million Australians could be involved in negative gearing this cycle.

(Negative gearing comes when a property investor’s income from a property does not cover expenses – the gap between the income and total expenses can be claimed as a loss and set against taxable income. The biggest expense is usually interest costs).

At CoreLogic, Tim Lawless says the hot spots will be inner-city Sydney and Melbourne suburbs where there are a huge range of entry-priced units and apartments.

In those areas, yields can be between 2 per cent and 3 per cent while in regional areas yields are between 4 per cent and 5 per cent.

As a result, CBD markets are the perfect zone for negative gearing since yields are lower but the prospect of capital appreciation over the long term is higher.

To put that another way, higher interest rates means bigger negative gearing tax deductions. Moreover, since rates are widely expected to rise at least one per cent more, the write-offs are only going to expand in the months ahead.

Although there is widespread concern that house prices will fall sharply – and top economists are still talking of a 15 to 20 per cent peak-to-trough decline – investors are coming from a different perspective.

The swing factor for investors is the prospect of finding bargains now which will pay off in the years ahead. Apartment units were oversupplied going into the pandemic, but the absence of students and migrants knocked the market flat over recent years.

Now the wheel is turning. “It’s the rental market in the cities where negative gearing will be rising the most,” says CoreLogic’s Lawless.

In fact it is Melbourne – the hardest hit of the city apartment markets during the pandemic – where there is now some of the hottest action. Rentals in the Melbourne apartment market grew by 19 per cent over the last 12 months, triple the inflation rate.

According to Yarra Capital’s Tim Toohey, one of the factors bringing investors back into the market is “excess liquidity”. Toohey suggests property investors – like sharemarket investors last year – have been desperate for income as cash rates remain historically low. He also points out that residential property has benefited from a swag of pandemic-era government assistance packages for homeowners.

For investors buoyed by rising rental income and unlimited tax deductions from negative gearing – the biggest risk may not be financial but political.

Negative gearing remains a bugbear for many outside the property market. The exceptionally low levels of activity in 2020 took the issue briefly off the political agenda.

But it is already clear that the last available number for its cost to the taxpayer – $165m from the ATO for 2020 – is both an outlier and substantially irrelevant in 2022. During that period rates were so low that negative gearing simply failed to materialise for many investors since their mortgage costs were so low.

What’s more, we had a combination of pandemic-related weakness combined with macro-prudential controls which restricted banks from lending to investors.

The market in 2022 it utterly different

Industry analysts suggest the figure is more likely to already have moved up near $3bn. As the rising volumes become more evident, the protests will become louder.

Although negative gearing is the best tax break open to everyday working Australians, a number of surveys have shown that wealthier salary earners are three times more likely to use it than workers earning less than $90,000 a year.

As Brendan Coates of the Grattan Institute noted, negative gearing is rapidly rebounding as a “substantial” cost to the federal budget.

The political dynamics is that the ALP had matched the Coalition in its election campaign by ruling out either capital gains tax reforms or negative gearing tax changes. In doing so, the Albanese administration effectively overturned an earlier plan to cut negative gearing attractions by restricting it to newly built homes.

This week the ALP moved the goalposts on taxing petrol cars with Climate Minister Chris Bowen saying: “Now is the time to have an orderly and sensible discussion.”

Bowen was Labor’s treasury spokesman when it launched that first round attempt to cut negative gearing. If the Albanese government gets to revive one contentious policy, they may well find the confidence to turn to another. Don’t be surprised if calls for a “sensible discussion” on negative gearing comes next.

The Australian Business Review Saturday, August 20,2022