The Impact of Negative gearing on the Australian Property Market
Negative gearing is a recurring terminology in the property market. Even though there are so many debates over it, investors take advantage of this grey area in the real estate business. It forms an integral part, and it has, over the years, shaped the way property owners have invested.
There are so many factors that we need to consider while studying negative gearing. The article here aims to give you a better understanding of how Negative gearing has impacted Australia’s property market.
Negative gearing is not a new subject matter for property owners in Australia. The various government policies encourage investors to take the utmost benefit from this scheme. Over the years, we have seen positive and discouraging negative gearing impacts on the Australian property market. To better grasp how it has affected the real estate business, we must first take a detour and determine how Australia’s property market works.
What is the property market?
The property market or Real estate business deals with the buying and selling land, including the immovable property fixed to it.
The entire operation involves policies, and it is highly regulated. Depending on the country’s laws, brokers and real estate agents have a license and follow different protocols.
There are different kinds of real estate. They are as follows:
The residential area covers non-business locations. The houses which the investors sell or lease are for people to reside. It could be newly constructed or resale homes. The most common residential areas include single-family homes, apartments, condominiums, duplexes, etc.
Commercial real estate involves property, which is solely for business purposes. Such locations may include malls, office buildings, shops, and hotels.
Industrial real estate deals with production houses. They are buildings for storage houses, production, distribution, etc.
Finally, we have the land real estate. Under such property, we are dealing with vacant land, farms, and ranches. You can further subdivide them into undeveloped and early development.
Property Market trend in Australia
As we have seen above, the property market entails a wide area of elements. Since you can directly or indirectly link many of the components to the real estate business, the economy is highly dependent on how it functions. More so for Australia, as over 1.7 trillion dollars is held by the bank on mortgages for home occupiers and investors.
This sum estimates to about 65% of the total lending amount. It is one of the highest among western countries. Imagine if the property market fails. It would mean the fall of the entire economy of the nation.
Over the years, there have been many views regarding the property market in the country. Some believe that it is an investment bound to collapse, while many others think otherwise. However, before making such claims, one should understand that the real estate business is not easily detrimental.
Many factors affect the trend in Australia. To better understand how the property market has been functioning, we must study the characteristics. Here are some elements that you can find in the property market in the country.
Housing prices are high
One would expect the prices of houses to be low; sadly, it is not the case. For over the past few decades, house prices in Australia have seen an upward trend. The Demographia Housing Affordability Survey in 2019 found that the average house prices average is about 5.7 times higher than the income.
It is higher than the US and UK rates, which is 3.5 and 4.8, respectively. In places like Sydney and Melbourne, this value is too high: 11.7 and 9.7, respectively.
Due to the excessive rate of house prices, individuals and investors shy away from buying property.
Though banks offer loans to encourage more investors, owning a property is still a tall task.
The market is highly divergent
It is challenging to club and assess the entire property market of Australia as a singular phenomenon. The case here is that the trend is different based on the location. While some cities may see a phenomenal rise in the market, others may experience a downward trend. It was the case with Darwin, as for the last five years, it saw a massive fall in price while its neighboring cities experienced a climb.
Supply and demand gap
There has been a gap between the supply and demand of housing needs. The problem here is that, over the last decade, the annual population growth has risen to almost 400,000. It was just over 200,000 in the year 2005.
The massive growth in the population meant a rising demand for housing needs. Based on the above numbers, it is estimated that it would require 75,000 extra homes to meet these needs. However, the supplies are far from being met. Undersupply is one of the reasons why house prices have risen considerably.
Unstable Price rate
One should not be under the false assumption that house prices only rise upward. As many factors have their influence, we find that the rate shifts. We have witnessed price declines of up to 10 % across different cities.
The unstable price rate makes the housing market sensitive. Any shift in the price can push the property market forward or backward.
One should bear in mind that a property crash is not easy to predict. For decades, analysts and experts have made various comments on property crash calls.
Many pointed out that the increase in house prices and high debt levels would lead the market to fall out. Even magazines like ‘The Economist’ in 2004 remarked Australia as “America’s Ugly sister.”
In 2019 crash calls were made in 60 Minutes. Due to the pandemic situation in 2020, experts expected the market to spiral down; however, the property market has seen a steady trend.
It would reduce unemployment at a considerable rate to witness a national housing crash, coupled with high-interest rates and oversupply.
What is negative gearing?
Negative gearing is a practice where investors buy a property where they incur losses during the initial period and hope to profit after selling the property. It is the financial leverage that buyers enjoy. The sole purpose of owning the property is to sell it in the long run once the asset’s price rises to a certain level.
A piece of property or an asset is negatively geared if the net rental income it produces is less than the expenses it incurs. It results in a net rental loss. The payments you have to cover are not only the building’s cost that you have to pay. It also includes payable interests, i.e., loan, renovation charges, and other miscellaneous investments.
After paying for all these, you might encounter an annual rental income lower than the money that you spend on your property. Though the entire situation seems horrible, the silver lining is that since your income is less, you’ll be paying considerably lesser tax at the end of every financial year.
Say, a man was to buy an apartment for rental purposes. The negative gearing will come to affect when the apartment’s rent would not be enough to cover the cost of maintaining the building, loan payments, and depreciation. However, in the long run, the buyer makes enough money by selling the asset to recover the losses he incurred in the initial stage.
Features of negative gearing
In a negative gearing strategy, the asset does not produce any profit during its initial stage. It means that in some cases, an investor should be ready to shell out his money to cover the building’s maintenance cost.
Investors employ this strategy because the losses he incurs would aid him in his tax bill. Apart from that, he sells off the property, which can help him gain a considerable profit.
It is crucial to note that an investor would profit if he sells off the asset. The risk here is that he could incur losses when he sells his property if he makes a bad call or prediction about the price rise.
Why negative gearing?
Negative gearing takes advantage of government policies. As a country that allows tax deductions, negative gearing helps to take advantage of this and help investors make a profit. Other countries that will enable negative gearing are Japan and New Zealand. In countries like France, Germany, Canada, and the US, allow the deductions under certain restrictions.
It is a logical choice for investors to opt for negative gearing when they can make substantial capital gains when they sell their assets or property. However, this strategy can backfire if there is only a marginal rise in the house price or if the price falls. When this happens, property owners will not be able to sell their assets at a profit. Thus, it comes with risks for investors.
Things to consider before investing in negative gearing
- Though negative gearing promises tax benefits, it is always best to know what you are getting yourself into. Be sure to calculate the expenditures and the investment you will have to make before jumping the guns so that you can turn in a profit.
- Research thoroughly and look for a property that has a possible growth and rise in price.
- Be realistic, and don’t overdo with your investments and expectations.
- Borrowing in your maximum capacity can hurt you in the long run.
- Be aware of recent government policy changes.
Cons related to Negative gearing in the Australian property market
1. It reduces the supply of houses for home buyers while encouraging property valuation and investment
Since the prices of houses are too high, owning a home has become a farfetched dream. People now only see property as merely a means to an end. With negative gearing in sight, more and more investors buy houses not for personal residential purposes but as lucrative investments.
According to a survey by ABS (Australian Bureau of Statistics), for the financial year of 2017-18, the number of people buying houses for renting purposes has increased at an incredible rate. About one-third of people are renting their homes. The survey also showed that the majority of the homeowners belonged to the middle-aged middle-income group. At the same time, the highest income group owned more than one property. It was estimated that out of almost 2 million property owners, one in five owned two or three properties. Leilani Farha remarks that “…housing is treated as a commodity, a means of accumulating wealth and often as security for financial instruments that are traded and sold on global markets … “.
Housing is no longer about getting settled with the family, but an asset which is manipulated to earn. Negative gearing makes it easy for investors to dive in and bear the brunt of the initial losses.
2. It benefits a selected few and helps the rich get richer
Though this is debatable, as negative gearing requires an investor to have enough money to pay for the initial expenses, only those who can lash out their money for their short term losses can invest in the market. As mentioned earlier, it takes advantage of the fact that the prices of housing should increase. Though the increase in property rate may be a boon for such investors, it becomes difficult for someone who is only looking to buy a decent home.
Also, since it attracts more and more people to invest in property marketing, many of the loans meant for people to buy homes are taken by investors.
3. It lures people to make investments filled with risks
You should keep in mind that the prices of property are susceptible to change. The trend is not always upwards. Not all the time do prices of homes rise; when this happens, the capital gain when the house is sold would not be enough to cover the expenses.
A slight change in government policy can also ruin the chances of earning a profit. There are so many unknown variables and unpredictable changes that an investor must keep in mind before investing. Say, for example, the pandemic in 2020 has led to a decrease in demands.
It is an investment that involves risks; however, it has not stopped people from investing in this market.
4. It reduces the housing supply for homeowners
As more and more people buy houses, the supply and demand chain is affected by it. According to a report submitted by Melbourne University, it suggested that about 75% of the population would own homes if negative gearing were removed. It is currently at around 66%, which is the lowest ever so far.
5. It increases the price of housing
Negative gearing is another factor that leads to a price hike in housing. There is no denying this fact that investors want to make a profit at the end of the day. Since they want to sell their asset to cover up their costs, they make sure that they do away with their property during its highest value.
Pros on Negative gearing in the Australian Property market
1. Moderate income groups also get the benefit
Apart from wealthy investors, some people who belong to the moderate-income group are also encouraged to invest in real estate. If done correctly, it is a lucrative market. Thus it becomes a source of income for even the average workers.
As negative gearing takes advantage of the reductions in taxes, and there is no hard and fast rule that an investor should sell the property within a specific period, he can wait for the price to rise. As long as he can cover the initial expenses, he can make a decent profit.
A report by REIA estimated that 2/3rd of the people that gain from negative gearing have an average income of about $80,000 annually.
2. Negative gearing encourages housing constructions
Since it encourages more investors, the demand chain rises. To meet the ever-increasing demand of homeowners, construction companies need to build more houses.
3. It affects the rental market
Since negative gearing acts as a safety net for property investors, they are ready to incur losses. The rent is low, keeping in mind that profits would come after selling the asset.
The very idea that the landlord can get capital gains after selling the property discourages him from raising the rent. Doing away with negative gearing would increase the rent by a considerable margin.
4. Rental accommodation
Since Negative gearing encourages more private renters, it provides cheap and accessible accommodation for many people. Doing away with negative gearing would ultimately affect this group of people.
Negative gearing is a complicated subject matter which has both its positive and negative impacts. There is no straightforward answer to whether it is beneficial or not. As there are so many variables, we cannot comprehend how it can affect the overall property market.
However, a slight change in the policies of negative gearing can significantly impact how the property market works in Australia. As either directly or indirectly, many elements are entangled to the property market, Negative gearing plays a massive role in how the nation’s economy plays out. Government strategies and policies are essential to creating stability in the property market and the country’s economy.