Why property prices could be about to plummet

Moira Geddes discusses how your lifestyle is being affected by the latest trend in the property market.

The Murray Inquiry criticised investor tax breaks including negative gearing. Source: Getty Images

WITH everyday Aussies finding it increasingly difficult to buy their first home, experts often point the finger at one controversial feature of the property market.

It's one of the most divisive tax issues in the country. Banks, the real estate sector and property investors like it, but many argue it unfairly benefits the rich.

Now, a major inquiry into Australia's financial system has sounded an ominous warning for the future of the contentious tax break, which could soon make it easier for first home buyers to enter the market.

Negative gearing is a popular tax arrangement used by property investors to reduce the amount of tax they pay on their income.

It goes like this: if the cost of owning an investment property, including interest on mortgage repayments, is greater than the rental income on that property, the loss can be used as an offset against other taxable income such as your salary.

Opponents argue it distorts the housing market, pushing prices up and forcing first home buyers to compete with already-wealthy investors — and that position appears to have been given some weight by the release of the long-awaited Financial System Inquiry final report.

Former Commonwealth Bank boss David Murray's sweeping review of Australia's financial system identified, in addition to its 44 recommendations, 13 taxes needing to be addressed.

It singled out negative gearing as one of a number of tax arrangements that "distort the allocation of funding and risk in the economy" and may "adversely affect outcomes in the financial system".

"The tax treatment of investor housing, in particular, tends to encourage leveraged and speculative investment," the report says.

In other words, the current tax arrangements are fuelling Australia's obsession with property, and overheating the market.

Could getting into the property market soon become easier? Source: Getty Images

EASING THE PRICE PRESSURE

While its original purpose was to boost housing supply by encouraging investment, data from the Australian Bureau of Statistics shows that hasn't worked.

New construction accounts for just 7.1 per cent of the total value of investor loan approvals, on a long-term downwards trend from 60 per cent in 1985.

Australia had 1.9 million property investors in the 2011/12 financial year, according to the Australian Taxation Office, most of whom failed to cover their costs — the collective net rental loss was $6.8 billion.

"The only reasonable conclusion is that most Australian property investors don't really care about rental yields," wrote Business Spectator's Callam Pickering. "They are in it for the capital gains, which is the very definition of speculative activity."

Matt Grudnoff, senior economist with the Australia Institute think tank, says negative gearing and capital gains tax concessions are pushing up residential house prices.

"Negative gearing is a tax break that primarily benefits the wealthy," he said. "Most houses are sold at auction, and about half there will be there to buy the house in order to rent it. Almost all of those would be for the purposes of negative gearing. Obviously with more people bidding, the price will go higher."

He says rising prices affect first home buyers the most. "They're not in the market. If you're already in the market and it goes up, the house you're in goes up, so if you're already in the stream, if you like, and can bid more," he said.

"The other reason is that a lot of investment properties are the kind first home buyers are looking for, houses that are a little older or smaller. They are targeted by investors who want to rent them out."

Mr Grudnoff says if negative gearing were removed altogether house prices would either come down or not increase for an extended period of time.

"People have an aversion to selling a house for less than they bought it. What often happens is rather than the price collapsing, it just doesn't increase for a period of time as the market catches up."

But an unwanted consequence of removing negative gearing entirely could be a slowing in construction. Ideally, Mr Grudnoff says, it would be limited to new houses and removed for second-hand dwellings.

"Anything that increases supply in the housing market is a good thing," he said.

Negative gearing pushes up house prices and hurts first home buyers, opponents argue. Source: Getty Images

WHAT AFFORDABILITY CRISIS?

On the other side of the debate is property analyst Terry Ryder, director of Hotspotting.com.au. He says the effect of negative gearing on house prices is negligible. More than that — the entire "affordability crisis" is a complete myth.

"The general rhetoric in terms of the impact of negative gearing on pricing is a storm in a teacup," he said. "The reality is it's only Sydney that's had a house price boom in the last few years. A few other cities have had moderate to solid growth, and others have gone backwards."

Mr Ryder claims the debate has been misrepresented. The section of the market most responsible for pushing up house prices is the section that never gets discussed: the "next home buyers", owner-occupiers who are upgrading or relocating.

"They comprise the bulk of the market and they have the capacity to pay top price. They never get talked about and generally they're the impetus for rising prices."

Investors comprise roughly a third of the market, but generally they don't pay top dollar for properties, he argues. Their motivation is to get properties at the lowest price, seeing as they're not going to live in them.

And the common refrain that the number of first home buyers is falling is based on a miscount anyway — earlier this year, the ABS admitted that its numbers were unreliable because they only represented those accessing first homebuyer grants, which many state governments no longer offer for existing dwellings.

"The problem of first home buyers not being able to buy is the greatest furphy in real estate," he said. "You even have a federal parliamentary inquiry based on this miscount."

Indeed, the two quarterly housing affordability studies — one by the Commonwealth Bank in association with the Housing Industry Association, and the other by Adelaide Bank and the Real Estate Institute of Australia — both show affordability has actually been improving.

"Both have found that right now it's the best it's been in 10 years, due to a combination of moderate price growth, steadily rising incomes and record low interest rates," said Mr Ryder.

Two quarterly surveys have found housing affordability has been improving. Source: Getty Images

RENTS COULD INCREASE

One potential side effect of removing tax breaks could be a sharp drop in supply, leading to rapidly rising rents, as Paul Keating found when he tried to wind back negative gearing the during the Hawke Government in the mid-1980s.

"He very quickly brought it back in," said Mr Ryder. "It reduced the attractiveness of property investment for some parts of the market. People stopped buying investment properties or sold the ones they had. That resulted in a shortage of rental properties and as a consequence rents rose sharply."

The 2009 Henry Tax Review issued a similar warning, saying changing the taxation of investment properties could have an adverse impact in the short to medium term on the housing market.

"Reducing net rental losses and capital gains tax concessions may in the short term reduce residential property investment," Ken Henry wrote. "In a market facing supply constraints, these reforms could place further pressure on the availability of affordable rental accommodation."

Stephen Kirchner, research fellow at the Centre for Independent Studies think tank, says it's a myth that negative gearing and capital gains tax concessions are responsible for rising house prices.

"Many people suppose that housing affordability can be improved by making investment in housing less attractive via the tax system, thereby reducing investor demand and benefiting owner-occupiers, including first home buyers," he wrote earlier this year.

"But this assumes that the effects of these policies can be quarantined to the demand side of the market and have no implications for dwelling supply."

The animus directed at negative gearing is as much an objection to the tax deduction as its supposed implications for housing affordability, he said.

"Property investors specialise in bearing market risks that many owner-occupiers and renters are either unwilling or unable to take. Reducing incentives for risk-bearing through the tax system will adversely affect the supply side of the housing market, as well as reduce demand, with uncertain implications for house prices and affordability."

Should negative gearing be abolished? Leave your comments below or email the writer at frank.chung@news.com.au

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