20 May 2010

In defence of negative gearing

Allegations that negative gearing is driving property prices up are being challenged by the Housing Industry Association (HIA), Australia’s largest building industry organisation.

Australian Council of Social Service has said that negative gearing is contributing to house price inflation and excessive household debt.

Tax Watch convener Julian Disney is one of many people asserting that negative gearing is to blame for house price inflation in Australia.

Disney is quoted as attributing rising property prices to the tax system, specifically negative gearing that allows investors to write off the costs of their interest payments and the concessional capital gains tax.

The HIA begs to differ maintaining that blaming Australia’s housing affordability woes on taxation arrangements such as negative gearing and capital gains tax on the family home is a gross simplification of a complex matter.

While many countries do not allow negative gearing because of the problems it causes with speculative inflation HIA Executive Director, Victoria, Gil King points out that the strong up-cycle in existing home prices in most regions of Australia started from 2001, many years after negative gearing arrangements had been in place.

“Home prices in many countries rose strongly through much of the last decade prior to the global financial crisis. Rising house prices was not just an Australian trend.

“HIA is concerned that ill-informed discussion surrounding the impacts of Australia’s taxation arrangements could lead to destabilising conjecture and uncertainty regarding the future of taxation and housing,” says King.

“The reality is that home prices and investment decisions are driven by a myriad of factors such as land supply, planning restrictions, population growth, interest rates/credit availability, and the strength of the economy.”

The obvious question that needs answering, says King, is why does Australia have a housing shortage in both the rental and the owner-occupier markets?

“If rental investment was so attractive and property buyers were so motivated by taxation arrangements would there not be a surplus?

“That question gets to the heart of Australia’s affordability woes. Massive structural constraints to boosting housing supply are driving unnecessary upward pressure on existing home values.”

Data shows that the majority of negatively geared properties are existing dwellings. One suggestion has been to limit the practice to new properties only, which would focus investment on construction and assist with the issue of supply.

“More and more people are being pushed away from new homes and towards existing property as the supply side costs associated with new housing, including increased regulation, continue to escalate,” says King.

“This is already a massive issue in New South Wales and Queensland in particular and has the capacity to considerably erode the relative new home affordability advantage Victoria currently enjoys.

“Simplistic solutions to housing affordability only invite confusion in the housing market and do little to advance and address the real issues hampering the provision of adequate and affordable shelter. Removing existing structural barriers to new housing supply and refraining from implementing new ones is the key,” King concludes.

The subject of negative gearing continues to arouse passionate debate and the blame game is hotting up.

The Australian Tax Office views a rental property as negatively geared if borrowed funds have been utilized to purchase the property and the net rental income – after deducting other expenses – is less than the interest on the borrowings.

The Real Estate Institute of Victoria offers advice and a clear explanation to anyone contemplating negative gearing.

It says: An investor borrowing funds to buy a property ideally wants the rent from that property to pay for the interest on the loan, with a small profit. If it does, this is called positive gearing; if it doesn’t it’s negative gearing.

“The critical numbers to compare are the rental yield and the interest rate of the investment loan. For instance, a median-priced house in Mitcham (an outer eastern suburb of Melbourne) costs around $577,500. If the property earns $500 a week in rent that would equate to a yield of 4.5 per cent (500 multiplied by 52 divided by 577,500). If the interest rate on the loan is 7.25 per cent, the investor is making a loss of around 2.75 per cent.

“The loss can be claimed as a tax deduction.

“While the deduction does make the property more affordable, it is not sustainable in the medium and longer term. An investor should ideally purchase a property that will appreciate over the medium-to-long term. This will deliver equity and capital gain.”

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