House prices ain’t falling?
Leith Van Onselen is a highly regarded economist and a former staffer with Australian Treasury, Victorian Treasury and Goldman Sachs. While we generally pay little regard to broad macroeconomics, to say we regard his views highly is an understatement.
Recently he quoted academic Dale Boccabella, who wrote: “Abolishing the sacred cow of negative gearing – where losses can be used as a deduction against other income – is considered by governments of all persuasions as electorally unpalatable. But this part of the income tax system is one of the few areas left which confers this highly favourable treatment…”
Many believe that negative gearing should be abolished.
Longer term however – and keep in mind I am still working on an insight into why house prices won’t fall – I believe it is not in any government’s fiscal interest to abolish negative gearing. For reasons I will explain soon, not only do I believe the government should and will retain negative gearing, but they will be forced to consider extending the perk and introducing tax deductions for residential mortgage interest on the main residence as well as investment properties.
You see, there’s a wave of financial catastrophe coming for a generation of people unless the government assists others to buy property. Stay tuned.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Kent Wong
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I totally agree with James.Benjamin3 message on 7 April 2014. I quote,”Negative gearing reduces the costs of owning leveraged property on the micro front and on the macro front, it increases the level of debt within the economy ceteris paribus. Having a leveraged asset is wonderful for one’s wealth where prices rise and the economy overall is growing, it is quite the opposite should prices fall or if one reaches the limits of growth”
I strongly agree that negative gearing should be abolished. It has already contributed the spiralling house prices by increasing demanding of the properties. It has created a very unhealthy economy.
Roger Montgomery
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Sadly that is not what motivates governments and legislation…
TaxpayersParty
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“For reasons I will explain soon, not only do I believe the government should and will retain negative gearing, but they will be forced to consider extending the perk and introducing tax deductions for residential mortgage interest on the main residence as well as investment properties.”
I would be quite interested to hear why you believe the government should retain negative gearing.
So far I haven’t heard any good counter arguments to removing negative gearing.
Great site set-up by the way!
Jules W
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It seems there is a fundamental difference in how people view property. For some it functions as shelter, one of the basic modern needs including food, water, sanitation, electricity. For others it is one form of investment vehicle, such as shares, currency, gold etc.
The best and most beautiful solutions to problems are the simplest ones. Looking forward to Rogers next insight on this topic.
james.benjamin3
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Negative gearing reduces the costs of owning leveraged property on the micro front and on the macro front, it increases the level of debt within the economy ceteris paribus. Having a leveraged asset is wonderful for one’s wealth where prices rise and the economy overall is growing, it is quite the opposite should prices fall or if one reaches the limits of growth. Given the policy of growing global debt through public sector balance sheet expansion, one really has to question the wisdom of pursuing policies where the private sector is encouraged to increase indebtedness due to favourable tax treatment of the debt. It seems clear there is an ongoing preference for deleveraging in first world countries’ private sector and as such, I can’t help but think this will not end well.
benjamin.mentha
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Isn’t the real issue Capital Gains Tax reform? By memory the Henry Tax review recommended a 40% discount on net rental income and non-business capital gains…
In terms of housing supply, the current tax regime and various state/local planning laws tend to be producing a LOT of 2-bedroom units, but very few 3 bedroom or larger units. The current situation is essentially restricting young couples to have smaller families if they wish live within a reasonable commute to the city for work (the ‘Australian White-Collar One Child Policy’?).
In terms of Chinese investors, given that they are purchasing 15-20% of new properties, but are generally unable to purchase used properties, could this create a greater disparity between new and used house prices forward? (i.e. theoretically the pool of buyers for new properties is 15-20% greater than for used properties).
komal.pandya.940
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Interesting…My thoughts…
I think interest paid on mortgage (residential property) should be tax deductible – reason – It will be an incentive to high income earners who think its better to rent than own & help the First home buyers struggling to make their first purchase. I still think FHOG is a good idea, to encourage owning at early stage of life.
For investment property, I think all the investors are disillusioned with the fact that property grows at all the times…Interestingly whenever I have done maths – I found out that average rate of return on a property is (income-expenses) – 3.5%-5.5% pa. This could be achieved by simply investing in TD and having the peace of mind.
So my forecast is that most of the investment property holders would be scratching their heads after 10 years.
I have been myself looking at investing into properties but most of the properties are 40%-50% over their value to earn any returns out of it…I think most investor’s have got influenced by Robert Kiyosaki’s model or a recommendation of the accountant to save tax or a simple philosophy of “WE ARE HUMAN BEINGS WE LOVE ACQUISITION AND PROPERTY GIVES THAT FEELING OF ACQUISITION”.
Equal amount of research done on shares would make one in a better spot…Ramsay, CBA, JBHIFI, CSL, SEEK, ANZ, would be some of the examples to look at – these companies have given on an average 20% of growth YOY, it would be interesting to find out a property that could double every 3.5 – 4years…
Last but not the least point is “Leveraging Possibility” the dynamics of Property Leverage are simpler than Leverage on Shares…but I think people understand property better than going through the ratios etc…
An astute investor may agree to the fact that – its easier to own a share portfolio as oppose to Property, or for that matter any physical asset like precious metals etc…But common sense is not common…And would conclude on this thought.
Martin Finn
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Here is line of thought that is completely new to me.
The Economist of 29 March has an article on China that states “Landlords view flats as stores of value, not sources of rent”.
Now think about the building explosion that is occurring in Sydney and Melbourne, of flats for purchase by the Chinese.
Perhaps it is naive to think that building approvals for flats in Australia will necessarily convert into lower prices and make it easier for first-home buyers.
Roger Montgomery
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Indeed. In China, they don’t rent their properties out because they want to keep it new. I know of one gentleman who demolished/renovated one of his investment properties after ten years of ownership. He had never rented it out and it had remained empty for the entire decade.
Kent Wong
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In my opinion, interest should be deductible for the home you live and own. On the other hand, negative gearing should be restricted to one investment property only,
At the moment, some people owns several properties and some people cannot afford to buy one. I believe this is not healthy to the economy of a country at all and is not fair.
Roger Montgomery
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Interesting…
douglas.d.mcnulty
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So how about this proposal? A new deal ?
1) abolish CGT on investment property
2) PPOR purchase are granted tax deduction on interest for 5 years.
3) investment property neg gearing of interest costs only allowed for 5 years also. After which interest deduction is only available within a company/ trust entity against other income of that entity.
carlos.cobelas.1
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personally I think it would be immoral to extend tax benefits for property investors which would thus promote higher prices and make it even harder for young people and the less wealthy to buy a home. Houses should primarily be treated as homes for people to live in, not as investment vehicles. It says a lot that only Ireland and Australia allow negative gearing.
Roger Montgomery
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Was it immoral to give first home buyers $14,000 free money to buy a property and not give the same as a “first share portfolio buyers grant”? I agree that both artificially provide support.
ANTHONY SCELZI
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Long term, as long as China’s 1,390,510,630. people which makes up around 19.3% of the world’s population want to come to Australia which has a population of circa 23 million, the supply versus demand will never change. We may just have to get used to it ..
Kay
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I read an article somewhere that NZ abolished negative gearing once. Investors start selling houses. Housing price fell so sudden so much. It caused economical disaster. Soon government brought back negative gearing system.
Hope Aust Gov will abolish negative gearing (for a short time) so that I may be able to buy a house I am always dreaming of.
Roger Montgomery
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Hope springs eternal Kay!
Paul Skillender
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Not quite true. NZ recently (within the last 5 years) abolished depreciation on investment properties and significantly restricted negative gearing. Neither change impacted house prices (which are still rising) or destroyed the rental market – both predicted outcome.
Hayden Bunyan
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Thanks for someone being on the side of buying an investment property for its merits and not just tax savings.
I just hope someone in the future will separate revenue losses on the annual negatively geared losses and hold these as future capital losses for when the property is sold. This should make people consider more reasonable lvr ratios and better assess the likelihood of any capital growth.
Also it would be great if the government could have land tax, cgt and interest deductibility on the family home to try and help Aussie mums and dads just not shove all there money into the family home.
I live in fairy land but we can all dream at night.
Cheers,
Hayden
I look forward to the next instalment
Roger Montgomery
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Nice Hayden!
Hudson
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The massive flood of baby boomers funds is driving the market.
This is unsustainable as is continued investment by the Chinese.
Look at the Japanese buying real estate in Australia that’s now dried up.
Compared to oversea cities there is no doubt Australia is not fairly valued.
It’s similar to a Ponzi scheme that requires buyers at the bottom to sustain the entire model.
Once the baby boomers need to start selling property to live in retirement the supply and demand equation works in reverse.
Unemployment is not falling in Australia.
Interesting times ahead.
If one expects similar capital gains in the future to what they received in the past I think they are in for a rude shock.
Jochi Maker
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I think the end result is that if we abolish negative gearing which presumably would smash property prices, is that the baby boomer generation will now be much poorer as the trend over the past 20 years is to buy, invest and own property, they have a natural distrust of shares having seen several long sustained downturns and the old adage goes ‘there is nothing as safe as houses.’
Thus to ensure that people have enough money to retire, we’ll have to keep the negative gearing and additionally give it to mortgage payments on residential housing.
At some point though, the pyramid of ‘wealth’ created through such a scheme will have to come to an end, but that’s probably more than a few election cycles away so it’ll be worried about later.
Roger Montgomery
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Thanks Jochi,
Another blogger, who didin’t leave their name has posted the following:
Roger, can your work in progress help here? The commentary that Australia’s housing is ‘clearly overvalued’ is just plain wrong. (see Joye’s graph and others) We need to look at reliability of the data measures. These are the facts (say vs 1993):
– Houses are bigger (ergo, more expensive)
– Houses are built to a better quality (a 1993 house had no wall insulation, double glazing etc) again more expensive
To compare apples with apples you need to compare a house of the same size and quality to determine if affordability has declined.
Secondly, rates are lower – say 1996 rates were 9.25% for two years. Now they are 4.75%. Lets call that half – this element does not feature in Joye’s graphs. This means that you could buy a house 1.5x as expensive and have the same payments. This will more than eliminate the move from 3.7x household income to 4.5 itself.
Thirdly, the measure ‘taxable household income’ or ‘household disposable income’ is not a match between the time periods.
Today’s boomer retirees pay no tax – therefore no / low taxable income, and now they are a much greater % of the population.
Many more people in business (you can check the data) therefore lower tax rate (average), and lower declared income. As well, in 1993 people on wages had to pay for their cars after tax, in business now they pay pre tax, or have a novated lease – again reducing declared disposable income or taxable income)
Marginal rates were higher then (bracket creep notwithstanding).
Deductible contributions to super, salary sacrifice all reduce THO and HDI and were not able to be accessed in 1993. Note these defer income today and put it to the future … when it will not be taxable, but still give the person house buying power.
Finally, the GST has added 10% to a house build cost. All changes which affect the data and if corrected will show houses are cheaper now or certainly not overvalued relative to previous periods
john oshea
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People can always buy the house you need tomorrow today as an investment and rent a house to live in while it is negatively geared. As time progresses and rental income increases with inflation, the property reaches a stage where it is positively geared (or near to), they can then move into the house effectively creating a tax situation that is better than any investor receives. Hard to see why you would abolish a law that helps the astute home owners outfox investors.
I like this option because it allows you to rent a right sized small apartment when young and then move into a larger house years down the track when needed. Not sure how many others think this far ahead.
danny Stojovski
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John, there is no such thing as an ‘Astute Home Owner’.
john oshea
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They don’t need a degree in tax law, they just need to ignore high pressure investment “tips” from “experts” that take commission on big loans. My neighbours were this smart. I don’t but only because I bargain hunt and only offer prices low enough to make them positively geared properties so it doesn’t work out worth my while.
It’s not like this is a special tax law that can only be used to one type of persons advantage. It can be used by everyone and actually gives home owners a better long term outcome than investors but people don’t inform themselves.
Andrew Legget
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Looking forward to hearing more Roger.
That ending, however, was like seeing a “To be continued” at the end of a tv show or movie that you are and don’t wan’t to wait for the next episode/installment though. I am sure i am not the only one trying to work out what that financial catastrophe you mention is.
eric.cheung.7359
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Roger – looking forward to hearing your views on this. This topic has been pondered extensively by (as you mention) the likes of Leith Van Onselen and Steve Keen. They argue that the main structural factors are:
1) Supply constraints due to restrictive urban planning policies, difficulty with getting land on the fringe of our capital cities rezoned to residential, and imposing infrastructure tax exclusively on new development.
2) Cheap credit due to low interest rates. I think Keen showed a significant correlation between the second derivative of credit lending and house price movements.
3) Favourable tax treatment of properties: as you mention, allowing property losses to be offset on other sources of income (‘negative gearing’). No CGT on PPOR. Stamp duty making it expensive to change houses.
4) Foreign Investment
Regarding 1): As your team described in one of your posts about the boom/bust nature of commodity booms – when a market with constipated supply receives a boost in demand, we will first see price inflation (boom). Then, as the suppliers scramble to ramp up production, supply comes on in a big wave, and we see price deflation (bust).
Interesting that we are seeing a large number of apartments coming up in Melbourne and Sydney recently – could the first wave of supply be coming online now?
Regarding 2): I think if you look at graphs of house prices you can see they started to inflate significantly when the financial sector continued to deregulate and started to offer high LVR loans. Will this stop? Unlikely. And with the current private debt levels I think the RBA is in a bit of a bind where they will find it difficult to raise interest rates much in the foreseeable future.
Regarding 3): Yes, the tax system offers incentives to high income earnings in top tax brackets to ‘invest’ in property. Proposals to fix this by LVO include replacing stamp duty with a broad based land tax, quarantining property losses to the same asset class (so losses can only be used to offset future rental profits or capital gains – not to offset PAYG income).
Regarding 4): There doesn’t seem to be any actual data about this, only anecdotes. So it’s hard to gauge the effect.
On almost all sensible valuation measures (eg. price/rent, median price/median income) our property is overvalued, both in historical terms in Australia, and also compared to current residential property in other countries.
As to why it’s not fallen? My personal guess is that it’s the old problem of valuation-is-not-the-same-as-predicting-short-term-market-price-movements. Coupled with Australia’s cultural belief in property being a one way bet that only goes up, and the love of owning our PPOR as part of the ‘Great Australian Dream’, and a generation that has apparently gotten wealthy from 35 years of house price inflation – you have all the makings of an inter-generational market mania.
Should it all go pear shaped, government intervention or ZIRP could prevent house price falls as you seem to be suggesting. In fact one reason I don’t think we will have a spectacular US-style crash is that the median Australian mortgagee has a variable-rate loan, whereas the median US punter has a fixed-rate loan. So the RBA can have a much more immediate effect arresting any house price correction.
Time will tell!
Roger Montgomery
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Really enjoyed reading the combination of property insights and value investing aphorisms.
portfolio14
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Huh? How will extending negative gearing assist the next generation to buy properties? It will increase the size of the pool of potential buyers. Thus, you increase demand. Market prices go up, completely offseting the saving the buyers are getting from negative gearing. Isn’t this the same issue with first buyer grants?
Do I miss something? :-/
Roger Montgomery
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SPot on. Watch this space.