Why Sydney and Melbourne property investors should be scared: ‘Weakened’

Questions around housing affordability have become a key talking point in our public life. Separating the facts from the myths has become difficult, though, particularly around the role that the tax system plays in boosting prices

Going back to basics for a moment, are Australian property prices actually unaffordable? For many Australians, the answer is yes. Recent data from the International Monetary Fund ranks Australia as the third-least affordable when comparing the ratio of house prices to incomes – only Canada and Belgium are more unaffordable – whilst a typical property in Sydney will cost upwards of 12 times the average annual income.

Are investors responsible for the unaffordability of houses in many Australian capital cities? Not entirely.

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Supply vs demand in the housing market

Many property experts point, with some justification, to supply issues in the housing market. Quite simply, we’re not building enough new houses to satisfy our increasing population.

Let’s be realistic though; the supply side isn’t entirely to blame. Visit many property auctions in Melbourne and Sydney and you’ll spot first-home buyers looking on disconsolately as cashed-up investors drive up the price for promising-looking properties beyond a level that’s remotely affordable unless you have cashed-up parents.

And many of those investors are there because the tax breaks available to them make the purchase more attractive.

When we talk about negative gearing we’re typically actually talking about two different tax breaks which are used in conjunction with each other as part of a property investment strategy.

On the one hand, investors can deduct the day-to-day costs of financing and running their investment property from their rental income.

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About two-thirds of property investors (over a million taxpayers) actually make losses, which they can offset against other income, often generating a tax refund at the end of the year.

On the other hand, our generous system of taxing capital gains (CGT) – we allow taxpayers to discount capital gains by 50 per cent if they simply hold their asset for more than 12 months – halves the CGT payable when properties are ultimately sold.

The interaction between the two makes property investment a highly tax-advantaged strategy at a time of rising prices. Conversely, where prices are falling, the impact of negative gearing is reversed and taxpayers can find themselves getting badly burned.

This latter point is crucial

Although tax perks can play a part in building up a housing bubble, ultimately there are usually bigger factors at play which are the main drivers of house price boom or bust.

In Perth a few years ago, property prices were pumped up by the mining boom and investors with an eye to a quick buck flocked in.

Subsequently, once the boom ended, the market weakened and suddenly negative gearing no longer looked like such a good idea.

Sooner or later, the same thing will happen in Sydney and Melbourne and it will happen whether the tax rules are reformed or not.

There may be sound policy reasons for looking at aspects of tax policy around housing – many countries only allow losses on investment properties to be offset against other property income, which feels like a broadly sensible idea – but wholesale reform of negative gearing is unlikely to be the magic medicine that cures our housing crisis.

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