If Labor comes to power at the forthcoming Federal election in May, one of its key policies is to make changes to negative gearing and capital gains tax.
These changes comprise limiting negative gearing to new housing only and reducing the discount on capital gains tax from the current 50 per cent to 25 per cent with the stated view to increase housing affordability, and the party has announced it will implement the changes on January 1, 2020.
There’s every likelihood that Labor will win too, with one of the largest majorities in Australia’s history, meaning it is extremely likely the changes will take place.
So what is the potential impact of these changes and why does it have investors running scared?
RiskWise analysis of the property market has already demonstrated that fears of the proposed changes have already impacted the market.
We clearly saw price reductions accelerate following the Liberal Party leadership spill in August last year, that significantly increased the chances of Labor to win the election. In addition, auction clearance rates, in the last quarter of 2018 dropped below 50 per cent in both Sydney and Melbourne. They now hover just above 50.
This has been exacerbated by APRA’s tighter lending standards, the impact of the Banking Royal Commission, restrictions on foreign investors, unit oversupply and a sharp drop in dwelling commencements.
We can now see that the majority of current property purchases are depreciating assets with a high level of risk in the short term.
Our research also shows the impact of these taxation changes on some of the areas is likely to last well into 2021 with a very high risk of price reductions, at least until the second half of 2020.
This impacts buyer sentiment and leads to a strong reduction in investor activity. Investors are also now realizing they need to wait for the election results, the implementation of the taxation policy, and a new low equilibrium point to be reached, before they act.
Investors understand the potential increases to out-of-pocket expenses due to the taxation changes, which are equivalent to a significant and sudden interest rate increase of 1.15 per cent in the Sydney unit market.
In addition, the increased risk associated with the changes will require banks to use ‘forward-looking information’ to assess provisions for bad debt, and to also integrate the potential impacts of the proposed changes into their credit assessments, for example, requiring lower LVR (i.e. higher deposit). Add to that much closer scrutiny of loan applications and another bottleneck starts forming with less approvals and greater approval times.
Furthermore, many investors are confused about what these potential changes will mean, and this only increases the level of uncertainty and the duration of low activity in the housing market.
It is also important to note that taking a blanket approach when implementing major policies unfairly undermines already weak property markets. These areas include those that were experiencing continued weakness in recent years due to poor economic growth following the end of mining boom, a soft job market creating very slow population growth and, in some areas, oversupply of units.
The impact on both the broader economy and, particularly, GDP growth, is already significant with the RBA downgrading the GDP growth projections and a 50 per cent chance of an interest rate cut.
Another issue that needs to be addressed is that, despite the reforms being ‘grandfathered’, existing investors will still be affected by the changes by the creation of primary and secondary markets. This is because buyers won’t want to pay as much for existing properties knowing they won’t reap the same tax benefits as primary purchasers. This means sellers will lose money, and this is something the Labor party has glossed over in its policy announcements.
Also, the issue with housing affordability is that if demand is high, it is unsustainable, and Labor’s proposal will add additional pressure, not take it away. With a very large number of newly created jobs in Sydney and Melbourne, it is unsurprising that the population growth in these cities is very high.
While there is definitely a strong downturn in the property market, this is only a temporary situation and the undersupply of family-suitable properties will have an impact on price growth in the medium and long term.
Re-finance will also become a major issue. This is because many interest-only loans are maturing, and many investors are looking to re-finance with another lender. However, this lender will require a new valuation, and a lower valuation might not enable the investor to do so.
In conclusion, the proposed taxation changes will have major implications and many investors will simply ‘sit on their hands’ and wait for the implementation of the changes and for the ‘dust to settle’ before making buying decisions.
CEO / Founder
RiskWise Property Research