Understanding negative gearing & its impact on housing affordability

Thursday, 9th Jun 2016

2830656_mNegative gearing has been placed under the spotlight recently after Labor leader Bill Shorten announced his party would make significant changes to the policy if he were to win government at the impending federal election.

Since then, we’ve received a number of queries regarding the proposed changes, what they mean for housing affordability and how they’re likely to affect investors and property markets. Below are some answers to the most frequently asked questions we’ve received.

What is negative gearing?

Negative gearing is when the cost of owning an investment property (i.e. mortgage repayments and maintenance expenses) is higher than the income it generates (i.e. the rent you receive).

For example, let’s say Toby owns an investment property that generates $20,000 in rent per year and the cost of owning the property is $25,000 per year. Effectively, this means Toby has to pay $5,000 each year to hold his investment property.

This $5,000 loss can be claimed as a tax deduction from Toby’s annual salary that he earns from his full-time job. This will reduce Toby’s taxable income and means he doesn’t have to pay as much tax.

Typically, over the longer term, Toby will be able to increase the rent he charges and he will begin to earn more than the cost of owning the property – in this instance the property will become positively geared.

If Labor wins the federal election, what is their policy for negative gearing?

Under Labor’s policy, negative gearing would be limited to newly-built properties only and could not be applied to existing properties. This policy would be introduced on July 1, 2017.

As an existing investor, how will Labor’s policy affect me?

Labor’s policy will be grandfathered, which means if you already own an existing investment property before July 1, 2017, you can still utilise negative gearing.

If you buy an investment property after this date, it can only be negatively geared if it’s a newly-built property.

What impact will Labor’s policy have on the property market?

Labor’s policy will skew investment decisions and essentially create two housing markets – one for existing suburbs and one for new suburbs.

With negative gearing limited to newly-built properties, many investors will be forced to buy house and land packages, which are predominately located on the outskirts of capital cities, as well as inner-city apartments.

This will actually cause a rental glut in these areas as investors are forced out of the established suburbs.

The established suburbs will also be affected as investor activity in these locations will drop as will rental stock, leading to higher rents.

Will Labor’s policy make housing more affordable?interest rate graphic

Limiting negative gearing to only newly-constructed properties does nothing to directly reduce housing affordability.

In fact, it would result in more competition for first home buyers and low income earners because investors would be forced to buy property in the same locations as these groups – either house and land packages on the urban fringe or new inner-city apartments.

Many first home buyers and low income earners purchase properties in these areas because they are typically cheaper, compared to stock in established suburbs.

What can governments do to make housing more affordable?

If governments were serious about making housing more affordable, they would start by taking steps to reduce land costs.

In the years between 2010 and 2015, the average price of land paid by new home buyers nationally has jumped 30%.

Unnecessary red tape, cumbersome planning processes and higher taxes on land developers can be attributed to the steep rise in the price of land in Australia in recent years.

Outdated taxes on home buyers, such as stamp duty, are also another major impediment to home ownership.

Housing affordability is being stifled by these high imposts that are being levied by governments. Ultimately, Labor’s changes to negative gearing are unlikely to improve housing affordability at all.

What should I do if I’m considering buying an investment property?

As an existing investor or someone considering buying their first investment property, you shouldn’t be too concerned. If you already own a property portfolio, Labor’s policy will not affect your current investments. If Labor is elected on July 2, their policy may have some impact on your future investment plans, though. Some investors may have to adjust their strategies depending on their individual goals and circumstances. As the saying goes, you can’t change the direction of the wind, but you can adjust your sails.

Ultimately, negative gearing property is not a standalone investment strategy, but simply a by-product of investing; therefore, the most important aim for any investor remains the same – to acquire high-performing investment properties.

Irrespective of the outcome at the federal election on July 2, property investment will remain a strong vehicle to create significant personal wealth. However, more than ever, investors will have to utilise the right research and advice to find the best properties that suit their individual circumstances.

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