Despite Labor party claims their proposed changes to negative gearing and capital gains tax will not affect existing investors, as the changes will be grandfathered, research house RiskWise says this is simply not the case.
The proposed changes would create two types of property markets - primary and secondary markets - which would significantly impact dwelling prices.
This is because when an existing property is sold, the buyer would not be able to enjoy the current taxation benefits, and thus, would be willing to pay less, i.e. the fair market value of the property would be lower.
The ALP has proposed limiting negative gearing to new housing and reducing the discount on capital gains tax from the current 50 per cent to 25 per cent.
However, they state all investments made before the changes would be grandfathered in full, meaning taxpayers would continue to be able to deduct net rental losses against their wage income, providing the losses came from newly constructed housing.
This sounds good on paper, but the changes will effectively create a primary market, comprising new properties and existing investment properties that qualify for negative gearing tax concessions, and a secondary market, comprising all second-hand dwellings that are sold following the changes, that do not qualify for these benefits.
This will have a significant impact on both buying and selling decisions by property investors with a flow-on effect to dwelling prices.
A simple example of an existing investor with a negatively geared unit, in a saturated rental market, worth $500,000.
The unit is not suitable for families so could only be used as a rental, as there would be little demand from owner-occupiers.
For simplicity, let's assume you are currently an investor with an income that is similar to the median salary in Australia, and in the current market you would expect the overall taxation benefits from the negative gearing and capital gains tax to be $60,000.
Now let’s assume the proposed changes take place, which means you can still enjoy the benefits of negative gearing as you are the primary investor, however, if now you want to sell to another investor, that investor will need to assess how much he or she is willing to pay given they will not be able to claim negative gearing against their wages and only receive 25 per cent capital gains tax discount.
So, if the capital gains tax discount only amounts to say $10,000, it means that the potential buyer/ new investor, will not be able to enjoy $50,000 of the $60,000 that the primary investor did. This means the secondary investor will have significantly lower financial benefits and therefore he will want to pay much less for the property.
It’s as simple as that.
And the same principle will be applied on a property valuation for re-finance purposes.
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The valuer should assess the fair market value of a property, assuming it is sold, and obviously, in that example, the valuation will be significantly lower if the taxation changes are implemented.
Re-finance could also become a major issue.
This is because many interest-only loans were maturing and many investors were looking to re-finance with another lender.
However, this lender would require a new valuation, and a lower valuation might not enable the investor to do so.
You can compare it to buying a new car where the dealership might give you five years’ free service, five years’ warranty and free roadside assistance services.
But if you sell the car to another private owner, they will not be able to take advantage of any of those benefits - no warranty, no free service and no free roadside assistance.
Investors did not want to buy depreciating assets and this would have a direct impact on buyers if the changes to negative gearing and capital gains tax were implemented.
By grandfathering the changes, the property investor could still enjoy the taxation benefits, and only lost them when they sold, and he will obviously get a lower valuation, if he needs to refinance.
In other words, if they don’t want to lose the benefits, they have to hold on to the property until the market adjusts and a potential buyer will see it as a positively geared property, something that could take many years.
This is a key reason for investors, even now, to sit on their hands and to wait for the implementation of these taxation changes and only then to reassess the market and to buy for lower prices - and we are already seeing the effect of these potential taxation changes, with accelerating price reductions.
This is because the probability of a Labor win at the next election, to be held by May 18, 2019, is around 80 per cent.
In addition, auction clearance rates are the lowest they have been for many years, with Sydney recently recording the worst preliminary results in a decade.