Is it time to buy your next investment property or should you wait?
Now that Labor has declared January 1st 2020 as the date their proposed tax amendments to negative gearing and Capital Gains Tax (CGT) come into effect property investors have just over 7 months to set themselves up.
You’d have to be living under a rock not to realise that Labor plans to halve the discount on capital gains and restrict negative gearing on property to new dwellings which in general will be new and ‘off the plan’ apartments and new houses in the outer suburbs (all terrible investments – but more on that later.)
So, should you buy an investment property now or wait for property prices to fall after the tax reforms are introduced?
But not so fast…
Firstly Labor need to win the election.Sure they’re currently the favourites with the bookies – but that doesn’t mean they’ll win.
Just ask Donald Trump.
Then they’ll have to get their proposed changes through parliament, which may get watered down by the cross-benchers or even blocked in the Senate.
A quick primer:
A property is negatively geared when the costs of owning it – interest on the loan, bank charges, maintenance, repairs and depreciation – exceed the income it produces.
Since the costs of producing an income are currently deductible against the taxpayer’s other income, property investors can effectively offset some of the interest expense against their wages.
This has made some argue that other, less fortunate taxpayers help these property investors meet their costs.
Now negative gearing is nothing new, it was first introduced with the Income Tax Assessment Act in 1936.
But let’s make things clear – negative gearing is not (or maybe I should put it differently – should not be used as) a property investment strategy.
It’s just a result of how a property has been financed.
So negative gearing has never been a reason to invest in real estate, even though some misguided (or self-interested) advisors have recommended it as such.
Generally investors buy a property that is negatively geared in the hope that their income losses will be more than offset by their capital gains (the growth in the value of their property) which they can access when they refinance or eventually sell their property.
Alternatively, a negatively geared property may become neutrally or positively geared as the rental increases, but in the main, negative gearing really only makes sense from an investor’s viewpoint if property increases in value.
And in Australia this capital gain is not taxed unless you sell your property, and then it is concessionally taxed.
Of course negative gearing is more favourable for taxpayers who earn high incomes, however the assertion that all negatively geared property investors are ‘ugly wealthy Australians’ is simply unfounded and incorrect.
Many ordinary mums and dads have used the tax benefits negative gearing to help their cash flow while they build a nest egg of investment properties to fund their golden years.
How much will property values fall if the changes are introduced?
There seems little doubt that if Labor’s proposed tax changes are introduced, property values will fall further.
But things won’t be as bad as predicted by many of the property pessimists.
- Around 70% of property purchases are made by home buyers; and the CGT and negative gearing changes won’t affect them.
- Currently the number of property investors in the market is at the lowest level for years (in part due to the credit squeeze) and so the impact of decreased investor activity will now be much less than it would have been a few years ago.
This means that locations with a large proportion of owner occupiers are not likely to suffer significant falls in property values if the tax changes are introduced, while areas where there are a high proportion of investors are likely to suffer the most.
However, the further price falls of 10% or more in Sydney and Melbourne that were predicted last year when Labor confirmed it planned to continue with its proposed negative gearing policy changes are unlikely to eventuate as much of these price falls have already occurred in part because investors numbers have already dropped significantly.
Unfortunately the introduction of these tax changes will also have the unintended consequence of creating primary and secondary markets for investor stock because as soon as an investor buys a new property to gain tax benefits, their investment will become a “used property” with a thinner market on resale and this will increase the risk of investing in new dwellings.
Of course more and more investors are beginning to realise that buying new apartments in the many high rise towers dotting our landscape or buying a new house in an outer suburb makes for poor investing because of lack of scarcity, no ability to add value through renovations and poor capital growth.
While these have been poor investments up till now, they’re likely to be even worse investments moving forward.
So back to the original question…
Should an investor buy now or wait till prices fall further?
In my mind the right time to buy is when you can afford to purchase an “investment grade property.”
Of course if you can afford this today, now is a great time to make your next purchase as you’ll find yourself in a buyers’ market with less competition.
However if you can’t afford an investment grade property then don’t make the mistake of buying a secondary property just to get into the market before the tax changes.
A secondary property today will be a secondary property in 5 year’s time.
Stuart Wemyss did some excellent research clearly showing the most important factors in a property’s long term performance.
And the stand out factor as you’ll see in the graph below was the quality of the asset and its capital growth.
Over the long term, the ability or not to be able to negatively gear an investment was nowhere near as important, and while paying CGT at the end of the 20 year period of his projections did eat into your profit, it shouldn’t be an issue for long term investors as they don’t sell their properties.
Source: Stuart Wemyss, Prosolutons: How important is it to buy property at the bottom of the market?
So what should an investor do now?
Firstly remember that prime ministers come and go, governments change, tax laws change but over the long term Australia’s strong population growth and the wealth of our nation will ensure that well located properties keep increasing in value.
But property investing is a game of finance with some houses thrown in the middle, so ensure you have the cash flow to see you through the next few years until our property markets rebound.
The good news is that another consequence of these proposed tax changes will be increased rental income.
Think about it…fewer investors owning the right type of property, at a time of strong population growth but a decreasing supply of new dwellings in the construction pipeline means that tenants will have to pay higher rent.
Investors should also consider the certainty offered by converting some of their loans to fixed interest laons.
And even if the RBA does lower rates later this year, some of this has already been factored into the current attractive fixed rates on offer.
And if you own an underperforming investment property, now is a good time to consider offloading it.
Of course it’s important to take a big picture view first – what will be the cost of buying and selling including CGT; are you able to get finance to purchase a better property and will your budget allow you to buy an “investment grade” property.
The bottom line
There is likely to be a lot of talk about the potential changes to negative gearing and CGT for the next weeks leading up to the election and even more so if Labor win the election.
Don’t get caught up in the hype. Remember what happened to others who bought because of F.O.MO. (Fear of Missing Out.)
Neither is this the time to change your property investment strategy.
Only buy properties that:
Have owner occupier appeal- Below their intrinsic value
- With a high land to asset ratio
- In a location with a long history of proven capital growth and which will continue to grow in value because the local demographic can afford to and will be prepared to pay to live there
- Have the ability to add value and “manufacture” capital growth through renovations or development
- And only buy a property with a “twist” — one that has something special, unique or different about it.
Have owner occupier appealSo what will you be doing?
If you’re looking for independent advice, no one can help you quite like the independent property investment strategists at Metropole.
Remember the multi award winning team of property investment strategists at Metropole have no properties to sell, so their advice is unbiased.
Whether you are a beginner or a seasoned property investor, we would love to help you formulate an investment strategy or do a review of your existing portfolio, and help you take your property investment to the next level.
Please click here to organise a time for a chat. Or call us on 1300 20 30 30.
