Off-the-plan units top the list of the most perilous property investments, and the risks will rise dramatically if changes to negative gearing and capital gains tax go ahead.
While there are already major risks associated with this type of investment due to a number of factors, including oversupply, the introduction of the reforms if Labor win this year’s federal election will compound them.
The ALP proposes to limit negative gearing to new houses only and reduce the discount on capital gains tax from the current 50 per cent to 25 per cent … and the likelihood of them winning is high.
A number of markets across Australia are already experiencing weakness and the introduction of these reforms will hit them hard.
Should the ALP policy be implemented there will be reduced demand to purchase rental properties due to the creation of primary and secondary markets, and this will cause new dwelling prices to decline in many regions.
The second owner won’t receive the same tax benefits of depreciation etc as the primary owner when they buy a property.
They will not be able to claim negative gearing against their wages and the capital gains tax discount will be cut in half.
Therefore, the vendor will have to drop the value of the property because the benefits to the buyer are lower, and it is therefore not as attractive to potential buyers.
So, when a market is already weak, for example off-the-plan units in an over-supplied area, as we see in capital cities around the country, this will contribute further to the price reductions.
An example of this is inner-city Brisbane where weakness in the market had led to lower valuations, rising defaults on settlements, major discounting, falling rents and ‘over-the-top’ incentives to get buyers across the line.
Brisbane City, Fortitude Valley and South Brisbane were all named in the Top 10 of the RiskWise 2018 list of the 100 Worst Off-The-Plan Suburbs in Australia, as were Zetland and Epping in Sydney and Southbank in Melbourne where oversupply of units is a huge issue.
In South Australia, the highest risk area for units was Adelaide CBD (postcode 5000), where oversupply was extreme and, according to CoreLogic, had delivered -2.9 per cent capital growth in the past 12 months.
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In Perth they delivered -6.5 per cent capital growth.
The Perth - Inner area has the highest rate of unit oversupply in Western Australia with 4362 units in the pipeline (a 11.1 per cent increase to the current stock), while the Greater Perth area has 12,687 units in the pipeline which is a 6 per cent increase to the current stock.
In addition, he said lenders were scrutinising loan applications much more vigorously and either required a much higher deposit as security or were turning down the application entirely.
It must also be remembered that rental units and owner-occupier units are not fully substitute products.
The dwelling types and needs of owner-occupiers are often greatly different from the dwelling types and needs of renters.
Units that are used by owner-occupiers are larger than units that are typically used as rental properties and, more importantly, the price per square metre of rental properties is higher than the price per square metre of owner-occupied properties, especially in Sydney and Melbourne.
This means that, overall, rental units in Sydney and Melbourne are significantly less affordable than units that are owner-occupied.
All this added up suggests that if the proposed changes to negative gearing and capital gains tax take place it is likely to put off-the-plan units at their highest risk ever and this includes equity risk, cashflow risk and settlement risk.
Unless there was phenomenal capital growth, the value of off-the-plan property in many regions was likely to be reduced and it would become significantly harder for investors to enjoy capital growth, at least in the foreseeable future.
And if you consider that many of the prices for off-the-plan units include a significant commission to the marketer, between 5-6 per cent of the value of the property and sometimes even more, and with the current risks to settle the property … all of these things together make purchasing off-the-plan units in many regions in Australia extremely high risk.