The Impact of Potential Negative Gearing Changes
Negative gearing has long provided an opportunity to Australian investors to purchase and renovate properties without taking on unmanageable risk in the form of unexpected problems. Whether it’s a blown budget, extended renovation, or previously unrealized faults in the property, renovations are costly and the incentives currently offered to help offset that make it more feasible for investors to take action.
Which is why the current discussion in the government to remove these incentives creates a potentially problematic situation in the property market.
How Renovation Creates Problems for Investors
The cost of renovation is never fixed. For most property investors, it’s a blank check until the project is almost complete. With average costs between $100,000 and $300,000, there are substantial risks that can impact how much will be spent on renovating a property – wasted efforts, projects that go over budget, and even litigation if there are major issues with the property.
Some of the most common situations in which unexpected cost might arise include:
- Finding structural problems that renovation cannot address.
- Multiple design steps being needed to offset changes.
- Starting on projects that do not conform to local council planning controls.
- Poor performance or incomplete projects by contractors.
- Lapse or lack of insurance and registration by builders.
- Dangerous materials in the home such as asbestos.
Any one of these problems can create a significant financial strain on the investor, largely because they tend to be unexpected. There is no realistic way to budget for them.
The Impact of Negative Gearing on Risk Management for Investors
Negative gearing provides a buffer for the financial shortfalls that can occur during renovation. So when restrictions were proposed in mid-February to only include new construction under the negative gearing incentives, there were concerns. One reason for this move is to encourage first time home buyers to enter the market, giving them incentive by removing it from investors. If there are fewer investors to battle for a given property, the thinking goes, then there will be more owner-occupiers looking at the property.
The core of the debate, though, is over who this will affect. A recent study of those who claimed lost rent, showed that 68.9% of claimants had a taxable income of less than $80,000, with an average of $2,050 per claimant. The vast majority of the benefit is taken by higher net worth individuals, and hence the concern is that the booming prices and affordability problem for first time buyers is being caused by the negative gearing rules in place.
There are several factors to consider here, though. While this is certainly one factor that can impact affordability, but so too does any tax break related to home ownership, as well as interest rates, employment rates, and the general population growth rate in high demand areas.
The impact of removing negative gearing would be felt by more than just first time home buyers. Similar reforms were attempted in the 80s and it lead to a spike in rent prices. Investors, especially high net-worth individuals, are not likely to bear the brunt of the lost rent and rent prices will likely increase to offset those losses, reshuffling the market. So should negative gearing be addressed? It may yet, but it would be evaluated as part of a comprehensive policy on all the factors that affect affordability.