The possible impacts of Labor’s proposed negative gearing and CGT changes

With a federal election expected to be called within the next 12 months, and Labor proposing some controversial reforms to negative gearing and the capital gains tax discount, a new report has assessed the risks of taking a blanket approach to their implementation across Australia.

At our annual Wealth Retreat Conference over the weekend one of our guest speakers Doron Peleg, chief executive of RiskWise Property Research, discussed a report he co-authored with Pete Wargent assessing the impacts of the proposed reforms.

The ALP has previously proposed to limit negative gearing to new rental dwellings and to halve the CGT tax discount from the current 50% to 25%.

When they initially announced these proposals, the stated intention was to level the playing field for first homebuyers competing with investors, improve housing affordability and strengthen the commonwealth budget position through limiting these subsidies.

Peleg said with the next federal election coming up in less than a year, government policies and their implications were being thoroughly assessed by policymakers, lenders, fund managers and property developers.

But things are different now

However, the landscape in the Australian property market has changed and this needs to be taken into consideration.

From the second half of 2017, the risks associated with the residential property market increased significantly, and the proposed reforms need to be assessed thoroughly across all geographical areas to ensure they do not unduly impact the weaker and more fragile housing markets.

Credit restrictions and tighter lending standards have had a direct impact on investors in the Australian housing market.

As a result, dwelling prices in Sydney and Melbourne showed a decelerating growth rate, followed by price reductions in Sydney and, to a lesser extent, Melbourne.

The two-speed economy driven by the resources construction boom has reversed, and those once-prosperous economies are now lagging.

This necessitates thorough modelling and impact analysis of the proposed tax reform package, according to Peleg.

One of the key findings of his analysis is that a blanket introduction of the reforms across the country would have unintended consequences, and some local government areas, especially those with weak or fragile property markets, would be adversely impacted more than others.

The report identifies the top ten local government areas that would be most impacted if the changes went ahead as currently proposed.

These include Darwin, Mackay, inner-city Perth and Townsville.

Like a 1.5% interest rate rise

According to the report another unintended consequence would occur in the Sydney unit market where the proposed changes would be the equivalent to a sudden 1–1.5% increase in interest rates.

Declining dwelling prices, or price deceleration in some regions, would lead to a reduction in dwelling commencements and deteriorating rental affordability in some locations.

The analysis also demonstrates that there would be some distortions in the investor market, with the creation of primary and secondary markets for investor stock if subsidies were limited to new housing prospectively, the thinner market on resale potentially increasing the risk of investing in new dwellings.

Report co-author Pete Wargent explained to our attendees at Wealth Retreat that for years property commentators had been talking about a two-speed economy driven by the resources construction boom, but this dynamic had reversed, and those once prosperous areas were now struggling.

“The last thing they need is a further dampening of demand. An introduction of Labor’s proposed changes to negative gearing needs a more nuanced response with some mitigating processes and policies that could be implemented so there is no unintended consequences.”

Peleg said the risks associated with the residential property market had increased significantly since the second half of 2017, and the proposed changes needed to be assessed thoroughly across all local government areas to ensure they did not unduly impact weaker housing markets.

“Credit restrictions have had a direct impact on investors in the Australian housing market. As a result, dwelling prices in Sydney and Melbourne showed a decelerating growth rate, followed by price reductions in Sydney and, to a lesser extent Melbourne,” he said.

“In a relatively short period of time, the landscape for residential property in Australia has changed significantly and this necessitates thorough modelling and impact analysis of Labor’s proposed tax reform package.”

The bottom line

The report was not meant as political commentary: just an independent assessment which explained that the proposed ALP tax reforms will achieve some of their stated objectives, including tackling the fiscal challenge and budget repair, but not the others.

In my mind, if property values drop significantly in some locations as suggested – and I have no doubt they will – there would be a significant economic flow-on effect due to falling consumer confidence as they see property values plummeting.

Another issue is that investors will be driven to buy new properties, both apartments (which will generally be in the CBD) and houses (which are likely to be in the outer suburbs).

Both these types of property make poor investments because of their locations and will make even worse investments as, once purchased, they will be established properties.

We know around 50% of investors sell up in the first five years, so if these investors plan to sell their properties the value will fall significantly, because they will no longer attract the tax benefits of a new property.

So these poor investors who are going to chase tax benefits will lose out in two ways: poorly located properties and ones that won’t appreciate in value.

NOW READ: What the fight against negative gearing is missing