In 1027, King Canute stood by the seashore and commanded the incoming tide to halt. Of course, the tide ignored him and he ended up with wet feet. As legend has it, he leapt backwards, saying: “Let all men know how empty and worthless is the power of kings.” Contrary to the common myth, the wise king was not showing off – he was demonstrating to his subjects the limit of his power.
Canute’s order to the sea is an analogy for the Labor Party’s attempt to make housing more affordable for first home buyers. It simply can't be done. It's ironic that the catalyst for the GFC was President Clinton's idea that housing should be available to everybody. It started with a boom as the American property market became overbuilt, with loans offered to everybody irrespective of ability to pay. It finished with a bust whose reverberations are still being felt around the world.
Australia faces a perfect storm
But the GFC was more than a bust. It triggered collapses in stock markets everywhere, with interest rates around the world falling to historically low levels as central banks try to stimulate their economies.
Australia was not immune, but what has become different here is the growing attack on our superannuation system by politicians and so-called independent think tanks.
So we face the perfect storm. The average Aussie investor has lost faith in the stock market, and they are scared off superannuation because of the adverse publicity and threatened changes. They also know that earning a piddling 2% in the bank isn't the way to go long term.
Consequently, they have invested in the property market. As interest rates fell, making mortgages more affordable, prices started to rise. As always happens, the moment any asset class starts to rise in value, everybody wants to jump on the bandwagon. Yes, that made it tougher for first home buyers, but historically every initiative by governments to make housing more affordable has simply raised home prices further, because more buyers are attracted to the market. Think of the first home owners grant and stamp duty concessions.
On new property, the developer has made the profit
Labor’s policy of restricting negative gearing to new homes won't work. It will push unsophisticated investors into new property where the profit has already been made by the developer, leaving the established market for more savvy investors. They understand that the way to make money in real estate is to buy a rundown property on a good block and add value to it. The irony is that they will use the money they can no longer contribute to superannuation as a deposit. This may make the property positively geared from the outset.
Let me quote a case study from Philip, who sent this to me in the interests of a more rational debate about negative gearing.
“I purchased an apartment in October 1987, borrowing 100% of the purchase price using my residence as security. The taxable loss was $7000 a year so my tax refund was in the order of $3,000 p.a. Three years later I paid it off when rates hit 17%. Total tax saved over those three years was around $10,000. After paying off the loan it was positively geared and I was paying $2000 in tax on the net rents.
The property has been positively geared for the last 25 years. Current net rent is $6,000 p.a. and at my marginal tax rate of 32.5% my tax is around $2,000 p.a. So having gained a net tax benefit of approximately $10,000 in the late 80's, I have paid $50,000 in tax since.
The value of the property has risen substantially from my purchase price of $58,500 to a current value of $320,000. But when I sell I will be liable for capital gains tax of $30,000.
Since 1987 I have enjoyed net tax refunds of approximately $10,000 but have subsequently paid $50,000 in income tax and will shortly pay another $30,000 in CGT. The government has made a significant net $70,000 benefit from my investment risk and the subsequent good capital growth will almost certainly eliminate my ability to claim a pension in retirement. This sounds like a great deal for the Government to me.”
Limiting negative gearing will be as successful a policy as was holding back the tide for a wet King Canute.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. See www.noelwhittaker.com