Negative gearing price models

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  1. How can Germany have Negative Gearing but no Mortgage deductability?

    Are they simply counting costs excluding mortgage exceeding revenue?

    One thing that bugs me most about NG in Australia is that the tax rate is based on income tax. If NG is going to exist, it should be fixed to the corporate tax rate – surely?! Failing to do so simply increases the incentive for high income earners to buy expensive houses while the middle class are effectively locked out.

    • I haven’t deciphered the German regulations sufficiently to be certain, but to your second question, the answer appears to be yes.

      Agree on the corporate tax rate, but how workable that calculation is for your average property investor I am not sure.

      • It would be very workable, but with a company tax rate of 30% how effective would it be. What material difference would it make. Some serial IP holders may well be paying much less than 30%.

        Even in a model where interest costs were quarantined and only claimable against the IP they are still deductible up to the point of break even, and then losses carried forward until the IP does become positively geared – net effective change zero.

        I understand your passion for this subject matter, and I can’t fault your logic (personal bias aside) but do you think it will change in our lifetime. I think it is now enshrined, carved into the same stone tablet that Moses carried down from Mt Sinai.

      • I just realised that if the Germans do it the way I suspect, it’s identical to Keating’s quarantined version.

        So sad that the most visionary and correct Australian leader in recent memory is also the most hated.

    • I don’t know the German tax laws on this, but it’s more common to rent in Germany than own when I was working there. The one things I found odd was that Germans owned Spanish property along with the Brits more so than others, and this was say 2001 – 2009 and I wondered why they’d own a holiday home and not one in their own country as the prices in Spain during that period were excessive. Not so now as Spanish property, in general, has crashed.

  2. I think your perfectly rational model cannot take into consideration the unrational auction or semi auction process that set houses prices at the margin in Australia.Without NG, very few mom&pop would play the game and with less players, the prices would be far lower.

    Also most property investors do not provide accomodation as they invest as 92% in existing dwellings, they take a home that was used by owners to a rental, no addition but families are now forced to rent instead of owning.

  3. I hardly think the solution is to remove tax concessions on property. We pay too much tax already.

    Far better to simply make income from savings based investments tax free or taxed much less. This would encourage people to put money in to savings rather than speculating on capital gains in property.

    At the end of the day, easy access to credit and supply constraints are a far bigger cause of unaffordable housing than a discount in CGT and negative gearing.

    • Two wrongs (on tax) do not make a right.

      The US situation highlights the problems of starving the beast.

      If you do not like paying taxes, go and find a deserted island and look after yourself.

  4. But the seat of the pants feel is that mum and dad “investors” or “speculators” look at the headline that you get a tax deduction. They don’t want to pay tax and are happy to sacrifice any profit not to pay tax now.

    also the bulk of property negative gearers are not in the 45% tax bracket. but understand this is just exacerbating any trend

    • Agreed. The actual numbers are interesting, but I think the psychology around an immediate income tax deduction is just as important.

      How many property ads to you see that start with – “Paying too much tax?…” or similar? No mention that you generally have to lose money (at least in the short term) to claim the deduction.

  5. Its good to see some disciplined analysis in this area, Rumple.

    However, you state “the investment market usually sets the price of housing.” Even your analysis strongly suggests that its the geared investor that sets the price and the more highly geared the more likely the price setter.

    The results change considerably if interest rates were higher than the 7% and particularly if borrowing to invest was significantly more expensive which it should be if the appropriate amount of capital was allocated by the banks.

    NG rules should apply to all business endeavours undertaken to produce incomne and capital gain. Level playing field rather than abolition would seem to still achieve goals of private funding of rental propoerty

    Lastly, the German situation must be looked at in the context of tennant rights which we should seriously look at here

    • “Even your analysis strongly suggests that its the geared investor that sets the price and the more highly geared the more likely the price setter.”

      True. The geared investor is the usually the price setter (I simply refer to this group as the investment market). And the more highly leveraged, the higher the ‘rational’ price. However, the price impacts of access to credit, particularly higher LVRs, was not the principle topic of the post. It is definitely one of the more important factors affecting home prices (e.g.. prices would be lower if investors could only borrow at 70% LVR)

      • The lower the LVR the lower the demand but equally important is the debt servicing ratio or mortgage repayments to net income which must be constrained. The servicng ratio determines the amount that can be borrowed not the LVR

        • Is there a DSR on gold, equities, oil futures, pork bellies, or any other investment.

          Why do you believe a new unwanted tax regulation would succeed that is restricted solely to housing?

          It defies logic.

          • DT – perhaps I do. I took your post to mean that you would wish to impose some DSR restrictions on IP borrowers. That doesn’t exist on any other leveraged asset.

            Whilst a direction from APRA could achieve that, what is the logic of selecting just one asset from the mix and imposing a DSR on that one only.

            We already have some complex rules that apply to consumers and not to business borrowers and even more rules that apply to sophisticated borrowers – for example on margin loans where in excess of $400,000 is held in shares.

            Everything is achievable, but at what real cost. It may be currently trendy to protest against leverage, but after a period of lower credit issuance it may be the complete reverse. It has been the case before, and it will happen again, so we should be aware of the unintended consequences of being over vigilant.

            If the USA hadn’t exported all of its manufacturing jobs to Asia, would we even be having this conversation?

        • How does that play out for the leveraged investor? How common is it for high income earners to be constrained on their borrowing for investment property by their income (rather than the rental returns)?

          • Cameron – all income including rental returns are taken into account when determining servicability.

            Generally there are buffers, eg only 70% of rentals are used in servicing to allow for costs and untenanted periods.

  6. “Removal of both tax rules (noting that removing the CGT discount would be inconsistent with other asset classes) reduces prices between 20 and 50%.”

    You should note that the removal of negative gearing for housing would also be inconsistent with other income earning asset classes.

      • You suggest that removal of only one of the tax rules for housing (CGT discount) would be inconsistent with other assets. The removal of the other for housing, NG, would also be inconsistent. NG is available for all income producing assets.

        On a technical note, there is no specific tax rule enabling NG. The temporary abolition of NG in 1986? required the addition of a new tax rule rather than the removal of an existing one.

        NG is a natural feature of the Australian tax system where personal incomes and expenses are aggregated.

        • Certainly, when housing income is aggregated with personal income, this is the case. And I was not going to even mention the treatment of other assets at all, but thought it wise to make some reference to the broader taxation system.

          You are correct. I will expand this point.

          The broader question is why is this so. Is it natural? Clearly is if such rules for residential property are quite different in other parts of the world, it is a more a product of uniquely evolved taxation and market structures.

          I guess the big question is, government is the rule setter, and within some wide bounds can determine rules that make markets function in a socially desirable way. If adding a new rule to quarantine costs and revenue for individual properties can be done, and it has the socially desirable impact of reducing the cost of home ownership, why should it not be done?

    • Why would it be an issue that one type of assets has a different treatment ?

      I still dont understand why all incomes are not equal in Australia.Why do we need a special (mostly)lower tax for capital gains ? quite unfair.

      • At present all asset classes are treated the same, all capital gains are treated the same, all income from an asset class is treated the same, and all deductions to earn any income is treated the same.

        Cameron is suggesting a special treatment for property. That would make it unusual. The more likely result is that all asset classes would be changed to meet the suggestions for a change in the treatment of property.

        EG – we don’t have a special “banana tax” all fruit is treated the same.

        • think i dont get is why income from an asset are treated differently than ones from salary for example.pretty unfair, i dont see the rational

        • Not quite true. Franking credits game dividends, particularly for super in pension phase, providing much higher returns than cash and other fixed interest, which is peculiar to Australia (and only a few other nations). But that’s beside the point and a minor one (kind of – I want to see the end of franking credits myself)

          Property needs to be treated differently because its position as an investment is completely reliant by the availability of ever-loosening credit, unlike other assets – particularly fixed interest (you don’t borrow money to buy bonds, normally, and margin lending for shares is still quite limited – think super).

          Because it requires credit – since it has become more and more expensive in relation to income (look historically where mortgages used to be 10 years and a down payment literally was 50% – this is going back awhile (1920’s) but it shows how expensive property has become), and the systemic risk that it poses to an economy, it needs to be treated differently.

          Price needs to come down, supply needs to go up (and be flexible to demand) and tenants rights need to be enforced and increased. Taxation regulation is not about fairness (or indeed raising revenue), its about controlling systemic risk and behaviour. Secondary assets (I include shares traded on secondary stock exchanges) need to be treated differently tax wise to primary assets (i.e new housing stock and IPO’s/capital raising).

          • But you are nevertheless supporting a special tax on property. Will that flow onto commercial property as well?

            With all due respect Prince, this is a philosophical call made on residential property only that will have far wider consequences.

            We don’t announce a tax on all males exactly 176 cm tall, we announce a tax on all people. How do you limit the tax to residential, how do you define an old house being used as an office for a caryard, with now purely commercial use.

            How is this simplifying an already over complex taxation system and ensuring there are no unintended consequences such as an under investment in new factories, which are also investment properties.

            Whatever side of the debate you are on, these are questions that require answers.

          • Peter Fraser
            We announce a tax on some people, subject to all kinds of discriminatory parameters based on social and political goals.

            Why should our principal goal be a simplification and standardization of the taxation system as it relates to investment in asset classes, disregarding any unintended consequences that particular goal in itself may precipitate ?

            It is already within the ATO’s current abilities to discern between shades of grey, I’m sure a well designed framework could deal with a house being used as an office for a caryard.

            Concern about additional complexity isn’t really a sufficient argument against change.

        • I think property is much more leveraged than any other assets class investment and therefore attract far more NG than any other asset class.stupid loss for the ATO.

        • I’d be happy to see all asset classes treated the same with interest and other expenses quarantined to being used to reduce the taxable income only from that asset class.

          e.g. Your interest cost on property could only be used as a deductible expense against your income from property. Same for margin loans on shares.

          Negative gearing is largely a scheme for converting income to capital gains in order to minimise tax.

          If it really is designed to encourage people to invest in rental properties then it should be limited to new properties, not established ones. Wasn’t there a graph here recently that showed >90% of investment went to established houses?

          • AB – I’m ok with that proposal. Simple and neat.

            Mr theponz the simplification of the tax sysytem is necessary in most western societies.

            Very soon we will have special taxes for bubble gum and plastic marracas.

            It’s become a joke.

  7. “This is why over the past thirty years, owning has never been more financially attractive than renting (except for rapid capital gains).”

    That conclusion (based on your link to UE’s article) only holds for a comparison of the costs in the first years. It is simply false to assert that renting has been more financially beneficial than owning over the last 30 years.

    • In a world with capital gains only reflecting rents growing around CPI, it is certainly the case that renting is financially beneficial.

      By that I mean if the renter incurred the same cost of ownership, putting what is left over from that cost (after rents are paid) into a reasonable low risk investment portfolio (or even investing in rental property), they would be better off than having incurred the same cost to live in the same house.

      Happy to run some numbers in a future post, or you can do the calcs yourself. Or happy for you to show me the conditions in which this is not the case.

      • It depends on CPI and interest rates.

        Consider CPI at 10%, Rent at 5% and interest only at 10% and a $500k house.

        Owner after one year. Spends $50k and has a capital gain of $50k. Net cost = zero.

        Renter after one year. Spends $25k on rent. Net cost = $25k.

        The owner is better off by $25k after only one year (ignoring purchase costs, which have been zero for many FHBs).

        • ..just to add….you can add say $2k to the renters position after a year for the interest on the $25k difference.

          • That’s quite an extreme example.

            The last time CPI was 10% was 1982. House prices were declining in real terms since the 1970s boom.
            Interest rates were 13.5%. Yields were about 8%. I have no idea what the net yields were after costs.

          • Ok. Less “extreme”:

            CPI 5%, rent 5%, interest only 7%. Savings interest 5%. $500k house.

            Owner after one year: Spent = $35k, capital gain = $25k. Net cost = $10k.

            Renter after one year: Spent = $25k, interest on $10k = $500. Net cost = $24,500.

            Owner better off by $14,500 after one year.

          • Russell,

            If this person rents an equivalent home, and buys this instead for investment, they will, after tax, be even better of than the home owner under this scenario (with the tax deductibility of losses in early years), as long as they hold long enough for the CGT exemption of the owner occupier to ‘discount away’.

            In this way, renting is always better. Maybe I should be more clear.

          • Gentlemen, you are both right… renting makes sense in the short term (10-12 year time span max) but buying and holding a property beats renting hands down in the long term (10+ years). The reality is that everybody needs a roof over their head. Assuming average lifespan of 70+ years, it means you need your own accommodation for at least 40 years… The conclusion therefore does not require any further explanation: everybody is better off buying rather than renting and the sooner you buy the greater benefit you will derive in the end! 😉

            The argument that you “can invest the difference” is often quoted in support of renting but it does not withstand the scrutiny of analysis.

  8. If we really must retain the incentive to encourage investors but want to curb short-term price growth speculation, then why not narrow its provisions so that it includes only investment in new stock of rental property (or re-development of existing dwellings), prescribe that properties must be held for a minimum period of time (say, 5 years) before the tax incentives are passed through, and structure the incentives so the longer you hold the property the more beneficial it is tax-wise ?

    • Agree, ng only for new construction with 5 yr holding period before full tax benefits kick in.
      Allowing investors to offset costs in excess of income generated by their ‘investment’ has only them to take on larger quantities of debt.
      Banks and govt love the outcome – higher interest repayments, higher stamp duties, higher GST revenues, etc.

  9. One significant difference between Europe and Australia is the existence in the former of not for profit housing cooperatives. I assume this must put downward pressure on the rents individual landlords can charge, since they are in competition with landlords who don’t make a profit. In combination with better tenants’ rights, these make renting a much more attractive proposition, and property investing as an individual less attractive.

    Anyone care to comment on why we have not seen a similar development here?

  10. SkoptimistMEMBER

    I think some of these tax concessions may also be there for other reasons. I have long suspected that the government realized that most baby boomers have insufficient savings to fund even a basic lifestyle into their retirement (especially with increased life expectancy and more or less the same retirement age).
    As the government doesn’t want to foot the bill for the baby boomers/retirees, they decided to manipulate the tax laws so that the assets that most of them already own (or were in the process of owning) rapidly appreciated.
    I strongly suspect the CGT exemption (introduced by Costello) was largely targeted to do just that. Why else was this concession introduced?, why not just allow indexing for inflation if it was about fairness.
    So it would appear as if we have adopted an alternative model by which the younger generations are funding the retirement of the older generations (it used to be via government pensions).
    I am not sure if this model is the most fair or balanced approach, but it appears to be what we have.
    Unfortunately, I suspect that our best hope of leveling the playing field (removing tax concessions or applying them more broadly) will probably take at least another 10 to 20 years (when most of those who benefit from it the most are in retirement homes or no long here).

    • The CGT change from index linking to a discount appears to have been done for simplicity. That tax take with the discount system is greater than the indexed system for all capital gains of less than twice CPI. I don’t see that anything was being given by the government. But the change may have had a psychological effect and a perceived benefit.

    • I think simplicity is the key here and you are right. Take a look at Canada which has NG but also a generous pension scheme, while they are also unquestionably in bubble territory, nobody is saying it is as a result of NG.
      My boomer mom earns probably 70k in a public sector job. Has maybe more super than most single women her age but not enough should she kick on for a while. Bought an IP in QLD about 7 years ago.
      Even if she read the financial pages of the MSM, she couldn’t understand them. She just did it based on a hunch and the idea that she is saving taxes. I guarantee you she has never looked at the numbers once in 7 years.

  11. Before the 50% Capital Gains Tax discount was introduced, CGT was applied to inflation adjusted capital gains. That older system was actually more generous to most investors than the current system. Is that the system you’d like to revert to?

    • The previous system is more generous in an environment of low capital growth (close to CPI), but the 50% discount is more generous in a period of high capital growth.

      Say a 200,000 home in 2001 was worth 350,000 in 2007 in Brisbane (which is approximately what happened). CPI over the period was 19%, which would have been the adjustment factor for the capital gains tax calculation. The current rule is a 50% adjustment.

      Thus, as I mentioned, both these rules contribute in some way to amplifying the price cycle. In periods of low inflation (of both asset prices and consumer prices), both rules have small, or no, price effects.

    • let’s rephrase that.

      It was more generous to the class of people we want to encourage.

      There is a downside to the flat 50% discount, it’s capped at 50%.

      Now after a long enough time frame under an indexed system, the discount can be even greater.

      This benefits people who sell their enterprise after 15-20 years with massive gain coming from embedded good will. i.e. hard work, risk and knowledge.

      Flipping something on the 367th day of ownership is not enterprise. In fact it encourages greater than normal liquidity, and entrenching a class of rent-seekers who make money from transaction fees.

  12. Rumple, is there any way to model the effects of this idea I posted elsewhere in various forms?

    Essence of it is to achieve the goal negative gearing was suppposed to: NEW housing stock & cheap rents.

    “You advicate removing NG on old property, while leaving it on new.
    There’s a way to achieve that that is simpler in the long run.

    Announce that NG will be removed in 3 years time. I would say longer, but election cycles as they are, make it a difficult promise to uphold.
    Then Decrease the “life span” of a domestic dwelling within the ATO’s definition.
    I would say change it from 40 to 15-20 years.
    What this does is it allows an investor to claim depreciation on the dwelling each tax year.
    The current 40 year life allows a 2.5% deduction of the structure’s cost per year.
    Further to that, it should only be claimable if the dwelling was occupied for 9 months or more a year.
    Because inflation is as it is, claiming 2.5% over 40 years has minimal value at the end of the life.

    Lets say a structure costs 100k and inflation is 3%.
    At the end of 40 years you’re claiming 2.5% of the original $100,000.
    In real adjusted terms, that’s $2500 from a $316,702 structure.
    It’s not worth it, realistically.
    Change it to 20 years, and you’re claiming 5% of the original $100,000.
    In real adjusted terms, that’s $5000 from a $175,350 structure.
    Change it to 15 years and it’s $7142.85 from a $151,259 structure.

    The effects I would expect are thus:
    Older properties would be redeveloped or sold. Redevelopment of older properties usually means denser housing in desirable areas.
    Prices would probably decline for the current negatively geared properties, while positively geared owners would not care.
    There would be 3 years for this adjustment to occur. It might be possible to stretch it out to 4 depending on the timing of elections.
    Newer properties would attract investors, but the requirement for a bond and payment receipts for 9 months should prevent over building.
    It should keep rents in check too. As newer investors struggle to gain tennants for 9 months, they will reduce rents so that they can claim the deduction.
    No one is going to leave a house empty for the sake of $20 a week and risk their deduction.

    The added benefit to this over a blanket rule of “No NG on 2nd hand properties” is that the deductions can carry over from owner to owner which tidies up the debates that would ensue.
    It also does not allow deductions for the cost of the land. Something that is a large portion of our current scheme.
    It would not affect the deductions claimable from capital improvements.


    • There could be a workable solution in that comment. Politically, creating advantages for the purchase of new properties by investors might appear to be ‘locking out’ owner occupiers of the dream of building their own home.

      There is merit generally to the argument that the first owner of an asset gets preferential treatment (with IPOs as well). But in practice, I am not sure how it would unfold.

      • The biggest issue is the current environment.
        Transitioning from a system that allows the entire mortgage repayments on the land and the structure to be claimed as a tax deduction, to a system that only recognises the historic cost value of the structure, will never be straight forward.

        I suspect that most of the investors who use negative gearing in older areas will simply sell rather than redevelop. They are the passive investors. They’ll sell to actual PPOR home owners, because most other investors won’t be interested in owning an expensive old house with meagre rental returns.

        This should actually put the people who NEED the big back yards near the city IN the houses WITH the big back yards near the city.

        Those investors who do actually invest, will reap their rewards when they demolish the asbestos ridden fibro deathtrap and rebuild higher density housing. Many of them will already own the land outright, but lack the incentive to redevelop. Changing the tax structure in this way to encourage actual development will see these risk takers recieving more reward for their efforts.

        Their redevelopment should also be a win for renters. The redevelopment is primarily going to occur in the too-young-to-be-historic areas within the 1960’s-70’s mortgage belts. These houses are in locations that are highly desirable due to proximity, but frankly, most of the actual houses are utterly terrible by any measure.

        It should also go a long way toward improving overall energy efficiency of our houses. Most of the older houses don’t even have insulation. They have the thermal properties of a tent. Astonishingly cold in the winter and sizzling in the summer. Massively inefficient.

        I would hope that this shift in tax policy would see the most deisrably located houses replaced or extensively renovated by investors or bought by honest to god 2.5 children owner occupiers at genuinely discounted rates.

        Obviously the hard part is picking the rate of depreciation. Too fast and decent newer houses get knocked down. Too slow and without negative gearing, there’s little incentive to be a landlord. I’d hope it could be reviewed every 3-5 years. Last thing we want is to encourage wasteful and unneeded demolitions of perfectly viable houses.

        • I should add that councils would somewhat limit the demolition of viable houses. If there’s no net change, they’re unlikely to approve demolition and rebuilding of a similar structure. Most would want to see a net increase in density or some other measure of value (so they can get higher rates).

          They’d be reluctant to approve the demolition of historic buildings because the loss of these buildings is likely to have a net negative effect on local values.

          Conversely, in the fibro areas where the general quality of the homes is barely above that of a trailer park, they’d happily approve reconstruction of more modern housing even if there is no net change in density.

          I doubt owner occupier builders would totally shy away from the market. For some strange reason they still exist in our current tax system. A system that actively encourages being a landlord AND a renter to anyone with enough brains to use a calculator.

          I don’t think it’s a panacea, but it has to be far more likely to achieve the goals negative gearing aims for than negative gearing does.

      • You dismiss this as a merely “political” consideration. I have a theory that the reason apartments are so badly designed in Australia is because every new apartment is designed not for the person who will be living in it, but rather, for the person who buys it as an investment. The investor generally just has a quick look, counts the bedrooms, etc., and does not pay attention to the finer points of layout, functionality, “liveability”, etc. So there is no incentive for the architect to pay attention to those things, either.

        • From my experience working with a large apartment developer, there is definitely ‘investment grade’ and ‘owner-occupier grade’ product. They develop to satisfy market demands after all.

          Your theory is sound.

  13. Rumple,

    I must take you to task on your statement “…making the investment market the price setter, rather than the owner-occupied market.”

    I think this may definitely be the case for houses around the median price, as that is where true property investors play, but for houses on the higher side of the median, ie, $1m+, I think you will find it is purely owner-occupier emotion driving higher and higher prices for features such as views, access to water, etc.

    Perhaps you should qualify that statement?


  14. I’m quite keen to hear if there are many NEW property investors contemplating starting out in the current envronment? Que? Perhaps a few miners…..

  15. Firstly, I like the ideas of ‘myne’ above.

    Once upon a time negative gearing did not exist. How did builders ever survive?
    Perhaps when they sold the newly built property they added the following
    * cost of land (inc holding costs)
    * cost of all labour/professional/legals
    * cost of interest accrued during the build phase
    * cost of foregone equivalent earnings on capital borrowed (eg 5% equivalent as bank interest).

    The buyer paid the total of this cost which was the price of the house.

    From my understanding, neg gearing was initially desgined to assist an investor (business owner) over some unforeseen temporary economic hump. It was not designed as some kind of mandatory investment manouvre.
    Under the current tax system it is possible for a string of investors’ to sequentially buy and negatively gear a 2nd hand house indefinitely.
    What kind of investment is it that is never positive?
    A neg geared one potentially.

    Today negative gearing is used as a debt accelerant by govt. It has resulted in reduced yields, pushed both investors and home buyers into dangerous levels of debt, for what?
    So that banks can stich up an ever increasing sway of naive optimists.
    I could live with that if, at the end of the day, I did not have to watch precious tax revenue wasted.

  16. Good start! Interesting discussions. Conclusions are definitely challenging some common beliefs on both sides of the divide (ie. pro and anti NG). Pity about the introductory paragraphs though… 🙂 I know, I know, you have to keep the majority of patrons of this blog “happy” but it detracts from the objectivity of analysis that follows.

    Since you took up the challenge, I feel entitled to a few comments…

    Since overwhelming majority of property investors will be in 30% bracket (ie. 45% marginal tax rate requires income of over $180K pa), if my understanding of the methodology is correct, this should reduce the differences between NG and no-NG scenarios even further.

    7 year time frame is not enough. “Everybody knows” that property is a long term investment class. The real benefits kick in in the later years. 15-20 year timeframe is more appropriate for analysis. If you extend the time frame to include positive gearing years, you will find that the existence of NG has very little impact indeed. By the way, for those who think that selling investment property every few years is the optimal approach to take “advantage of the system” please note, cost of selling a property will greatly reduce the return. It’s better to stick around a few years longer when property becomes a real “cash cow”… But I am not denying, they will be jockeys who think that flipping the asset as soon as they are in black make them “investment geniuses”.

    Please correct me if I am wrong but I understand you are trying to “reverse engineer” property price for each required rate of return. That is, you are assuming required rate of say, 10% then calculate the level of price in Year0 under NG and non-NG scenario? Are you then implying that price difference in Y0 is 0-35% in Scenario1? Ie. if no negative gearing – is $100K, then with NG it would be $100-135K? Not disputing the methodology, just trying to get a better understanding of calculations… It would be really great if you could share the figures.

    I would love to pick up on specific points but maybe at a later time. For now just one more reflection. Applying traditional accounting principles to property investment is proving to be very challenging and somehow artificial, hence using common financial models for evaluating investments is also rather meaningless. I will not go into further details but just some food for though: “annual losses” are really capital inputs by the investor (ie. it is a form of external funding – price of the asset is irrelevant here – see below), positive flow in future years is in reality a “dividend” that goes to the investor for other perusal, reflecting positive change in cost of asset goes against traditional accounting principle hence change in the value of the property has to be considered in “profit” like terms. Crack this and it is easy to understand why German property investors are still making good money!

    • “you are trying to “reverse engineer” property price for each required rate of return. That is, you are assuming required rate of say, 10% then calculate the level of price in Year0 under NG and non-NG scenario? Are you then implying that price difference in Y0 is 0-35% in Scenario1?”

      Yes. Email me for figures – remember, they simply are used to demonstrate the relationships and not designed to reflect any particular time frame.

      I agree that property is a long term investment, and annual losses can be considered as further ‘capital instalments’. Although looking at the situation in the US, for example, shows that leveraged investors from the peak years, say 2005-06, will need a very long time to make positive returns.

      However, as far as rent v buy calculations go, if one is to rent and buy as investment, surely that is the best outcome under all foreseeable scenarios for quite a long time (say 25 years).

      The German market arrangement is very different to our own, with many long term institutional players. Perhaps their rules about CGT discounts only applying after 10 years would go some way to nudging investors into the habit. I’d be interested to see what the average period of home ownership, both for occupation and investment, is these days.

      • I have just sent you an email. Thanks!

        Re: buy investment property and rent for a time being is a good strategy indeed since you are participating in the market but are not necessarily committed to a specific location. However, considering 40 year time span, buying a place to live as soon as you can afford the location you want is the best option.

        I don’t have specific info on peculiarities of German market on hand but as far as US is concerned, the cycle just keeps repeating for them – the last downturn was only in 1986… In comparison, we have a very stable property market in this country.

        • Sorry, haven’t received it. Check the address.

          I happen to have created a model comparing renting (+investing the difference), owning, and owning plus investing in an identical rental property. I will send you a copy as well.

          It actually shows that owner occupying, over a 30 far horizon, if better sometimes, renting to invest is also better other times. Very sensitive to assumptions.

          Also, as incentives go, the CGT discount after one year encourages a degree of speculation in high capital growth rate conditions, since the longer you hold, the less benefit you get from this.

          Anyway… it has been a very high quality debate. Thanks to all commenters.

    • Just going to correct your statement on the tax brackets.

      The majority would be in the 37% tax bracket.
      Not many people earning under 80k could afford to negative gear.

  17. Tassie TomMEMBER

    Congratulations – what a beautiful article, and it has provoked some very intelligent discussion.

    It makes houses look like they should be a fair bit cheaper than they actually are if a reasonable ROE is desired.

    I wonder how many people do these sums before buying an investment property?