Busting negative gearing’s myths

Please find below another interesting article from Philip Soos debunking some of the common misconceptions around negative gearing of Ausralian property. Philip is a Masters research student at the School of Humanities and Social Sciences, Deakin University.

In Australia, few housing market policies are more contentious than negative gearing (NG). At the forefront of defending NG is the influential housing lobby, representing a multitude of vested interests, always alert to any threat that could potentially diminish its economic and political power. Despite the lack of evidence to support NG, it remains in place via a number of well-entrenched myths the housing lobby has manufactured. To this end, counter-arguments to these myths are presented in the analysis below.

Myth #1: Quarantining of NG during the 1980s caused a surge in rents.

The favourite scare story fabricated by the housing lobby is when the Hawke/Keating government quarantined NG during 1985-87, it caused rental prices to surge, quickly leading to its reinstatement. Fortunately, not only did the evidence contradict this urban myth, it showed NG can be safely quarantined, if not abolished. The federal government realized by 1985, negatively-geared property was becoming a favoured tax shelter in Australia, costing approximately $175 million in that year.

The government decided to quarantine NG by prohibiting any excess of expenses and interest repayments over rental income to be deducted against other assessable forms of taxable income, but only on properties purchased after 17th July 1985. Any losses made could be offset against positive returns from other rental properties purchased after this date. This form of quarantine was fairly permissive, for the government could have prohibited any loss arising from an investment property from being deducted against any type of income tax liability.

Out of Australia’s eight capital cities, real (inflation-adjusted) rents increased strongly in only two, Sydney (6.2%) and Perth (10.7%), while rents in both Canberra (0.7%) and Melbourne (1.1%) edged up above the rate of inflation during this period. Rents decreased in four capital cities, with Brisbane (-7.6%) and Darwin (-8.1%) falling substantially while Adelaide (-2.0%) and Hobart (-1.5%) posted smaller reductions.

Overall, rents across Australia increased by 2.7 per cent. If the removal of NG did cause rents to rise, it would be expected to adversely affect all capital cities, not just two. This is a critical point, and evidence of a drastic and universal surge in rents is absent. Moreover, it is likely the steep increases in Sydney and Perth rents would be independent of the quarantining given the lag in the market adjusting to the change. These two cities already had very low vacancy rates when the quarantining was implemented.

Other factors may have had greater impact on the housing market during the period of quarantine. The cash rate in July 1985 rose from 15.48 per cent to a peak of 19.39 per cent in December 1985, a relative increase of 25 per cent, before falling to 12.43 per cent in July 1987. The rapid increase in the interest rate in the latter half of 1985 appears to have curtailed investment into the residential rental market, as the value of new investment commitments fell from $193 million in July 1985 to $130 million in December 1985.

In September 1985, the capital gains tax system was implemented by the Hawke/Keating government, though it was only applicable to assets purchased on or after the date of implementation. Also, a stock market boom was then underway, with shares a more attractive investment opportunity than residential property. To date, no analysis has been provided by the housing lobby to disentangle confounding factors to prove the quarantining of NG was the primary or sole cause of the rather small national increase in rents.

Another episode from this era also tests whether rents surged in response to the quarantining of NG. For a brief period in 1983, the Victorian Deputy Commissioner of Taxation prohibited the deduction of interest costs over rental incomes. Any losses could not be carried forward to be offset again future gains. This was a more restrictive quarantining of NG than had occurred in 1985-87. As the other state Deputy Commissioners did not take this stance, eventually the Federal Commissioner of Taxation ordered the Victorian Deputy Commissioner to revoke the quarantine in the same year.

The reason for this policy shift is because this specific quarantine was not lawful and instead was based upon the Deputy Commissioner’s relative interpretation of the law. Over the four quarters of 1983, Melbourne rents increased by 0.95 per cent in real terms, essentially noise and certainly not a surge. It is easy to understand why the housing lobby never mentions this more restrictive period of quarantine, since no market-shaking increase in rents occurred.

Myth #2: NG results in an increase in the rental stock and lowers rents.

The housing lobby’s primary justification for NG is it provides an incentive for investors to buy rental properties, presumably lowering rental prices according to the traditional supply and demand model. Despite the imagery of a policy that simultaneously benefits investors and tenants, this argument in favour of NG is flawed. NG will only increase the supply of rental properties relative to the total residential dwelling stock if investors, spurred into entering the market via this incentive, purchase newly-constructed dwellings that are additions to the current stock, not from the existing stock. If the latter occurs, it is simply a substitution of renters for owner-occupiers, with the implication that the previous displaced owner-occupiers will purchase elsewhere.

In 1985, the proportion of the value of investment loans used to finance the purchase of existing properties reached a low of 32 per cent, as opposed to 68 per cent for newly-constructed dwellings, which, on the surface, would appear to partially validate NG. Two years later in 1987, the ratios inverted. The proportion of loans used to purchase existing dwellings quickly increased during 1990-1992, and has slowly increased over the last two decades to peak at a staggering 96 per cent in 2010 before falling slightly to 92 per cent in 2012.

In the long-term, it makes little sense for the supply of rental properties to increase compared to the total residential stock unless there is a profound upward swing in housing prices, with investors spurred into the market on expectations of making a substantial profit through realising capital gains upon sale. Even if there is no expectation of selling, the increase in equity can be borrowed against to finance other investment opportunities and consumption. If enough investors believe that housing prices will rise in the future, they will flood into the market, causing prices to rise, essentially creating a self-fulfilling prophesy, otherwise known as a positive feedback loop.

Alternatively, if housing prices are stagnant or falling over the long term, then there is no incentive for speculative investors to remain in the market, thus exiting en masse and refusing to return until they are sure that prices will fall no further. NG thus risks amplifying housing cycles on the up and down. Further, it is difficult to disentangle the causes of investment that may be prompted by NG with other housing policies, for, instance, the 50 per cent discount on capital gains tax for properties held for a year or more.

Another fault in the housing lobby’s line of reasoning has to do with the continued implementation of NG. If this policy enticed more investors into the rental market thereby lowering rents, then NG could be wound down and eventually removed. The strange leap in logic is, as NG has been in operation for a very long time, it has held back a substantial surge in rents over the same period. Clearly, its implementation over the long-term is contradictory. One cannot maintain the pretence that rents are ready to blow out at any moment, thus utilising NG to relieve it, because if this pressure has existed for such a long time, then NG is the wrong policy to implement due to its demonstrable ineffectiveness.

Additionally, if the premise that NG lowers rents is accepted, then it is a poorly-targeted policy. Wealthy tenants who do not require assistance, for instance, high-income professionals and millionaires, also benefit as well as those who do need it.

Myth #3: Removing NG would cause rents to surge.

Another favoured scare tactic of the housing lobby is to claim quarantining, or worse yet, eliminating NG, would cause a drastic surge in rental prices. Yes this argument too carries a contradiction. Why would investors oppose significant rent rises? The alleged spontaneous increase would compensate for the loss of NG in part, in whole or perhaps even more.

Yet another contradiction emerges if the claims of the housing lobby are taken at face value. Positively-geared investors not enjoying the benefits of NG should be strongly advocating the removal of NG on the grounds it suppresses their rental incomes and its removal would therefore have the opposite effect. Perhaps negatively-geared investors are more numerous in relative and absolute terms, and are thus more politically and economically powerful.

While this might hold true for 2009-10 (the last year ATO data on investors are available) when 63 per cent or 1.1 million out of 1.7 million investors were negatively-geared, it becomes more difficult to believe for 1993-94 (the earliest year for detailed ATO data) when 51 per cent or half a million investors were negatively-geared. Positively-geared investors would have approximately half the power, so investor-led calls for ending NG should’ve been stronger back then. Clearly, these calls have not been forthcoming.

This contradiction is simply explained as the housing lobby and investors recognize, but never publicly acknowledge: NG has little, if any, effect upon market rents. Removal of it would hurt the bottom line of negatively-geared investors but not tenants. If rents did rise due to rental stock shortages, those on the margin would share house, return to parents or move away. Few recognise just how elastic the residential rental market is.

The well-targeted Commonwealth Rent Assistance scheme (CRA) can easily be boosted to compensate accordingly. Thankfully, the CRA is one policy investors and the housing lobby don’t oppose on the grounds that, as a demand-side measure, it places upward pressure upon rents. Increases in the CRA would have the effect of pulling tenants out of housing stress faster than the associated rise in rents.

Probably the strangest contradiction of all is when the housing lobby defends NG, it is done so in terms of helping tenants. Investors enter into the rental market for one obvious reason: to profit from rents and capital gains. Yet NG is defended on the grounds it assists tenants who would struggle if NG were not available (this is despite the overwhelming evidence that NG doesn’t lower rents).

It is blatant hypocrisy to hear profit-motivated landlords and the housing lobby transform themselves into raving socialists whose only concern is the welfare of their poor tenants. Conservative economists, for instance, Milton Friedman, have argued the only social responsibility that investors have is to increase profit. Supplying rental properties should be the limit of landlords’ concerns about tenants’ welfare, but strangely, their impersonal market-oriented arguments abruptly change when talk of quarantining or removing NG occurs.

In fact, if landlords were truly concerned about the welfare of their tenants, they would attend to repairs and maintenance in a timely manner. Evidence indicates the primary problem faced by property managers of private rentals today is not rent arrears but ensuring that landlords undertake maintenance and repairs. The advent of rental databases has made it easier to filter out candidates with a troublesome history, so the issue of rent arrears has almost disappeared compared to the time before databases became widespread.

Myth #4: Removing NG would cause investors to flee the rental market.

This interesting myth follows on from the previous one. If NG were eliminated, thereby causing rents to surge, why would investors exit the market? The argument by the housing lobby would have the opposite cause to the one claimed. Rising rents and the possibility of growing capital values provide a market signal for investors to enter the market rather than to leave.

Another point that is never clarified is how many landlords would, against their self-interest, exit the market. As of 2009-10, there are 1.7 million residential investors, owning approximately two million properties. As noted, 63 per cent of landlords are negatively-geared, meaning an estimated 1.26 million loss-making properties. Those who spread this scare story never attempt to specify how many landlords would pack up and leave if NG were to be removed. The exit of only a few would have a limited effect upon the rental market. But this is not what the housing lobby is suggesting. Rather, a mass exodus is implied. Absurdly, we are supposed to believe hundreds of thousands of landlords will sell immediately if NG is removed.

It doesn’t take a genius to figure out this many new sellers on the market would collapse housing prices. In fact, the supply surge would swamp demand. As economist Saul Eslake pointed out years ago, if landlords do exit the market and housing prices fall, this is not necessarily a bad outcome for tenants. Housing prices would fall, enabling many currently obliged to rent to purchase, reducing pressure on the rental market and hence rents.

Housing prices have recently experienced the largest boom in recorded history, escalating by 122% between 1996 and 2010, adjusted for both inflation and quality. During this period, capital values have often increased by $50,000 to $100,000 annually, a substantial windfall of unearned wealth (outside of improvements) for both owner-occupiers and investors. Even if NG were to be quarantined or removed, no sane landlord would exit the market during a housing boom just because they are receiving slightly less benefit than before.

Mortgages are larger than ever, leading to increased current net income losses stemming from greater interest repayments. If this does not deter fresh investment during a boom, there is no reason to believe that a further net income loss from removing NG would result in investors exiting the market en masse. As with the First Home Owners Grant (FHOG) and related boosts, it can be argued the benefit of NG is capitalized into higher property values, raising housing prices. Negatively-geared landlords thus suffer a double hit in the form of higher debt repayments and supposedly lower rental incomes. It is not clear if the benefit of NG outweigh these two factors.

Myth #5: NG is not an unjustified subsidy.

The housing lobby likes to claim NG is not a subsidy provided by the government to landlords, rather, it is simply the way the tax system has always functioned. Technically, NG is a tax expenditure, which arise when departures from the generally accepted or benchmark tax structure produces a favourable tax treatment to particular activities or taxpayers.

Australia’s tattered tax code abounds with many exemptions, concessions, deductions, preferential rates, allowances, rebates, offsets, credits, and deferrals. By allowing landlords to deduct expenses that exceed gross rental income against the tax liability on other income streams at their marginal tax rate, NG becomes just another defect in the tax structure.

An ever popular argument in favour of NG is it has always existed, somehow cloaking NG in legitimacy, as if the past is the universal measure of what is appropriate today. Even though NG provisions apply to other investments (shares and businesses), this does not make its application to real estate any more legitimate. Interestingly, the tax code provides property with the most generous deductions relating to NG, with shares and businesses less so.

Myth #6: NG is a costly housing-related policy.

Although there is some debate about NG as an unjustified subsidy to speculators (some landlords are in the market for a long-term rental play rather than hoping for capital gains), it is merely a small fish in a large pond as there are much greater defects in the tax code concerning property. In 2009-10, NG cost taxpayers $2.9 billion, comprising a tiny proportion of the economic defects in the housing market.

The biggest fish is the privatization of economic rents from land, in the order of hundreds of billions of dollars a year. At a distant second is the exemption from capital gains tax on owner-occupied property and the 50 per cent discount on investment properties, yielding tens of billions of dollars to owners annually. Economist Judith Yates’ 2009 report on the numerous tax expenditures relating to housing provides an in-depth analysis of the structural defects in the tax code regarding real estate.

To ensure NG functions as the housing lobby claims it does, at a minimum it should be quarantined to the purchase of newly-commissioned properties to ensure it expands the stock of rentals. Better yet, it should be eliminated altogether to ensure financial stability.


Unconventional Economist
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  1. “Better yet, it should be eliminated altogether to ensure financial stability.” But we all know it won’t be. It’s election time, after all……..

      • Why do business ventures go broke? Too many tax deductions. Tax deductions mean you are spending money, real concrete tangible money.

        Australia’s army of ‘Gearers have, by definition, not considered the risk or opportunity cost of this behavior.

        Capital gains are not worth having if one has to sell the property to stop the arterial hemorrhage of big borrowings.

        Rents will catch up? Mate! The gap between rents and market cap are mind boggling. It would take year after year of above inflation, above wage growth increases to close this. The correction will be to price.

        Don’t Buy Now!

        • And this behavior is evidence of garbage tax policy as millions of middle-income earners flee PAYG income taxation.

          Listen to Ken Henry and change taxes to immovable bases – mining and the land while removing 125 vile imposts.

          • You are ofcourse correct. It’s mind boggling to me that the govt. even bothered with the review given they ignored it’s outcome. Oh, wait, now that i think about it, it would have been brain boggling if they actually implemented the recommended measures, instead of sticking their thumbs up their candy asses. That part was expected.

  2. Thanks Philip, a really excellent contribution.

    I hadn’t heard of the temporary 1983 ban on negative gearing in VIC, before.

    Is the 2009 paper by Judith Yates that you mention publicly available? I just had a quick look online and couldn’t find it.


  3. Tony and Gillard really do represent the last of the old boomer complex that has helped transform Australia into a nation of landlord boomers and debt serfs.

    The young folks should make no mistake, these old farts do not represent their interests

    • +1

      Both Torynuffs and ALParatchiks are merchants of generational ransoming – both expect anyone under 50 to go into massive debt to pay for those over, to work longer etc etc etc

      • And its not just the debt serfdom, it’s the disgusting things that fall out of it. ‘Working families’ my ar&e – mum and dad working long hrs kids in long-term child care just to survive the property ponzi.

  4. I posted this elsewhere…

    Many of us argue for cutting negative gearing, but I also propose replacing it with an adjustment to the ATO’s depreciation schedule for properties. Currently, the defined lifespan of a dwelling is 40 years. That amounts to a 2.5% deduction on the construction value of the dwelling over 40 years. Given the rate of inflation has been relatively stable for 20 years now, and assuming that rate continues more or less on track, the deduction is frankly not an incentive to renew our housing stock.

    I’d suggest a 20 year depreciation schedule which would amount to 5% of the construction cost each year for 20 years. Factoring in inflation, this is front loaded as a relatively high deduction in the first few years before tapering off.

    In nominal terms, on a $100,000 property, the deduction would be $5000 a year for 20 years.

    In real terms assuming a perfect 3% inflation rate, the real deduction would look like this:

    Year Deduction
    1 5000
    2 4850
    3 4705
    4 4563
    5 4426
    6 4294
    7 4165
    8 4040
    9 3919
    10 3801
    11 3687
    12 3577
    13 3469
    14 3365
    15 3264
    16 3166
    17 3071
    18 2979
    19 2890
    20 2803

    Total 76034

    I believe this would provide a reasonably decent investment carrot towards redevelopment of existing land. Goodbye fibro shithouses.

    And there’s no reason a deduction like this would not be appropriate for owner occupiers.
    Unlike mortgage interest it is not based on the land portion of the property and thus isn’t simply tied to “how much can I borrow?” but to the actual intrinsic cost of the dwelling itself.

    So it’s not a rort. It’s a reasonable policy to improve the quality and density of our residential properties. There can also be other clauses added to avoid the destruction of good quality properties.
    Perhaps a date and/or a quality specification to avoid like-for-like replacement – that is, demolishing a 3BR double brick house with good structural integrity and replacing it with a 3BR double brick house.
    That is clearly a like-for-like replacement and adds no value.

    If however, the house was a 3BR 1940’s cottage made of matchwood and was replaced with a 3BR brick veneer house, there is a clear increase in the quality.
    If the same 3BR cottage was replaced by a pair of 2 story townhouses, then the density has increased and there is also a clear improvement of quality.

    • I propose we just get useless investors who add absolutely nothing to society other than a desire to rentseek of others out of the market.

    • Hi Myne,
      This is interesting, because the rate of capital allowances used to be 4%pa, implying a 25 year life for the Building.

      Re: your suggestions around date, quality and density restrictions, I think it might be better to achieve these goals through general building guidelines and restrictions (like NABERS) rather than tax policy.

    • If you could get that time frame reduced to 20 years you would win the praise of property investors everywhere.

      They will love you, but the ato won’t.

      You see if a property is sold, the property is valued at the purchase price and the depreciation resets to year one. The new owner will engage the services of a Quantity Surveyor who will determine the value of any depreciable assets, and then the IP owner will claim depreciation on the value at the rate determined by the ATO, which you have now increased to 5%. Due to increases in construction costs, the depreciable asset may have increased in value – other goods such as ovens, hotplates, airconditioning etc will probably have reduced, although if still functioning and acceptable to the tenant, they still have a value even if the previous owner has all but reduced them to zero on his depreciation schedule.

      Our tax rules are really quite complex, and there are no silver bullets.

  5. hubris_and_hyperbole

    Linking to the ABC story elsewhere on this blog, it would be nice to see the 7:30 report devote a half hour to all of this.

    …and maybe the commercial idiot brothers of the 7:30 report (TT, ACA) could follow and eventually get it into the heads of punters.

    • Mining BoganMEMBER

      Don’t hold your breath. Negative gearing was raised on Q&A a while back. Joe ‘Flounder’ Hockey replied with myth number one. Rents will go up he says. Like when Keating played with it he says. Then he flashed that killer smile and sat there looking smug. Not one person questioned him on it.

      Nobody cares.

  6. Negative gearing puts property on the same level of treatment as other similar investments, to change that would make housing “special” which I thought was not what people wanted to do.

    However if NG was to be abolished, and the quarantining of losses was abolished, then that would suit professional investors just fine. Under those conditions I think that we would see the following occur:-

    1. Mum and Dad investors would be gradually replaced with a more professional class of investor.

    2. Initially that might make some small difference to house prices as ownership of rentals rotated to professional investors.

    3. After that period rents would increase as real investors sought to earn the returns that they require. The Mum and Dad investors are incredibly soft on tenants, but professionals not so – they demand market rents.

    4. Tax implications – firstly existing arrangements will probably be grandfathered, so the rotation will take some time. NG is a small part of the market now as interest rates have fallen, and all properties eventually become positively geared at some stage.

    Losses above the income will be treated as “Loss Forwards” – for those unfamiliar with the tax code, that means the losses are carried forward until such time as they can be claimed against a neutral or positively geared tax year. In other words it makes absolutely no difference to the investor other than delay the timing of the deduction.

    As an avid reader of articles on property I read a lot of beatups, and of all of the beatups, the argument both for and against negative gearing are the great grand daddy’s of them all.

    It used to suck in a lot of inexperienced investors, but I think that those days are gone. It also gets up the hackles of the bears and gives them a point to focus on as the instrument of all of their woes.

    But any experienced property investor couldn’t give a hoot what they do, They will still be able to claim every single dollar spent in earning that income whether that claim is right now or next year – what does it matter to someone who has done their homework and calculated his/her future cashflow based on the taxation laws as they stand.

    But NG has sold a lot of newspapers – so it’s positively geared for journalists.

    • The timing of the deduction is crucial to investors, in my experience.

      Not just from a time-value of money perspective, but because a deferred deduction means cashflow constraints – borrowing or selling investments to pay this year’s tax bill.

      Forcing losses to be carried-forward would also increase their ‘burn rate’, because inevitably some investors will sell the IP before it becomes ‘income-positive’.

      • yes there will some minor cash flow constraints. I really doubt that they would concern any intelligent investor, except perhaps in times of exceptionally high interest rates, but on long term averages the hip pocket effect would be modest. Do the sums.

    • With respect Peter – that is total tosh.

      Interest rate deductions are have been serially abused as a tax minimisation tool across the world to the extent that all major jurisdictions are looking to regulate.

      Debt-equity provisions, thin-cap and transfer prising are all moving against the unfettered and unsustainable use of interest deductions by global corporates and global capital.

      Proper interest quarantine provisions part of a real and multifaceted policy response will go a long way to getting useless speculators out of the market.

      • I disagree – I look at real figures all of the time. If an IP is earning 5% of the property value but paying 6% on the debt, how can the difference really be a large sum of money. Given a property worth $500K earning a gross rental of $25K but paying 6% on a debt of $400K then they will have an interest bill of $24K plus rates, insurance, deperciation, maintenance of maybe $8K so will have a loss of $7K @ a tax rate of 30% equals $2100 – if an investor needs the $2100 pa to carry on then they are playing in the wrong area – but they still claim that $2100 at a later date. A professional won’t worry about that.

        • Interesting figures compared to my renting experience. I was previously renting an estimated $2m property (inner-east Melbourne) for $35k per year. Makes a bit of difference to your calculations above.

    • “Mum and Dad investors” – Yet another one of those cliches rolled out to defend just about any form of rent seeking/middle class welfare. PF, you have a great future in Aussie politics.

      John Quiggin had a good post on the great Australia pastime of coming up with atrocious cliches.

      Mums and Dads

      First, the claim is undoubtedly true. By the time they have enough money to invest in, or speculate on, the share market, the great majority of Australians have children. Nathan Tinkler, for example, is a father of four. Gina Rinehart is, at least according to her kids, a spectacularly bad mother, but she’s a mother all the same. The unremarkable fact that most owners of shares have children does not entitle them to any particular sympathy.

      • I wasn’t trying to evoke any sympathy for them, I was classifying them as less than professional investors. Whilst I have the highest regard for them as individuals, they fall short in other measures, which depending on your POV is either a positive or a negative.

        Whether our society is better off with them as landlords than professionals who would demand their pound of flesh is not my decision.

    • ‘The Mum and Dad investors are incredibly soft on tenants….’

      Please. Many landlords let existing tenants’ rents rise more slowly than the market for new tenancies – but that’s a rational discount to keep a known quantity. There might be a few ‘softies’ when it comes to rents, but there’d be many more who take the increase whenever the agent suggests it, and some who are pushier about it.

      Moreover, for every softie there is at least one control-freak who adds a list as long as your arm of daft additional terms to the agreement, who peers into your wardrobe during inspections, and who generally mistakes micro-management for genuine property management.

      These ‘Mums and Dads’ – properly, amateurs and speculators – don’t trade on their reputations. Many are reasonable people… until they’re not, at which point our renting laws are pretty accommodating of them, especially in relation to the termination of tenancies.

      Our laws accommodate them as speculators – easy termination so they can sell with vacant possession when it suits them – and as amateurs – easy termination when it all gets too hard.

      Residential rental: the $28 billion pa industry run by amateurs… at a $10 b loss. It’d be nice to see more professional landlords, particularly not-for-profits (the community housing organisations have this potential), but wouldn’t mind seeing a for-profit rental housing company, that traded on its reputation for giving customers (ie tenants) quality service for a competitive price, for as long as the customer was happy to pay for it.

      • The NZ Productivity Commission Inquiry into Housing Affordability found very low involvement in residential rental property by professional institutions, and suggested that this is because such institutions do better “due diligence” than mum and dad investors. The latter tend to believe in a whole lot of myths about housing as an investment, thanks to a few get-rich-quick success stories. The fact that a goodly number of “greater suckers” are needed is overlooked. It is classic Ponzi/pyramid “wealth creation”.

    • After that period rents would increase as real investors sought to earn the returns that they require. The Mum and Dad investors are incredibly soft on tenants, but professionals not so – they demand market rents.

      “Market rent” is not the rent required to make a positive return, it’s the rent that the potential pool of tenants are capable of paying.

      Where is the evidence suggesting a meaningful proportion of tenants have spare money they can put into more rent ? For all that renting is generally around half the price of buying, renting is still far from cheap.

      NG is a small part of the market now as interest rates have fallen, and all properties eventually become positively geared at some stage.

      Really ? How many interest-only mortgages have you sold ? They were certainly all the rage a few years ago.

      In other words it makes absolutely no difference to the investor other than delay the timing of the deduction.

      Uh, how about if the property accrues losses until it is sold, then sells for a capital gain smaller than the accrued loss ?

      • In that case any accrued losses would be used to reduce the tax payable on the sale profits, which in my view is a much better outcome for the investor.

        • In that case any accrued losses would be used to reduce the tax payable on the sale profits, which in my view is a much better outcome for the investor.

          That was my point. If the sale profits are less than the accrued loss, I’d say that makes a difference rather more substantial than just “timing”.

          • Yes in that circumstance you are absolutely correct – no arguments from me on that. That adds some weight to the argument that only the more professional investors would enter the market, because only they would understand and accept the risk

            The Mum and Dads have had a pretty easy run so far and most have done well. From now on it won’t be a case of just buying anything, they will need to be more selective and more professional.

            Honestly I don’t care either way, I’m only stating my view that investors in residential housing in the future should be more professional, especially if you chase the amateurs away by taking NG away, and that change will have an effect on the housing market. Professionals will have less concerns about NG and will probably use company structures, where losses are quarantined anyway.

            It’s only sole proprietors and partnerships that can use NG.

        • dumb_non_economistMEMBER

          Peter, how is delaying your deduction a benefit when you are inflating (deflating) its value away i.e. a $2000 deduction is worth more now than in 5 yrs.

    • Assuming that the ‘mums and dads’ (how many times are we going to have to endure this phrase, particularly in an election year?) are soft on rents is a complete fallacy. The income of the average property investor isn’t high, can they really afford to be ‘soft’?

      The other thing of course is that the amateurs get to unleash their prejudices on the market pretty much unchallenged. An anecdote: in renting out a property we own, the REA casually told us that she would, of course, make sure no Indians rented the place, thinking we’d be impressed with her market nous.

      Would a property corporation get away with this kind of blatant discrimination? It’s easy to disguise when the market is so fragmented. How would you even launch a complaint?

  7. How many boomers will want their NG properties as they retire and can no longer use the tax loss? They sell 5 years before retirement…now…

    • Paul – those properties will have become positively geared well before then. I couldn’t say whether the owners will cash them up or hold them as a side income on top of their pension.

      I don’t see that decision as being urgent though, so they might take some years before they sell and hope for extra capital gains. What would you do in their position?

      Serious question – I don’t want your philosophy. If you want to know what someone will do then put yourself in their position and answer the question honestly.

      • And to answer your question, if I were 5 years from retirment and have NG’ed properties, I would be selling them up now.

        • Paul – nowhere did I say that the BB segment did not own property. More strawman arguments.

          Ah – I see you are giving me your philosophy again instead of rationale.

          It’s 2013 and we have had 5 years of little or no growth in house prices, but the market is now moving up and if history is a guide, we may see some reasonable to solid growth over the next 5 years.

          It would be illogical to sell right now.

          • Sadly that reply is nowhere ………………………………………………………………………………………………………………………………………….

            Self censored.

          • “history is a guide, we may see some reasonable to solid growth over the next 5 years”

            Historical Returns do not have to represent future returns.

        • Most of those approaching retirement probably aren’t negatively geared any more. I suspect many of them would hang on and avoid realising any loss – just continue to get the rent, pay the mortgage and hope for the best.

          • Wrong….
            “A recent MLC survey of 250 financial advisers (both aligned and non-aligned) found more than a third of the respondents’ clients will downsize their home, about one-third will sell their investment property, and about one-third will sell an existing business during the next five years to shore up their retirement savings.”

            “However, they’ve been a particular favourite of baby boomers. Statistics from the Reserve Bank show that 27 per cent of boomers have an investment property, while this same demographic owns one half of Australia’s total number of investment properties.”

            “Of the 27 per cent of boomers who hold an investment property, 40 per cent have a mortgage.”


          • Mmmm, so approx 900,000 boomers stiull have a mortgage on their IP’s. Yep, no problem here when you consider the vast amounts of Super they have….not!

          • “One third will sell their investment property”


            “27 per cent of boomers have an investment property”

            Hmm. Those consulting financial advisers in the MLC survey are clearly not representative. What exactly is the value of any statistics based on this survey?

          • Plus, of course, if it were a fact that one third of boomers with an investment property intended to sell, that means two thirds do not intend to sell. Which was the point I was making in the first place.

          • Ok, 615,600 boomers have IP’s with a mortgage. Many would be positive, no doubt, and many would be using NG.

      • “Second, once somebody enters retirement, they tend to become more risk-averse and more concerned with achieving a stable flow of income rather than potential capital growth. Retirees with inadequate income are also more likely to become net sellers of property (as well as financial assets) in order to generate the funds necessary to maintain their standard of living in retirement.
        With the oldest Baby Boomers having turned 65 in 2011, the large migration into retirement in Australia has already officially begun, and will only gain strength throughout the decade as more and more Baby Boomers exit the workforce.
        Logically, therefore, the incentive to unwind property holdings would be greatest amongst the lower-to-middle income earners and the older age cohorts that hold the bulk of Australia’s negatively geared investment properties.”

        Read more: http://www.smh.com.au/business/property/nation-of-lossmaking-landlords-20120430-1xuh4.html#ixzz2LsQJIY60

        • and the youngest Boomers are just turning 49 this year.

          Now honestly do you think that they will all be rushing out to sell this weekend?

          Why would they, they have 11 to 16 years of their working career left.

        • Nice to see Leith getting a guernsey in the SMH. One thing about that article I would question, though. The stats make it clear that a majority of rental properties are owned by BBers. It is also clear that a majority are negatively geared. But that does not mean that we can conclude that BBers have lots of negatively geared property. It may be that most of the negatively geared properties are owned by younger “investors” who have bought more recently. I would have thought it likely that the older the cohort, the lower the negatively geared proportion. This is not clear from the available stats, but would fit in with general perceptions of older investors preferring lower risk profiles. Also with the idea that the longer the property has been held, the lower the likely gearing.

          • Yes, interest rates have fallen much more than anyone expected in the early months on 2012, wages have risen, rentals have risen, and as a result the number of negatively geared properties has fallen.

            The game has changed.

  8. Soos has finally written a decent article.

    When supply is choked then idiot demand schemes (NG) will not solve the problem (shortage), they just raise prices.

    However the NG debate is a red-herring in my opinion. It diverts attention away from the real serious problem – the choked supply.

    Consider a place like Dallas where supply is not choked and rents and house prices are low. Do you really think introducing NG would quickly ruin that market and create terrible shortages and high rents and prices? Of course not. Choked supply is the bigger problem.

    Should NG be removed? Yes. Allow the excess costs to be carried forward and eventually deducted against profit.

    • Someone needs to get Soos over onto the side of light and truth, on the supply issues. He is obviously a valuable scholar.

    • Hahaha

      I believe there is a housing shortage in Australia!

      I also believe in Santa Clause, The Tooth Fairy, Peter Pan, Dragons and other mythical creatures

      • I believe there is a housing shortage in Australia!

        The first thing you should learn is that housing is local. A house in Sydney cannot substitute for one in Perth.

        The next thing to learn is that there are many shortages around, Sydney houses, Darwin houses, transportation, Taxi licenses etc.

        What was your point again?

        • *Yawn*

          You sound like some American guy I was debating with back in 2004 over a housing shortage in Carlifonia

          – He told me there was a housing shortage in Carlifornia and the USA as a whole
          – He told me banks were lending conservatively with strong regulation from the SEC, Frannie and Freddie
          – He told me American houses were based on strong fundamentals like “supply and demand” and population growth from Asia

          Sounding familiar?

  9. Whilst I think property is overvalued and due for a fall I think PF is right on this one. NG is more noise than driver. From what I see & hear (including many property blogs, etc) NG is not the main driver – it still comes down to the Aust belief that property values will just grow & grow. NG is just cream. I’d say there are just as many high PAYG earners gearing into equities & ETFs, SMAs, etc.
    “Mum & Dad’s” might favour property NG but many are on lower tax rates so the removal won’t change much.
    FHB may use the strategy in early years (ie live with mum & dad) so maybe removing NG will hinder this more?
    No hard facts just anecdotal.

  10. The Mum and Dad investors are incredibly soft on tenants, but professionals not so – they demand market rents.

    Could you please give us a few examples that you are familiar with? Just use first names, suburb names, market rent and actual rent demanded by the mum and dads.

    • Come to think of it. Can anyone please put me in touch with some of these soft Mum and Dads?

      I just realised – the couple I am renting from MUST BE CHILDLESS!

    • There are a thousand examples right here Claw – I couldn’t count the number of times I have read where renters have achieved rent reductions from their BB landlords who stupidly rent the house on a small income margin.

      If that was a corporation they would say “pay the prescribed rent or move out”

      • You’re relying on comments at macrobusiness to support your argument, Peter? I think that means you just lost…

      • With corporation’s you’d have front line staff with no direct personal gain from the rent who may cave on price.

        See how useless and circular this argument is with no data?

      • > If that was a monopoly they would say “pay the prescribed rent
        > or move out”

        There – fixed that for you, doesn’t that look better now?

        Seriously though – if that was a corporation … the reverse is also true – due to the (presumed) competition: “Lower the rent, or keep it empty”


    • “Could you please give us a few examples that you are familiar with? Just use first names, suburb names, market rent and actual rent demanded by the mum and dads.”

      Maybe I can help here.

      Location: Liverpool NSW Australia.
      2 flats in one building in Goulburn St.
      Highest rent we are charging for them is $280/week. Other flats in that building are being rented for $300+ / week.

      Location: Liverpool NSW Australia.
      4 flats in another building in Goulburn St.
      Highest rent we are charging for them is $285/week. other flats in that building are being rented for $330+ / week.

      Location: Fairlight NSW Australia.
      1 top floor water front and view flat on the foreshore. Rent was $500 / week untill a month ago when we put up the rent to $900/week with new tenants. ( body corporate fees were $2000/quarter, council rates were $2000+/ year, land tax was $6400/year, with other outgoings). (mind you, this flat is worth over $1M.)

      Plus some more …..

      All the above were owned by my parents whose estate I am now sorting through.

      Yes …. he was a softy and his tenants took advantage of him.

      YES … I am slowly putting up rents but they will still NOT go up to full market rates because I do not believe the tenants in them can afford to pay so much of an increase in one go.

      YES ….. I will carry on the family tradition of being a land holder (for most of the flats) and will probably still charge around 10% under market value in rents after I slowly bring up the rents, but I will not be such a softy as dad was.

      OH yes, relevant information is that none of the flats have any debt on them so NO negative gearing applies.

      Hope that helps.

      • sydbod – glad to see there are still some softies left.

        An investor is entitled to a fair ROI, but I would be saddened if we lost the human touch completely.

        Corporations don’t have that.

        • “An investor is entitled to a fair ROI”

          They should not expect, or be entitled to, a fair ROI if they over pay for the asset.

          • “They should not expect, or be entitled to, a fair ROI if they over pay for the asset.”

            How can some one over pay for an investment.
            What dimwit would pay more than what THEY thought an investment was worth?

            A fair ROI is “The ROI” and is based on the market and never on the purchase price of an investment.

            Just because some person may pay a high price for some investment never means that they will get a higher ROI. Otherwise one would spend all ones money on the most expensive shares one could find.

          • Um…what?

            ROI depends on sum paid, cash flows and realisation value. Pay too much for an asset an you shouldn’t expect anything other than a disappointing return.

          • “Um…what …..?”

            Of course ROI depends on cost price.

            We are talking about a “FAIR” ROI.
            Some people may think 2% is fair others may think 20% is fair but this has nothing to do with it at all.

            A “FAIR” ROI is based on whatever the investor payed for the investment and the “CURRENT MARKET” return on that investment, and not on some arbitrary % pulled out of thin air.

            It may not be your expected ROI but it still is a “FAIR” ROI in the true sence of the word.

          • “When I use a word,” Humpty Dumpty said in rather a scornful tone, “it means just what I choose it to mean — neither more nor less”

            Good to see there’s some Lewis Carroll fans here sydbod. ROI can mean whatever you want it to mean, don’t let these naysayers get to you!

      • Hope that helps.
        It does answer my question and I thank you for that.

        It doesn’t help me because Liverpool doesn’t suit for various reasons and the Fairlight place is too expensive for me at $900pw.

        On an unrelated matter I was recently reading some family history and apparently one of my ancestors kept 6 or 7 slaves and he would beat them 10% less than the average master. I think I know where I got my soft side from.

        • “On an unrelated matter I was recently reading some family history and apparently one of my ancestors kept 6 or 7 slaves and he would beat them 10% less than the average master. I think I know where I got my soft side from.”

          I think we must have something in common.

          I was also recently reading some family history and apparently one of my ancestors was a viking …… but a really good one …., as he would only rape pillage and plunder 10% less than the others of the time.
          Thank god he was not like my dad as he would then have raped pillaged and plundered at lest 20% less than the others. That would have ruined my family reputation totally. 🙂

  11. People who “invest” in property under the current system are not investors, they are speculators. They are betting on an increase in the real price of an asset without a corresponding increase in its true value.

    Back in the dark ages of the 50s and 60s, rental property was owned by conservative investors who held it for yield, not capital gain. Property was a very low risk, stable investment.

    Anyone who thinks they are “investing” in property at current unrealistic prices has rocks in their head.

    Negative gearing is only one small part of the sickness infecting our property market at the moment, as regular MB readers would know well.

    • Exactly, it is classic Ponzi/pyramid stuff. The supply of “greater suckers” has to run out somewhere.

    • “People who “invest” in property under the current system are not investors, they are speculators. They are betting on an increase in the real price of an asset without a corresponding increase in its true value.”

      That may apply to some but one must remember that there are many current property investors that are not very sophisticated in their knowledge of investing.
      Many are petrified of going into the stock market (they still think it is going down).
      these people just do their simple calculations to justify their current property investments.

      Let me give you an example of the investor that purchased the last flat that I sold six months ago. (I am rationalizing my investments as I don’t want to have 100% of assets in property only and I was renting it out for only $240/week myself)

      Location: Liverpool NSW Australia
      2 bedroom flat with car port.
      He payed $235k + stamp duty.
      He is renting it out for $300/week.

      Even taking into account of $800/year council rates and $1600/year body corporate fees, the returns are getting close to a term deposit account.

      Of course … should he eventually build up his holding so that land tax becomes an issue, and should he be a bit of a softy like me, then the numbers start to look a little worse.
      but if one believes that interest rates will still fall a bit further, then the numbers look appealing for some people even with no capital gains.

      NOTE: this only applies to my experience in the area I deal in and may not apply to many other locations.

      • Fair enough. There may still be some doing it the old fashioned way. I think in general people go in expecting to make a killing on capital gains.

      • What was the purchasers deposit? What would the outcome be if he or she needed to sell in a couple of years time and the value of the asset had fallen by, say 8%?

        How would it compare then to the term deposit?

  12. Anyone who thinks they are “investing” in property at current unrealistic prices has rocks in their head.

    If interest rates stay low, and rents continue to rise as they have over the last few decades then current prices DO make sense.

      • So it becomes like a hostage stand-off, where central banks dare not ever raise interest rates.

        There was a time when interest rates were high and everyone expected them to be lower one day – defeating inflation was a top priority.

        But expecting interest rates to stay at record lows or fall even further – is that wise?

        • I don’t know about wise, but it would be interesting to see a post on the potential triggers for interest rate increases.

          Perhaps a guest post from Janet?

          • Perhaps I should say:

            “….But expecting interest rates to stay at record lows or fall even further, DURING THE NEXT 20 TO 30 YEARS….is that wise?”

            If banks were offering fixed-interest loans for 20 to 30 years it might be different. And non-recourse mortgages.

            I constantly marvel at young Australians propensity to be suckered into debt servitude without even having the same inducements of non-recourse and ultra-long-term low interest rates, as Californians did.

    • “If interest rates stay low”

      Yes interest rates have stayed low in the US and Japan. Why is Japanese property still falling?

      “rents continue to rise”

      This is the big IF. This could theoretically apply to all assets. Its like saying I think BHP shares should be worth 300 dollars each because I am betting on a 10,000% increase in net profits for the company.

  13. NG is only a delightful side benefit of purchasing a highly-leveraged investment property.

    The elephant in the (rented) room is that the investors who currently benefit from NG have greater access to leverage.

    Property prices are simply a function of availability of credit (are you listening Dr. Wilson? “Demand” = desire + credit).

    Swapping investors for owner/occupiers for the entry-level properties reduces the quality of the credit risk at the base of the pyramid and has a subsequent knock-on effect throughout the entire market.

    Removal of NG returns only one missing element of sanity to the market, which will probably result in a small dip in prices. Lending practices still account for the majority of the froth in the cappuccino however. Don’t believe me? Have a look at the graph of rent versus purchase price on Leith’s excellent presentation 2 weeks ago.

  14. Re Myth 5: “Technically, NG is a tax expenditure, which arise when departures from the generally accepted or benchmark tax structure produces a favourable tax treatment to particular activities or taxpayers.”

    This is completely wrong.

    Negative gearing is simply a function of the general application of the taxation provisions – it is not a specific ‘exemption’ or a departure from the generally accepted tax structure. Rather, landlords are entitled to a deduction for interest, land tax, rates, repairs etc because they are expenses incurred in deriving assessable income.

    Limiting those expenses to rental income would in fact be a departure from the norm.

    If there is not a reasonable expectation that the landlord will ever derive sufficient income to cover the expenses (ignoring any capital gain on sale) then the ATO already has case law at its disposal to deny deductions to that extent. If expenses are incurred to derive the capital gain on disposal, no deduction arises (s.51AAA).

    • Limiting those expenses to rental income would in fact be a departure from the norm.

      I find no problem in that.

      Residential property is clearly not a standard form of investment, thus should not be treated as standard forms of investments.

      You want that standardised treatment, then invest in those instead.

      • Define “standard form of investment” in terms that coherent people can understand without chemical assistance.

    • Hi MikiDora,

      s.51AAA simply prevents people ‘double-dipping’ by trying to claim expenditure as a tax deduction AND including it in the calculation of a capital gain.

      It doesn’t have anything to do with whether a landlord’s negative gearing is ‘excessive’.

      I’d be interested to know what case law you’re referring to, as well.


  15. Abolishing of NG can drive housing prices down, time to safe for deposit, lesser loan repayments, boost retail and bring more money for ATO, give better social conditions.
    We need a political will!
    At the present time money are withdrawn from healthy economical cycle.

  16. Political will or political insanity? Bashing 1 million NG investors (and 5 million wantabes) is really not going to win elections in Australia.

    Maybe easier to disallow council rates as a deduction but lower the core tax rate from 30% to 28%. The logic is the impact should balance out. In reality both will hurt NG investors and foster more efficient allocation of resources.

    Now is a good time to tackle the issue with low interest rates making the economics of holding a property the best in a while (for those who have held their properties since before 2008).

    • Political will or political insanity? Bashing 1 million NG investors (and 5 million wantabes) is really not going to win elections in Australia.

      What about up and coming millions of Gen Y voters who may feel they may have been outbid by negative gearing investors?

      Negative gearing is another one of the Great Australian Middle class welfare.

  17. I know only a few people who have investment properties.
    They are all professionals, mainly doctors.
    They invest in properties to reduce their income tax.
    Of course they benefit from capital gains over time as well, but the initial purchase is motivated by desire to “reduce tax” (from the horse’s mouth).

  18. “What about up and coming millions of Gen Y voters who may feel they may have been outbid by negative gearing investors?”


    Politicians better to be wise today. Not after they find from bureau of statistics about drop in birthrate, skill shortage and pure manufacturing and small/medium business data.
    Money in real economy has times better turnover (including GST component), then in “home loan lender-borrower” rotten enterprise!

  19. Speculative finance may well magnify trends, but the same policy no doubt also add much needed liquidity to a sometimes rigid market.

    For the speculation to magnify a trend into a bubble, there still has to be an underlying trend, and that trend is at the moment pointing relentlessly upwards. Unless something is done to address the inability of supply to match demand, housing will remain unaffordable (as mentioned in this blog when referring to Texas’ housing markets).