A lot of people don't understand "Negative Gearing " and there is pressure building in the Australian parliament for it to be banned. It certainly has delivered immense profits to some people when applied to the rapid price rises of Sydney and Melbourne housing, but it also contributes greatly to the supply of homes available for tenancy. It's removal could have severe " unintended consequences " !
Negative Gearing is a form of financial leverage where someone borrows money to invest and the gross income generated by that investment is less than the cost of owning and managing the investment. This loss is then tax deductible and can be claimed against other forms of income the investor may be receiving.
So if that investment is a house, the interest paid on the mortgage may be more than the rent obtained from a tenant, so the owner can claim that loss against his other income to lower the tax rate he must pay. Of course, when he sells that house any profit against the original purchase price will be subjected to capital gains tax.
The abnormality that is drawing attention to negative gearing is the bubble that has been ongoing for decades with house prices. In prices rise sharply - year after year - the owner of any house has an ever increasing asset that is delivering wealth far in excess of most other forms of investment, and some of that wealth is being garnered at the expense of the tax man.
Of course the loser is the first home buyer denied getting on the real estate ladder because of ever rising prices, but it should be remembered that the vast majority of negative geared properties are not the home of the owner. To become a tax deduction they require a tenancy to balance the cost of acquisition against the rent obtained - and this goes a long way in ensuring that rental housing meets the needs of our ever growing population.
Economists would do well to understand the change that removal of negative gearing would have on the availability of rental housing if it ceased to be a tax deduction. There is also the possibility of a market reversal. Should this house pricing bubble burst - as happened back in 2008 - some investors may find themselves owing more than their property would bring in a forced sale. There are no guarantees when market forces occur. It would indeed be a Pyrrhic victory if we banned negative gearing to make housing available to first home buyers - and at the same time imposed an impossible drought on those who need to find a rental property to survive in Sydney and Melbourne.
Perhaps a greater impediment to first home buyers is a trend emerging out of China. A vast middle class is emerging with money to spend on travel - and the wise in investing, and the rate offering on bond purchases and fixed deposits is minimal. Savvy financial advisers are suggesting a better option is to invest in western world housing, but in the majority of cases this is not being offered for rental. Oriental thinking differs from that of the western world and the intent of many Chinese is simply to "park their money " in the safety of real estate and ride the roller coaster of ever increasing home prices. This practice actually reduces the stock of homes available for rent and further fuels price appreciation.
The government is threatening to crack down on foreign home purchases that ignore laws that restrict sales to the newly built segment but it is obvious that all housing stock is being promoted as available to foreigners. Much advertising is specifically presented in Mandarin and ignores English. A period of amnesty is offered for illegals to come clean and restore their properties to legality, but it is likely that this trade will be driven underground and be placed in the hands of nominees.
Like all law changes, those demanding the end of negative gearing would do well to think long and hard about exactly what they wish for !
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