Do Bill Shorten's policies spell the end for property investors?

Investopoly

All the clowning around in Canberra last week is likely to have increased Shorten's chances of winning the next election. Given the ALP's proposed changes to negative gearing and capital gains tax, will these policies spell the end for property investor? Why the change? According to the ATO[1], approximately 2 million Australians invest in property and 61% of them claim negative gearing benefits. Negative gearing occurs when you borrow to invest in a property and the income from that property isn't enough to cover the expenses and interest related to that property investment. That loss helps reduce your total taxable income resulting in a lower income tax liability. According to the ALP, higher income earners benefit the most from negative gearing. The ALP report that The National Centre for Social and Economic Modelling estimate that the top 20% of income earners enjoy around half of the negative gearing benefits. What is the ALP proposing? Labor is proposing to scrap negative gearing on any investments in established property that are made after a yet-to-be-determined date. Existing property investments will be grandfathered. Negative gearing on new-build properties will still be permitted. If you do invest in established property after the yet-to-be-determined date, you will be able to carry forward the income losses and offset them against future property income or capital gain. The ALP is also proposing to increase the rate of Capital Gains Tax (CGT). Currently, if you own an investment for more than 12 months and make a capital gain on sale, you only pay tax (at marginal rates) on 50% of the net gain. The ALP is proposing to reduce the discount such that the CGT liability will be on 75% of the net capital gain. Again, existing investments will be grandfathered. What is the impact on the after-tax return? The impact of these taxation changes on the internal rate of return will be material. Internal rate of return is an estimate of the profitability of a potential investment. The internal rate of return under the current tax laws on a $750,000 investment in property is 12.6% p.a.[2] Adjusting for the proposed ALP changes reduces the internal rate of return to 9.3% p.a. That is, the proposed tax changes wipe out 26% of the after-tax investment return! The reason is that the carrying cost is higher (because there's no negative gearing benefit) and the investor pays a higher rate of CGT when they sell. How will these changes impact property markets? You don't have to be a Rhodes scholar to work out that demand for property investment is almost certain to fall materially if these changes are implemented. The chart below compares the volume of owner-occupier and investment dwelling finance commitments with the median house price (average of Melbourne and Sydney) since 2000. It demonstrates that housing prices are heavily impacted by both investment and owner-occupier housing finance commitments. If the demand for investment housing finance was to fall it is likely that it would have a negative impact on property price growth. Property prices in locations where the majority of dwellings are owner-occupied will be somewhat insulated from the risk of price falls. Conversely, investor-owned dense locations will likely be impacted more severely. It is likely that some of the additional cost to hold a property investment will be passed onto renters - so its reasonable to expect that rents will rise as a result of these proposed changes. A property developer and spruikers dream! The fact that new-build properties will still receive negative gearing benefits will mean...