NICK BRUINING: The unintended consequences of Federal Government’s Budget housing changes

While the government will be keen to push the line that an additional 75,000 home owners will result from Tuesday night’s announced changes, it’s the unintended consequences we need to think about.

Let’s start with the capital gains tax changes.

As recently as late last week, property experts were warning that the turning point in Perth’s booming residential property market may have already been reached.

Respected property analyst Gavin Hegney and others had detected a shift in some fundamental indicators over the past 6 weeks or so.

Days on the market are starting to increase as are the number of listings of properties for sale. Sure these might be incremental shifts for now, but heading in the wrong direction nonetheless.

Mortgage brokers are reporting that some investors with multiple properties are selling down to reduce debt, cashing in on the double digit returns enjoyed over the past three years.

We’ve seen three interest rate increases already. Combined with expectations that we would see at least one and possibly two more hikes before year’s end, some investors are already both stretched and spooked.

Let’s also not forget that capital gains tax liabilities can be reduced by the negative gearing losses generated by the same properties during the year.

Tuesday night’s imposition of a minimum 30 percent tax on growth above inflation from July next year, makes the whole deal less attractive as a long term investment proposition. Cashing in now under the current capital gains tax rules will make perfect sense to many.

That particularly applies to someone that’s nearing retirement and can time the sale of an investment property to reduce the total tax payable.

The bottom line is, there’s a very real possibility that the looming 30 per cent tax impost, coupled with what could already be a wobbly market, translates into even more investors deciding to cash in while they can.

The changes to negative gearing may also have unintended consequences.

If you have a negative gearing arrangement in place as of last night (or a signed contract in place) you’ll be “Grandfathered”. That simply means the new rules won’t affect you and you continue under the current arrangements or “old” rules until you sell the property.

From July, only new builds will allow negative gearing as it exists now. Currently the expenses you incur like bank interest, local government charges, insurance and maintenance costs can be claimed as a deduction against the rent. When those expenses exceed the rental income, you can carry them across to reduce your income from other sources, typically employment income. That reduces your total taxable income and the tax payable. It’s the heart of negative gearing.

If you decide to press on and buy an established investment property from today, you can still negative gear under the “old” arrangements, but that ends on July 1 next year.

While you’ll still be able to claim a deduction, the effective transfer of the loss to other income will no longer apply. If you make a loss, it builds up against the property and can then be used to reduce future income from the property. While that might include future positive gearing arrangements, and the capital gain that you make, the effective benefit of the carry-over loss could be years away.

The issue here is that the attractiveness of gearing into an established property is less attractive – which is the intent of the policy shift. The idea being that you’ll decide to invest in a new build where the old rules will still apply.

But knowing that the existing negative gearing rules will only apply for what amounts to 13 months, is likely to make many potential investors think twice about investing into an established property in the first place.

Reduced demand thanks to a decline in investors, coupled with an increase in supply as others are selling, doesn’t bode well for house price growth in the short to medium term.

Meanwhile, you have first homebuyers hanging back, wanting to be sure they’re not paying too much in what could be, a declining market.

The government argues that the changes to the negative gearing and capital gains tax rules will encourage investors to favour new builds over established properties to boost the total housing stock.

But let’s look at the outcome realistically.

New builds tend to be in outlying areas. Like anyone, people looking to rent are also after convenience. That often means access to public transport and other amenities like schools, shops and medical services. Things that tend to appear later on the time-line of a new subdivision, rarely from the get-go.

Sure, you may find some renters who want to keep an eye on their own home being built and get used to an area by renting, but these tend to be on a short term basis.