Let’s set the scene:

According to the Australian Taxation Office, in 2015 we saw $3.6 billion in rental losses.

In other words, the costs to ‘service’ investment property exceeded the rental income.

As back of the envelope math – that’s at least $1 billion in lost tax revenue which could have been better spent elsewhere (eg education, health, investment, infrastructure etc).

Repeat: over $1B lost opposite speculation.

Put it this way – what serves the longer term economic benefit of the country better?

Higher house prices or things like education, health and infrastructure?

Most people (1.3M Aussies to be precise) clearly think the former.

Here’s my question:

When will our government get serious about phasing out (and eventually removing) what is one of the biggest tax rorts (and misallocation of capital) we have ever seen?

My answer – not in the near term.

Why they are in No Hurry

It’s well documented that Australian politicians have a strong self-interest in property.

For example, if you look at this report – there are 535 of our politicians (according to ABC’s research) who own property.

There is nothing wrong with owning property – most of us do.

But here’s the thing:

238 (or 44%) of our politicians list their assets as either investment or commercial.

Conflict of interest anyone?

For example, Karen Edwards lists 9 investment properties!

I don’t think we will be seeing Karen vote in favour of removing this policy.

Anthony Albanese lists 2 investment (houses) in Sydney’s inner west (there’s at least $3M to $4M); and Mathias Cormann lists 5 properties in his name… and so on

Now let’s be very conservative and assume an average national investment property is valued at $400,000.

That’s around $100,000,000 in investment property assets owned by our own politicians.

Do you think they would be in any hurry to ‘unfeather’ their own nests?

Not likely… not this bunch.

But let’s put their own self interests aside — many Australians are tied up in this scheme (sadly).

Fortunately I am not one.

Yes, I own multiple properties, but equally I have no debt. And unlike many – I think that’s a healthy position to be in… but I am in the minority.

Interest Rates will Rise One Day

For the past few years, property speculators have cheered the RBA’s to drop rates to just 1.5% in nominal terms (ie zero or below in real terms).

And the longer interest rates stay low – the more the property party rages.

For now, it’s fair to say Aussie speculators feel “rich”. As I say, the average Sydney property is now worth around $1.0M (assuming you are within about 20km of the CBD).

And typically, that feeling of paper wealth flows through to spend throughout the economy.

Over 60% of Australia’s GDP is based on consumer spend (typically with money people don’t have on things they don’t need).

I often like to quote former Fed Reserve Chief – Paul Volcker – “if you hand someone free (or very cheap) money on a platter – they will generally take it”

And yes we have!

Low interest rates make it easier for us to borrow more… take a look:

Annual Growth in Housing Debt

Using data from the ABS (here) – we see how fast housing finance is growing year on year.

At its peak in 2010 – housing debt grew over 30% in one year.

And then in 2014 – this figure almost repeated.

It’s a terrifying pace in any sense… however it’s only possible due to one thing: low interest rates.

Do you think we would see the same growth if retail rates were say 8% or more?

I don’t.

You see, when we reprice risk (ie what interest rates are) — we give ourselves a false sense of what we can afford.

For example, instead of choosing to pay back $800 on the average monthly mortgage, we might only elect to pay $600 because that’s what interest rates tell us.

And that’s more money to spend on “stuff”.

Our hope (of course) is the capital value of the property keeps rising (in turn boosting our equity).

All good in theory… 

Government Budget Impact… 

Rising interest rates will hit speculators hard… but that time could be at least two or three years away.

We don’t pretend to guess exactly when… instead we simply watch the price action in bond markets (eg the US 10-Year).

The more they fall… the higher rates will go.

And whilst I feel for Aussie speculators in future years (most have no clue what’s coming) — I am also thinking about the impact on the government budget.

Think about it…

Today our tax claims on investment property are $3.6B per year — at a time of historically low interest rates.

The biggest portion of those claims are opposite the interest expense (ie not insurance, water rates, management fees and building / capital works depreciation).

So what happens when (not if) interest rates rise?

Obviously that figure which dramatically rise.

For example, thanks to the current policy, it’s foreseeable that tax claims will soar well above $4B when we see rates start to tick higher… which in turn will remove billions of dollars in lost tax income.

What then?

Forget falling property prices – Houston we have another problem?! 

1.3M Aussies Claim Tax Offsets 

There were 1.3M Australians who made a claim on negatively geared property last year.

There’s a good chance you were one of them.

To be brutally honest – Australian taxpayers are subsiding the private wealth of negatively geared property owners.

And sadly – that’s a model which is encouraged (at least by 238 of our politicians!)

As I mentioned in the preface, that’s billions which could have been better allocated. As I say, things which will shape the future of our economy like education, health and infrastructure.

As an aside, the people who really make me laugh are the ones who “bang the table” about the importance of these things… but also negatively gear property. I digress…

So when (not if) retail interest rates double to say 8% – what then?

Well logic tells me the biggest tax rort of all time (because that’s what it is) is set to also double. For example, instead of today’s $3.6 billion in rental losses — it will be closer to $7.2 billion.

Net-net – there’s another $2B lost in investment which could have been allocated productively.

Government Spin…

I am yet to meet anyone who trusts one word of a politician… and why would you?

Most lie to serve their own purpose. Left, right and in the middle – they are all the same.

Today, the spin we hear from these folks is everyday households are major beneficiaries of negative gearing. Right?

Well that’s what ScoMo recently told us…

For example, they argue that by enabling this, it allows for rental prices to come down due to more investment property being available.

Well not according to the data:

Sydney Rental Prices

According to data from the ABS – rents appear to be increasing at a much faster rate than inflation.

Furthermore, recent research by the Grattan Institute has said the biggest beneficiaries of this rort are high income earners; ie surgeons, anaesthetists and lawyers.

Nurses, teachers and other common workers are not enjoying the same gains as these folks.

And based on the ABS chart below — the acceleration of this (ominous) trend looks set to continue 

I say that because there is strong correlation between the annual growth of housing finance and the annual growth of house prices six months later…

Funny isn’t it…

It wasn’t that long ago where investment finance was only 35% of all housing finance versus 65% owner occupier. Today it’s almost 50/50…

Well played… 

Putting it All Together…

Recently the government hit the banks with a new $6B tax on their liabilities.

It was more short-sighted policy from the government (more centred towards vote winning)

Banks are an easy target… no-one likes banks (or bankers).

When I saw this policy announced – the first thing I said was banks will just simply pass that on with either (a) higher rates; and/or (b) greater fees.

Sure enough I was right.

Either way, banks are not going to pay the tax. But you will!

On the basis interest rates are raised – then watch the negative gearing claims (ie tax offsets) increase as well.

Here’s what the government should do:

Start phasing out negative gearing with a view as to when it’s removed all together.

Data has shown us that:

  • it’s done nothing to lower house prices;
  • it’s done nothing to improving rent affordability;
  • clearly favours higher income earners; and finally
  • costs the government in excess of $1B per year in lost receipts (which will only increase as interest rates climb).

So why persist with it?

For the purpose of clarity — I am not saying that negative gearing is the only reason for housing unaffordability (ie hot Chinese money and record low rates are the two primary drivers) – however it’s not helping.

Wake up Australia. Get rid of it.

Sometimes the best decisions are not always the most popular.

… trade the tape

When investing in shares, you can lose you some or all of your money. The potential gains on my blog are based on investing in Australian and US markets and don’t include taxes, brokerage commissions, or other fees. It’s important you seek independent financial advice regarding your particular situation. For any investment, never invest more than you can afford to lose, and keep in mind the ultimate risk is that you can lose whatever you’ve invested. If in doubt – always seek independent financial advice.

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