Episode Details

If the ALP wins the election in May and ban negative gearing on established property (as proposed), does that mean property is no longer a good asset class to invest in? The answer is no, if you do it right. In an environment of no negative gearing, capital growth becomes even more important.

The razzle dazzle of tax savings is too tempting for some people to ignore

Too many people have been seduced by tax benefits when selecting a property investment. Potential tax savings distract investors’ attention away from an asset’s poor quality (lack of fundamentals). The problem is that you have to live with the asset’s quality long after the tax savings have evaporated. And the asset’s quality will dictate whether you will enjoy adequate investment returns (mostly in the form of capital growth) or not.

Tax benefits can come in two ways.

Steer clear of depreciation benefits

Firstly, there’s ‘depreciation’ which is a measure of the reduction of a dwellings value over time. If you are the first owner of a property, you can claim a depreciation deduction in respect to the building and its fittings and fixtures. The problem with depreciation is that it actually happens. It’s like driving a new car off the lot – they say it immediately depreciates by 10%! A new building will depreciate substantially in the first decade of ownership. Therefore, for the investment to work, the land value must appreciate at a much faster rate to (1) offset the building depreciation and (2) contribute to the property’s overall value appreciation (if there is to be any). The problem is that new-build properties typically have a smaller land value component so that doesn’t happen. The existence of a depreciation benefit is a red flag that a property isn’t investment-grade and therefore should be avoided from an investment perspective.

Negative gearing should help you generate capital gains

Amazon is worth over $USD830 billion according to the stock market. However, it makes $USD3 billion profit per year – which is not a lot for a company that is worth so much. Therefore, the reason that people invest in Amazon is because they think that the businesses will be worth a lot more in the future. Amazon shareholders are clearly investing for growth, not income (it’s never paid a dividend to shareholders).

The same concept is true for investment-grade property. Smart investors don’t invest for negative gearing. Negative gearing is merely a positive consequence of their investment. Smart investors are targeting capital growth so that whatever they lose in income (net loss after tax benefits) will be dwarfed by the amount of capital growth in the long run. However, some investors have incorrectly focused on (or been seduced by) tax savings when making investment decisions. In reality, this is an unwelcome distraction from what is ultimately going to make-or-break an investment in the long run.

In the future, you’ll have to be more picky

If you agree that the primary reason we invest in property is for capital growth, then, when considering any prospective investment, we must consider its future capital growth prospects. That is, we must be sure that a property’s future growth will more than offset any income losses to the extent that the net investment returns are still very healthy.

The existence of negative gearing means that an investor needs a lower amount of capital growth in order to generate an adequate return. However, if negative gearing was to be abolished, I would argue that all investors must become even more