The Valor Blog.
Investment News and Views, Direct from Our Team.

The great property bubble part 1: The wrong incentives

The current incentives in the property market in Australia are absolutely ridiculous and they are likely to cause significant pain in the coming years.

Negative gearing is a bit like the police encouraging drink driving by breath testing all cars going out of the city on a Saturday night and booking the sober ones!!!

If you are conservative (one of the sober drivers), you get taxed on your income at up to 48.5%. You then save that money in the bank and are taxed up to 48.5% on the money you make in the bank. Not only does the government double tax you on your money, once you have shown a regular amount of interest for a few quarters, they make you pay the tax upfront!!!

The opposite to this is the bullish property “investor” (the drunk driver). This person gets to prepay his interest and get a tax deduction upfront by losing money every year on his investment. They can then offset that losses against income which has nothing to do with the losses they are making. So lets simplify this. The government is encouraging people to go out and lose money. Let me repeat that – the government is encouraging people to go out and lose money. Once more for the dummies in less words – government encouraging losing money. If this isn’t the most ridiculous concept of all time, I am not sure what is?

The typical property investor (drunk driver) who is losing money on their “investment” would argue that without them rent would be much higher. This argument is just daft. There are dozens of countries around the world which don’t have negative gearing for property which have significantly lower rents than Australia. Negative gearing on new properties is perhaps rational. It would increase supply of housing and lower house prices. Negative gearing on used houses is by definition a circular logic argument. Would be buyers become renters because “investors” push prices out of reach of would be owners. There is no increase in supply of housing and so there is no net benefit to the economy apart from pushing used house prices higher. Increasing asset prices would usually lead to an increase in consumer spending, however when housing debt is growing at triple the rate of wages, the benefit to the economy is a net negative. Add to this $8 billion of tax minimisation and there is a further drag on the economy because someone has to pay another persons tax losses. The higher wages required to purchase a place to live lead to Australia becoming uncompetitive for about everything because our wages are some of the highest in the world.

We will be writing numerous articles about Australia’s great property bubble over the coming weeks. We will highlight why the risks are increasing and why the storm clouds on the horizon are threatening.