Abolishing negative gearing won't solve the problem

Topics: Housing affordability, Negative gearing, Supply and demand
Author: Jeremy Sheppard
Date: 25 March 2015

I'm a property investor and I'm OK with the abolishment of negative gearing - so long as it is done carefully. Too often the government mucks with things and there are winners and losers. But if the plan is phased in very slowly, it should have minimal impact on my investing.

And that's my point - minimal impact. Getting rid of negative gearing will not solve the problem. If the problem is high prices, then getting rid of negative gearing won't solve it.

What causes price growth?

Prices are determined by the forces of supply and demand. If your opinion is that prices are too high, then in your opinion, demand has exceeded supply for too long.

As a property investor I want to capitalise on cases where demand exceeds supply to get rapid capital growth. I'm looking for markets with a high demand-to-supply ratio (DSR).

But a high DSR doesn't last forever. For example, nothing subdues demand like a long stint of strong price growth. With demand subdued, the market balances back to a DSR close to the long term national average.

Feedback loop

In a free market, developers supply property to meet the demand. Developers are more likely to build new property in areas where demand is high and supply is low. When supply catches up, the developers back off since there is less profit or more risk.

This all happens naturally without the government needing to stick their nose in. A free market reacts to the changing forces of supply and demand. It has its own built in feedback loop.

What would happen?

If negative gearing was abolished overnight, a whole bunch of investors would exit the market. Developers would suddenly lose a significant chunk of customers. Some would go belly up. Some developers would simply scale back their operations.

The sudden abolishment of negative gearing would cause mayhem. The end result would be a crash in property prices. Some first home buyers (FHBs) and renters, who nearly had a deposit ready, now have enough and jump in buying cheaply.

So there would be winners and losers overnight. Investors and developers would be the losers, while FHBs and renters would be the winners. But will this wealth reassignment last into the future?

Problem solved?

Not really. With investors leaving the market and cheaper prices, developers also leave the market. With less development, there is less supply.

But none of that has stopped people from making babies. And with lower prices, Australia now looks even more appealing to immigrants. The abolishment of negative gearing won't dampen population growth.

So what we end up with very quickly is limited supply and high demand again. And we all know what that causes.

Supply and demand will always have its way. You can muck with it for a short time, but it will always win. You win a battle, maybe win some votes, but you end up losing the war.

Phase it out

By removing negative gearing slowly, you end up with the same result, but you get there slower. It gives time for the forces of supply and demand to adjust. So with less swings of imbalance, you have less obvious winners and losers.

But there is still no reason why prices would be cheaper. Instead of an instant drop, halt and then resumption to growth, there would be subdued growth.

But during the period of subdued growth you'd see rental prices increase faster than average. Investors would need a higher proportion of income from rent to cover the cost of ownership. What an investor would lose in growth, they'd gain in rent.

All you're doing by removing negative gearing is shuffling how the dollars come in. But you're not increasing the supply of accommodation nor reducing the demand for it. So prices remain high.

Don't muck with it

There are trouble-spots around the world with cheap property prices caused by economic instability, war, corruption, natural disasters or civil, political or religious unrest. Australia is quite literally one of the best places in the world to live. So obviously property prices are going to be high here. Just come to peace with it, don't muck with it.

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