Challenges for the property market ahead
The Reserve Bank has belatedly acknowledged the damaging impact of the banking royal commission-induced credit squeeze on the residential property market.
Both investor and owner-occupiers are expecting further price falls, adding to market uncertainty and falling auction clearances.
Potential purchasers are being deterred by the difficulty of obtaining sufficient loan finance to complete their transactions even at today’s lower prices. The most serious obstacle is the detailed scrutiny of purchasers’ expenditure commitments and lenders’ assumptions about future interest rates.
The good news for existing borrowers is that a significant increase in official interest rates is not imminent and there’s even speculation that the struggling property market could result in a rate reduction to help stabilise the economy.
The prospect of major changes to negative gearing and capital gains tax rules under the next government is also worrying potential investors.
Even though the proposed changes will only apply prospectively to new investors, there’s not been the expected jump in investor demand and related borrowing to take advantage of the current negative gearing and capital gains tax rules while they still apply.
New investors now must cope with stricter borrowing requirements and obstacles that limit access to and charge higher interest rates on interest only loans. Even when adequate funding is available, investors face uncertainty about how the proposed 50 per cent increase in the capital gains tax on new investments will affect future property prices.
The proposed removal of the negative gearing tax benefits on future purchases of existing properties won’t have the severe impact on property investors that some critics suggest. The annual losses will still be available as a future tax deduction reducing capital gains tax payable.
The proposed 50 per cent increase in the capital gains tax rate by reducing the inflation discount from 50 to 25 per cent is a more serious concern. It will eat into the profits needed to compensate for owning an investment with a very low or negative annual yield. Higher taxable capital gains assessments will also increase the marginal tax rate applicable to the gain especially for long term investors because gains accruing over several tax years are taxed as a lump sum in one year.
The current 50 per cent exemption of gains from tax favours investors realising large gains quickly. This is not the typical property market experience where investors purchase assets which they hope will steadily appreciate over a relatively long period of time.
Overall, the combination of tighter lending standards and concerns about the impact of potential adverse tax changes are contributing to a weakening property market. They could even alter the attractions of investing in property that has always contributed to Australian wealth creation.