Distortions. Negative gearing changes a gift for investors

Jim Chalmers’ budget did the economy a favor by removing policy distortions from negative gearing and CGT cuts, he writes Michael Pascoe.

You’d never guess it from the usual suspects’ headlines, but Jim Chalmers’ budget does retail investors a big favor by forcing them to rethink the sacred cow status of residential real estate.

Yes, Virginia, home prices are up. No, Virginia, this doesn’t mean homeownership is the smartest or foolproof way to build wealth.

Every headline denouncing the budget’s impact on resistance speculation, every homeowner whining on TV, every Liberal politician declaring the end of aspirations goes a little way in countering the power of the massive real estate industry and our cultural and media biases that elevate investment properties above their relative value.

If a love of bricks and mortar runs through your veins, a strong love for illiquid assets, huge transaction costs, maintenance, rates and land tax, do this. As long as you buy a new one, nothing has changed.

But the truth is that a sensible share portfolio, combined with the discipline to reinvest dividends, outperforms residuary investment properties and does so with much less effort and much more flexibility.

Big budget hopes buried in media hysteria

The best hope for this budget is that it will trigger a reassessment of investment options and eliminate the distortion that occurred after Howard and Costello adopted the Ralph Report’s recommendation of a 50 percent capital gains tax cut.

Ralph hoped the CGT gift would encourage investment in productive assets that are bought and sold more frequently, but a bunch of estate agents and our property-obsessed media have hidden cuts in higher tax rates rather than profits.

Amid the AFR’s overwhelmingly negative take on the changes at the heart of the budget and being left at the bottom of a term John Kehoe’s story was:

The analysis, published alongside the budget, found that in the 25 years since the deduction was introduced, the share of tax returns declaring dividend income has fallen by almost 20 percent, while the share of those earning rental income from investment properties has increased by more than 10 percent.

Stocks do better than property

This suggests that many people are shortchanging themselves by jumping on the homeownership bandwagon at the expense of better-performing equities.

While certainly talking about his own book, Sydney stockbroker and financial advisor Mark Gardner put it more clearly on Livewire:

“The government didn’t just change the tax rate. It removed the crutch from under the laziest investment strategy ever invented. Twenty-seven years of asset allocation were built on a political accident. It’s over. For investors willing to think clearly, this isn’t a crisis. This is the first honest market Australia has had since 1999…

“Any approach that works solely because of a tax concession is a habit, not a strategy.

The financial planning industry has built empires on this habit under the guise of long-termism. The half-truth used to justify inertia for decades is “Time in the market beats market timing.” Remove the advantageous tax provision, the entire thesis needs to be re-examined.”

Dinner party investing myths

Gardner favors more aggressive investment products and is therefore not a big fan of passive stock investing, but saves his sharpest moves for resistance:

“Housing investment in Australia has never been about rental yield. Two to three per cent gross is noise, not income.

“The whole trade has been a leveraged bet on two policy settings remaining intact at the same time: negative gearing and CGT relief. Half of that equation has been removed. Yes, negative gearing has survived. But those two settings worked together. Remove one and the inefficient property account looks a lot less smart than it did at every dinner party in 2021.”

“People who own five investment properties yielding 2% in suburbs they’ve never visited and tell themselves they’re savvy investors, they’re not. They’re addicted to politics. The budget just sent them a bill that always comes in the mail.”

Chancellor of the Exchequer Chalmers lost his way a bit with Insiders when he tried but failed to explain how the changes would encourage more money into the stock market, falling back on the idea that “removing distortion” would reverse the tide on property investment over the past quarter-century.

But distortions continue

In effect, it created a distortion by eliminating negative gearing on existing housing while continuing to allow it for all other investments. As the government has explained, this is primarily aimed at encouraging new housing spending, but in a rational market it should also encourage equity investment.

The education problem is that a large portion of the population is happy to borrow large amounts of money to buy housing, but does not seem happy to buy shares. Our banks are happier to lend money for real estate investment (such easy security) and apparently do so cheaper than margin loans typically intended to build a portfolio.

However, for those who have equity in their own home, it is possible to negatively affect the shares by borrowing at the mortgage loan interest rate, especially the cheapest one.

A typical stock portfolio offers a much better return than residential real estate, especially when backed by franking loans. Capital gains comparisons are thrown around, but cheaper transaction and maintenance costs make a clear difference, let alone the challenges of property ownership.

As senior consultant and author Peter Thornhill regularly says at conferences, Woolworths never called him in the middle of the night about a roof leak.

The Treasury makes even bigger bets in favor of shares that outperform housing under CGT indexation, but I take some of this with more than a pinch of salt.

Ditto the Treasury’s rather pessimistic view of the budget’s impact on housing supply. I suspect economists are underestimating the real estate and banking sectors’ interest in encouraging new housing investment, using the psychological appeal of bricks and mortar to Australians and the other distortion introduced by Chalmers: the 50 per cent CGT rebate option reserved for entirely new homes.

This builds on the previously reported lived experience over the last two and a half years in Victoria, where increased taxes on homeowners have seen higher housing completions, more FHBs and lower house price and rent increases than other states.

Housing crisis. Will Labour’s ‘fantastic’ housing budget fix housing?

But if you were the Treasurer and you took your department’s forecasts seriously, they would reinforce the idea of ​​increasing public housing spending as the only way to get closer to the government’s new housing target.

Victims of political crimes

I reiterate from previous efforts that what should be the budget housing headline is that we spend $7 billion this financial year and $7.4 billion in the new financial year on Commonwealth Rental Assistance – effectively subsidizing landlords for the 1.4 million tenants who would otherwise be unable to pay the asking price.

The lives of the victims of various governments’ housing policy crimes will not be changed by the CGT and negative gear changes.

As for the opposition’s response, Angus Taylor promises to do even less for people who shouldn’t be in the broken private rental market. Labor’s promise to scrap the Housing Australia Future Fund will further reduce Australia’s inadequate social housing rate.

Chalmers’ Budget seeks more productivity and less rent