It’s been a very long time since we had a property crash in Australia

Real estate expert Louis Christopher from SQM Research says the odds of a slow down in the property market have increased for the second half of this year. But it would take a sharp rise in interest rates, unemployment or supply to start a correction.

Last week in Talking Finance Louis highlighted budget changes to the rules of depreciation for property investors. After having a closer look at the wording, he’s back this week with more details.

Louis Christopher tells Alan Kohler that the changes mean you can’t claim plant depreciation on a second hand property, and it might even affect new properties.

Louis, you started telling us last week about the depreciation changes. How big a deal do you think it is?

I believe that the new depreciation measures are significant as they massively reduce the ability of property investors to make deductions on their investment property, thereby reducing their ability to negatively gear. Just looking at the exact wording the treasurer used last week, Scott Morrison said that from 1 July 2017, the government will improve the integrity of negative gearing by disallowing deductions of travel expenses, which I think the media has been focusing on. And for properties bought up today, the government will also limit plant and equipment depreciation deductions to only those expenses directly incurred by investors.

So what was happening prior to budget was that … Alan, if I sold you a property which I did a recent renovation on, say to the tune of $200,000, and there was a lot of plant and equipment I did as part of that renovation, when you bought it, you could continue to claim that the depreciation benefits on that plant and equipment. Now with these measures, you can no longer claim those depreciation benefits and potentially based on the wording that’s being used, if you, Alan, decide to buy an off-the-plan development or a newly constructed property offered by a developer, you can’t even claim the plant and equipment depreciation in that new property. We’re trying to get clarification from the government on it. They have not clarified that point yet. We’re hoping it will not be as draconian as that, but it potentially could be.

What if, when you bought a property, either a new one or a recently renovated one, you bought the plant and equipment – that is to say, the stove and the air conditioning and all that stuff – separately, so that you did a transaction with the vendor for the property that didn’t include the plant and equipment and then separately, you bought those things from them on a separate deed?

Good point, Alan. I think the ATO is planning to create rules, taxation rulings on that so that you cannot actually even do that. I think they’re working to that because I think that’s already been put forward as a workaround, and the answer is no, we will cover for this scenario.

So you obviously think that there’s quite a lot of deductions that are claimed in this area. Would you call it an attack on negative gearing. Presumably you don’t think it’s as big an attack as perhaps capping it in some way, but can you give us some sort of quantification of what you think it does to negative gearing deductions?

I’ve run some schedules which we put up on our newsletter on the scenario of a $500,000 property. Now, if it’s a new property, on a $500,000 property, the normal depreciation allowance you get out of plant and equipment on year one is to the tune of about $700,000. Now that does drop away because certain planted equipment items such as a fridge or an air-conditioning unit will have a useful life of less than, say, five years, so it does drop away eventually. But in the first five years of a new property’s life, roughly the average type of plant and equipment depreciation you can claim usually runs to the tune of about $20,000. So it’s not immaterial, it’s quite relevant and taking this depreciation allowance away will effectively mean that many, many thousands of properties out there which were effectively, after tax, cash flow positive – they’re no longer cash flow positive if you buy into those properties. Keeping in mind of course, this is being grandfathered, so if you already had one of these properties then you’re not affected, other than potentially a new buyer might demand some type of discount for a lack of depreciation, but for new property investors, we think this is significant.

Do you think that this is a housing affordability measure or a revenue raising measure, or perhaps a bit of both?

Arguably it’s probably a little bit of both. The government has basically said, “the savings on the forward estimates combined with the travel expenses savings will mean a total combined saving of about $800 million to the budget.” I mean, that’s not massive, but neither is it small. On the affordability side, it falls into the argument that if we take away negative gearing, that means there’ll be less property for investors in a market, pushing up prices, and potentially, that could play out. We do think there will be less investors in the market, but what will be required is for the first time buyers to replace those investors. Otherwise, we may well have a negative impact upon affordability later on, because if there’s less buyers overall in the market, it is likely the developers will not be able to get as many projects out of the ground, and that could have negative ramifications for rent in about a year and a half to two years from now.

The other two housing measures, particularly for folks on housing affordability, were the measure to allow first time buyers to take some of their super for a deposit, and also the measure to allow downsizers to put 300,000 bucks of the proceeds into super. On a net basis, do you think that’s going to be positive or negative for the housing market?

I think the additional superannuation contribution scheme that’s been brought in is going to be neither here nor there for affordability. It won’t push up prices. Just keep in mind that buyers have got to save that money first before they can go out there and put a deposit on, so there won’t be any immediate impact upon the market itself, and I think the additional tax savings were in senior empty nesters to downsizers – actually a very good measure. I think it will bring in some stock into the marketplace. Just keep in mind too we don’t think there’s that many empty nests to the point where we’re going to see a downward trend in prices, but I think it will free up some stocks overall. I think that that is a good measure.

And what is your assessment of the market at the moment? Particularly in Melbourne and Sydney, is it tipping over?

No, our evidence is showing that the market is still moving ahead. When we look at auction clearance rates it’s still very strong in the high 70s to an early 80s for both capital cities. That’s implied in past double digit capital growth. When I look at days on market in terms of how long it’s taking property to sell, it’s still very low numbers for both those capital cities. When I look at the official price indexes of, say, the Australian Bureau of Statistics or the Australian Property Monitors, they’re still recording strong results albeit there’s a bit of a lag there as we all know. But then when I look at other leading indicators such as housing finance approvals, asking prices … they’re all heading north still, so we’re not seeing, in our view, a slow-down yet in those two capital cities.

Are you getting worried about it?

I think the odds have increased that there may well be a slow down the second half of this year. I think if these new measures are passed, combined with potentially the banks coming into the market again and passing on the new bank levy in the form of maybe higher interest rates, that could be enough to tip the market. I’m not expecting any type of crash at all, but the odds have definitely increased for a slowdown in the second half of this year.

It’s been a long time since we’ve had a housing crash in Australia I guess, hasn’t it?

It’s been a very long time. Just keep in mind that it’s been a very mixed housing market, so there have been regions which have recorded crashes, the most recent one has been the big mining downturn which has hit a lot of mining towns. Karratha for example has seen a 70 percent fall in prices so they have some experience in crashes. The Gold Coast was the previous one between 2010 and 2013 where prices came off 25 percent. But for a capital city, there hasn’t really been a massive correction in a long, long time.

I guess you need something to spark that, such as a big increase in interest rates or a recession.

Agreed. I think the triggers are an aggressive rise in interest rates, a sharp rise in unemployment, a massive oversupply situation. I think those are probably the three triggers out there that would cause a major correction. The one thing though that’s been going on which makes us more cynical about any type of major crash in say Sydney and Melbourne is a very strong population growth rate. Sydney has been now expanding by about 95,000 people a year. Melbourne’s been rising at 120,000 people a year, and Alan, you may recall that this time last year there was a great concern about a situation in Sydney and Melbourne. Well that hasn’t materialised because of the very strong population growth numbers absorbing all the stock. So while it’s not impossible to see a crash in those two cities while we’re having such explosive population growth, I think that makes that scenario more difficult to play out.

One other measure or series of measures in the budget that weren’t presented as housing affordability measures, but in fact in my view might be, and those are the regional rail expenditures such as upgrading the Geelong rail line and the north-east Victorian rail line and I think there’s a few in Sydney as well. It could potentially bring regional cities and towns into commuting distance, or viable commuting time. Do you think those might actually take some pressure off the housing market as well?

I think long term, it’s great that we’re encouraging development and more population in our regional townships. It needs to happen because there’s a lot of strain on the capital cities right now in terms of the required infrastructure to meet the population boom. We need to see the growth of regional townships occur, and additional transport infrastructure such as the ones you’ve just mentioned, and other measures to help these regional townships economically are a great thing and will help housing affordability. People may not be aware of this, but the growth of regional townships in the United States in the 1800s in particular was one of the main reasons why the United States has been so economically successful over the last 300 years.

In fact, do you think there might be some investment opportunities arising from this? A mate of mine said that what he wants to do is buy a house or investment properties on the outskirts of Geelong on the upgraded train line. Do you think that’s a good idea?

It’s not a bad idea long term. I think investors need to keep in mind that one of the risks in regional townships is the volatility of the housing market. You see a lot more variation in price changes, so when the times are good they’re great. When the times are bad, they’re absolutely miserable, and an investor can really get burnt, especially if they’re bought at the top end of the market and they’ve geared up like most property investors do. It can really hurt you, and there’s no doubt there’s been property investors who bought at the top of the mining peak in towns such as Karratha and other townships which have now basically lost everything.

Yep, there’s cautionary tales there. I appreciate it Louis, thanks very much.