Capital gains: risks rise for residential property investors

If residential property investors are not losing sleep already … they will be now.

Housing prices have risen unevenly across the nation.

If residential property investors are not losing sleep already … they will be now. The underlying argument for investing in residential property has been hit hard in recent weeks and it could get a lot worse before the year is out.

Property is bought for two reasons — income and capital gain.

Here’s the income scenario: In most places most of the time the notion that property provides reasonable income is already under serious pressure — rental yields especially in Sydney and Melbourne are dismal.

However, property investors have continued to plunge into this asset class because very low rates made investing in this “big ticket” asset class possible and the miserable net rental income (income after all expenses are paid out) could ultimately be offset by a healthy profit on resale.

The only problem is that gross yields remain poor — 4.5 per cent at best in the major cities. While net yields — when you take out the rates, the insurance and a host of other expenses — are often less than 3 per cent.

While this flat income picture continues, low rates for property investors are gone — this week the Commonwealth Bank raised its interest-only investor loan rates (a favourite among investors seeking negative gearing tax breaks). At CBA standard variable rates for investors are 5.56 per cent and interest-only rates now 5.68 per cent — just for the record that interest-only rate is nearly four times the official cash rate of 1.5 per cent.

As Luci Ellis, an assistant governor of the RBA, reminded us this week: “The housing sector is especially sensitive to interest rates.”

Here’s the capital gains scenario — in Sydney and Melbourne prices continue to move strongly higher (10 per cent to 15 per cent per annum).

But it is only in those cities — in the inner-ring suburbs — and only for houses. Apartments are not getting this capital appreciation.

Every single indicator — contemporary and historical — suggests residential property is at a peak yet investors have stayed positive because they believe the capital gain will ultimately save them.

But this week we had reports from Canberra that elements within the Coalition are again campaigning to lift capital gains tax.

As a property investor the twin obstacles of a potential flattening of price growth and a potential raising of capital gains tax on that threatened price growth are now squarely on the agenda.

But wait … there’s more. Once again the banks are readying to choke-off the residential property market growth with a sequence of moves on the financing of property investment. Specifically, the chances of getting a new loan — or refinancing a loan — are greatly reduced with a swag of cutbacks in previously generous loan terms offered by key banks — notably the nation’s biggest lender, the Commonwealth Bank.

Buyers pile in

So why, you ask, was there an uptick in the volume of property investors over recent months?

Well it was not because the prospects for this asset class have improved and we know it was not due to cheaper finance or indeed because the banks are being more accommodative (they are tightening their terms).

Rather the explanation regularly put out is that it was due to an assumption that the new super rule changes looming on July 1 have pushed retail investors back into property.

Some of that swing towards property may indeed have been as part of sophisticated planning around the forthcoming $1.6 million balance “cap” for super, more likely though in many cases it was a knee-jerk reaction to the shock announcement that the government had actually managed to pass the super reforms.

But here’s the thing: The fact remains that under the new rules a couple can have $3.2m in super and pay no tax in retirement (that’s $1.6m each) and on top of that each individual in the couple is allowed (at minimum) $18,000 tax-free personal income outside of super income each year.

With that in mind perhaps the swing back into residential property investment may have been based on a misunderstanding by some — if not many — investors that super was no longer worth the effort.

Coalition leaders — especially the assistant Treasurer, Mathias Cormann — have explicitly denied reports that the treatment of CGT on residential property may change. The specific suggestion is that the 50 per cent discount you get on CGT if you hold a property for more than a year may be cut — perhaps to as low as 25 per cent.

But can investors actually relax and assume this will never happen? Not one bit! As the budget gets closer in May there will be an escalation of community pressure on the government to “improve housing affordability” — few solutions in this area will make conditions any better for private property investors.

And if the ALP wins power the CGT changes will happen automatically as it is a plank of Bill Shorten’s political manifesto to make this mooted CGT change (cutting the discount from 50 per cent to 25 per cent).

The risks in residential property investment — already high — have just been stretched further.