In 1027, King Canute stood by the seashore and commanded the incoming tide to halt. Of course, the tide ignored him and he ended up with wet feet. As legend has it, he leapt backwards, saying: "Let all men know how empty and worthless is the power of kings." Contrary to popular perception, the wise king was not showing off – he was demonstrating to his subjects the limit of a king's power.
This is a perfect analogy for the current hype about making housing more affordable for first-home buyers. It simply can't be done. It's ironic that the catalyst for the global financial crisis was US President Bill Clinton's idea that housing should be available to everybody. It started with a boom as the American property market became overbuilt with loans being offered to everybody, irrespective of ability to pay. It finished with a bust whose reverberations are still being felt around the world.
![Policies to help first-home buyers can backfire.](/web/20161107212327im_/http://www.smh.com.au/content/dam/images/g/s/d/m/3/g/image.related.articleLeadwide.620x349.gsgzh1.png/1478222234221.jpg)
But the global financial crisis was more than a bust. It triggered collapses in stock markets everywhere, and interest rates around the world falling to historically low levels as central banks tried in vain to stimulate their economies.
Australia was not immune. But what was different here was a growing attack on our superannuation system by many politicians, and so-called independent think tanks.
So we faced the perfect storm. The average Aussie investor had lost all faith in the stock market, they had been scared off superannuation because of all the adverse publicity and threatened changes, and knew that earning a piddling 2 per cent in the bank wasn't the way to go long term.
Consequently, they went for the property market. And as interest rates fell, making mortgages more affordable, prices started to rise and, as always happens, the moment any asset class starts to rise in value everybody wants to jump on the bandwagon. Yes, that made it tougher for first-home buyers but historically every initiative by government to make housing more affordable has simply raised home prices, because more buyers are attracted to the market. Think first-home owners' grant, and stamp duty concessions.
Labor's policy of restricting negative gearing to new homes was deeply flawed. It would have pushed unsophisticated investors into new property where the profit has already been made by the developer, leaving the established market wide open for savvy investors who understand that the way to make money in real estate is to buy a rundown property on a good block and add value to it. The irony is that the well-heeled will be able to use the money they can no longer contribute to superannuation as a deposit. This will make the property positively geared from the outset.
To make matters worse, we are once again being subjected to calls to end negative gearing on the grounds that it is nothing more than a tax lurk. The reality is that in this environment of low interest rates, negative gearing is hardly a tax saver.
Let me conclude with an email from Philip who sent it to me in the interests of a rational debate about negative gearing.
"I purchased an apartment in October 1987 borrowing 100 per cent of the purchase price using my residence as security. The taxable loss was $7000 a year so my tax refund was in the order of $3000 a year. Three years later I paid it off when rates hit 17 per cent. Total tax saved over those three years was about $10,000. After paying off the loan it was positively geared and I was paying $2000 in tax on the net rents.
"The property has positively geared for the last 25 years. Current net rent is $6000 a year and at my marginal tax rate of 32.5 per cent my tax is about $2000 a year. So having gained a net tax benefit of about $10,000 in the late 1980s, I have since paid about $50,000 in tax.
"The value of the property has risen substantially from my purchase price of $58,500 to a current value of $320,000. But when I sell I will be liable for capital gains tax of $30,000.
"Since 1987, I have enjoyed net tax refunds of about $10,000 but have subsequently paid $50,000 in income tax and will shortly pay another $30,000 in CGT. The government has made a significant net $70,000 benefit from my investment risk and the subsequent good capital growth will almost certainly eliminate my ability to claim a pension in retirement. This sounds like a great deal for the government to me."
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: noel@noelwhittaker.com.au
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