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Wednesday, March 23, 2016

Rights and Wrongs of Labor's Negative Gearing Policy

Last year I wrote a post on negative gearing (The Politics of Negative Gearing), finishing on this note:
"Despite housing affordability being a hot topic at the last federal election, neither of the major parties had any policy specifically directed at tackling it. Though quarantining negative gearing to new builds or removing it completely would only be one part of a solution to tackle the problem, Abbott has made it quite clear that he's not interested in a sensible debate on the matter. Last month Labor released a discussion paper aimed at informing Labor’s Housing Affordability Strategy (to be taken to the next election). I'd expect that with the right mix of policies directed to tackling housing affordability and the right attitude, Labor might just have an edge that could help them secure a win at the next federal election."
Recently Labor released their policy on negative gearing (along with reducing the capital gains tax discount) and it has been making plenty of headlines since.

For a long time negative gearing has been considered a sacred cow, but it was obvious with housing affordability concerns growing that something would need to change and we are nearing a point where even the 'untouchables' of our tax system may end up being manhandled (if not as a result of this election, then perhaps the next). Sentiment and polls have moved in Labor's favour following their policy announcement, but not yet decisively enough to win them an election.

Sadly some of those who have been campaigning for changes to negative gearing for as long as I have are blinded by the shiny coating of Labor's policy and are not interested in looking under the bonnet at the details.

The subject of negative gearing brings out a very black and white argument from most. Both those for and against negative gearing changes seem content spreading any research they can to support their particular side, without any consideration to the accuracy. For example the Liberal Party was quick to highlight the details from a BIS Shrapnel report and connect them to Labor's policy even though the details modeled were not all the same as Labor's policy. Similarly those in support of Labor's policy have suggested independent modeling from Ben Phillips is a 'slam dunk' in support of that policy despite the fact that it doesn't account for behaviour changes, doesn't consider the accounting impacts (such as carrying forward losses) and doesn't differentiate between the types of income investors negatively gear against (i.e. wage vs investment, so at face value it doesn't appear to model Labor's policy either).

I have tried to take a more objective approach even though I am in favour of changes to negative gearing in order to reduce investor demand in the housing market. We do need to take care when changing the rules which govern our $6 trillion housing market. Negative gearing should only be removed or changed with an objective in mind and it should only be changed if we are confident the legislative changes will achieve that objective. With that basis I present what I consider to be the rights and wrongs of Labor's negative gearing policy (because it's far from perfect).

Firstly, what Labor got right...

Making the first move

Changes to negative gearing are something that have been raised regularly in political discourse, but not to the point where a major political party was ready to take a policy to an election (in recent history). Labor released a discussion paper on housing affordability in early 2015 and now have a policy to change negative gearing (and capital gains tax) to improve the same. Whether you agree or disagree with the policy (or parts of it), there is no question that it is a brave move and Labor deserves applause for taking the issue seriously and being the first to bring forward firm policy for consideration.

Tackling housing affordability

Some may be surprised that I support changes to negative gearing, which essentially results in higher taxes for investors (at least in the short term). I come from a position that government controls essentially all levers affecting the housing market (see Who's to Blame for Australia's Expensive Property?), if that degree of control over the market is to continue (and I would be all for a change to that), then government needs to take responsibility for the outcomes of their policy, such as the reduction in housing affordability and home ownership rates (source).

Click Chart to Enlarge
Abolishing (or changes to) negative gearing isn't a one policy fix to housing affordability, but it will reduce investor demand by removing an incentive and reduce the level of debt they can carry/prices they are prepared to pay.

Click Chart to Enlarge
Secondly, what Labor got right/wrong depending on how you view it...

/ Grandfathering existing investors who are negatively geared

As Jordan Eliseo pointed out in a recent post, grandfathering existing investors is unfair:
..it hardly seems fair to say to 1.3 million Australians that they can keep a tax lurk that will be closed forever more to the remaining 20 million plus Australians, the great majority of whom are nowhere near as well off financially as a large portion of those who will get to keep the sweetheart deal in perpetuity.

If it is bad policy it should be junked outright.
It could also pull forward demand as is highlighted by Eliseo, if the policy is introduced at a future date investors may rush out to buy before the cutoff.

However not grandfathering investors is also unfair to those who've made significant decisions based on the current taxation settings.

Also, it's likely a policy change wouldn't get wide enough support without the grandfathering of existing investors.

/ Allowing negative gearing for new builds

There are well-intentioned reasons for allowing negative gearing (against salary/wages) to continue for new construction. It has the potential to encourage investors to provide and drive new supply. That means jobs and a boost to economic growth.

The downside to encouraging more new residential construction is that many say we already have an oversupply, particularly in the apartment market. Such a policy could broaden the oversupply to other types of housing and/or increase the oversupply of apartments, which I expect would lead to a collapse in prices. An oversupply of property has been one characteristic of other global housing bubbles which have collapsed.

Lastly (but not least), what Labor got wrong...

It will help to repair the budget

Labor's policy document states that:
Two specific tax deductions – negative gearing and capital gains subsidies – are both significant calls on the budget and are growing at a rapid rate.
However, negative gearing shouldn't be seen as a budget boon for reasons I have highlighted in the past:
The reality is that an end to negative gearing for property wouldn't be a huge budgetary boon (as these commentators have suggested). Most advocating for it's removal suggest a 'grandfathered' approach, which means properties already owned by investors aren't affected (until the asset is sold). Even when investors make a purchase (following negative gearing's removal), any losses which would have previously been deducted in the same financial year against other income could be carried forward to claim against future income or profit from the same asset class (property). While it might delay when deductions are made (and some investors may not make a future profit in property meaning it never is), improving the government budget in the short term, it's long term impact would be negligible.
Furthermore, it's likely that over time investors would adjust their expectations and reasons for investing in property. Currently a large number of investors buy for the tax advantages that negative gearing (and other tax breaks) offers. 
It's removal would result in a lower number of investors prepared to speculatively purchase at higher prices knowing that (as it stands now) low yields (& resulting losses) are partially offset by a tax deduction against other income at the end of the financial year (or as they go for those investors using an Income Tax Withholding Variation). Over time this would likely result in a normalisation of rent to price ratios so that fewer investment property purchases would be loss making from the outset.
Other than the carried forward losses and behaviour changes, we also have to consider that Labor's policy doesn't necessarily stop an investor from negatively gearing an established property if they have other income (that doesn't fall under salary / wages) against which they can claim their property related losses (covered in more detail below).

Only stops losses claimed against salary/wages 

Some have tried to claim that negative gearing (as it relates to property) is only those net losses which are claimed against salary / wages, but that is not the case. The ATO makes it quite clear:
A rental property is negatively geared if it is purchased with the assistance of borrowed funds and the net rental income, after deducting other expenses, is less than the interest on the borrowings.

The overall taxation result of a negatively geared property is that a net rental loss arises. In this case, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income (such as salary, wages or business income) when you complete your tax return for the relevant income year. Where the other income is not sufficient to absorb the loss it is carried forward to the next tax year.
Labor's definition and policy appears to only affect those offsetting losses against salary / wage income:
The investor can deduct any losses associated with the investment from their salary and wage income.
&
This will mean that taxpayers will continue to be able to deduct net rental losses against their wage income, providing the losses come from newly constructed housing.
This suggests investors will be able to continue buying established homes and negatively gearing those losses against income other than wages. Granted salary and wages are the largest income item, but there is plenty of other income that property losses could be offset against. Look at this table from the ATO (showing 2013-2014), rental losses are minuscule compared to the other income they could be offset against:

Click Table to Enlarge
Based on the information we have available I am not convinced we can conclude (with certainty) that negative gearing of established houses will reduce with Labor's policy.

It could increase rents in desirable (established) suburbs

Some have made the point that negative gearing won't increase rents because even if the pool of rental housing reduces due to fewer investors (in the established market), these houses have to be sold to someone, i.e. one less investor is one new home owner. They also highlight that increased investor participation in new builds will expand the rental supply.

I agree with those comments and would think it unlikely rents in aggregate increase as a result of Labor's policy, however... while median rents may see downward pressure or a lack of growth, the ability for investors to negatively gear new properties could create a distortion where most of that downward pressure on rents is in the outer suburbs (where the number of rental properties will increase), while inner/sought after suburbs with mostly established housing stock see rents rise as natural attrition of existing established investors reduces the pool of available rental properties. Yes that means an increase in owner occupiers in those suburbs, but those who can’t afford to buy in those suburbs may be left to pay higher rents or be forced to move to less desirable suburbs.


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As you can see, while well intentioned Labor's policy is far from ideal, in fact we can't even be sure it will achieve what it sets out to. Sadly many of those who want negative gearing to go are defending Labor's policy without giving it the careful consideration it needs. Here's hoping that changes as we near the election or if Labor does get into office, then I hope they review their policy and make the changes required to meet an objective of improved housing affordability and a higher home ownership rate.



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Monday, February 15, 2016

Australia's Bullion GST Fraud Still Under Wraps

More than two years after the Australian Federal Police initially reported serious fraud was occurring in Australia's bullion industry we are yet to see any publicised progress on the investigation or action that has been taken.

In July 2014 there was an article from Chris Vedelago which provided details from two civil lawsuits in Queensland's Supreme Court containing allegations involving a number of businesses in Australia’s precious metals market.

The AFP Annual Report for 2013/2014 briefly mentions the operation (Operation Nosean, no follow up is made in the 2014/2015 Annual Report):


An estimated loss to the Commonwealth of $300 million and growing, which I assume suggests the value of Gold funneled through this type of fraud to be in excess of $3 billion (figures likely higher now we're a couple of years along).

A recent Judgment in the Federal Court of Australia highlights another possible case of this fraud, with GST input tax credits of over $40 million claimed (relating to acquisitions of gold from suppliers who were not registered for GST purposes):


The problem with the lack of publicity around this industry fraud is that eventually a large number of private bullion investors/consumers could get caught in the crossfire should one of the companies involved be a retailer who gets shutdown by the ATO.


The ATO reported in a mid year performance report (2014/2015), h/t SilverPete:
GST litigation casework continues to flow from project work relating to cash economy matters and refund integrity issues. Also, there are a steady number of new cases involving inappropriate input tax credit claims made between associates, often in the context of phoenix activity.

Seven new significant cases were received during December 2014. Six of these cases involve similar issues concerning the purported purchase of gold jewellery and subsequent dealings in gold bullion. The Commissioner’s view is that these cases involve sham transactions. These cases will be progressed in the early part of 2015.
It was announced that the ATO would be provided additional resources in the 2015/2016 budget to tackle GST fraud:
The Government will provide $265.5 million to the Australian Taxation Office (ATO) over three years to extend the GST compliance programme. 
While the Government recognises that most taxpayers do the right thing, the ATO will continue a series of compliance actions to make sure honest businesses have a level playing field. This programme will allow the ATO to continue to identify fraudulent GST refunds, under reporting of GST liabilities, failure to lodge GST returns and outstanding GST debts.
Here's hoping the additional funds are used wisely, with those responsible held to account and in the meantime I would recommend if you are buying psychical bullion, you continue to keep your orders to a sensible level in case justice is served while you are mid-transaction:

"Limit the size of any single order with an individual or dealer to an amount you’d be prepared to lose if the deal goes sour." - Bullion Baron

[Addendum]

I found this transcript from an Economics Legislation Committee on the 26/02/2015 which shows Senator John Williams questioned Mr Chris Jordan, Commissioner of Taxation, on the investigation:



I don't know how much detail would normally be shared in this type of committee meeting, but the answers appear evasive to me.

If you can provide any additional information on these investigations, you can email me: bullionbaron@gmail.com

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Monday, February 1, 2016

Bullion Baron's Australian Property Chart Pack

Residex updated their property indices to December 2015 on Friday. I have created some charts with the latest data which may be of interest to readers. Those who follow me on Twitter may already recognise a few of them. Click on any of the charts for a larger size.

Sydney's mental house price growth over the last few years. Is the peak in? I think at the minimum we have a cyclical peak forming (aka: Sydney late 2003/early 2004, expecting perhaps a 10%+ fall in the Sydney median and a nominal peak not being surpassed for 4-6 years), but Australia's expensive property market has not really been tested by a sizable economic downturn, we could see much larger falls in event we had one.


What juiced house prices? A variety of factors, but the RBA cutting interest rates to very low levels certainly didn't help any, you can see the booms follow each rate cut cycle and growth slows or prices correct with each rate hike cycle.


It would seem that interest rates are winning out versus the unemployment rate, Adelaide house prices have risen despite a rising unemployment rate in South Australia.


I wouldn't call Adelaide house prices 'cheap', but compared with Sydney they are looking far less expensive (& the rent vs buy cost comparison isn't looking too bad). This ratio shows we are back at levels when Sydney last peaked. That suggests to me that price growth is likely to be higher in Adelaide (compared with Sydney) for the foreseeable future...


And here is a chart showing the last major cyclical correction in Sydney versus Adelaide's prices since its peak from 2011.


Adelaide house prices have passed their previous peak, while unit prices are still languishing around the same price they were back in 2010.


Sydney's house price ratio with Brisbane shows Brisbane is also comparatively far less expensive.


When comparing Brisbane and Adelaide using a ratio we can see they trade within a much smaller range and the ratio suggests Adelaide is less expensive than Brisbane, though very close to the middle of the range.


Growth in these cities (Brisbane and Adelaide) has trended quite closely with the data that's available.


Likewise growth in Sydney and Melbourne track quite closely. I expect both will see their AAGR (Average Annual Growth Rate) roll over to the downside in 2016.



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Wednesday, January 6, 2016

A Koalaty Bullion Silver Coin For 2016

It's been awhile since I've strongly recommended a particular bullion silver coin on this site, but the last I recall was the 2014 1oz Bullion Silver Wedge-Tailed Eagle. That coin was available for A$29 per coin on release and now sell for well over $40 ($60'ish on ebay individually or low to mid $40's by the roll elsewhere). That is despite a drop in the spot price of silver over the same period. I have since sold the box of those I bought. So here's my next tip... lame jokes aside I think the 2016 1oz Bullion Silver Koala Coin from Perth Mint is a solid 'buy' (provided you pay a reasonable premium, under A$7 per coin over spot).

Many of the sought after, mintage limited Perth Mint bullion silver coins have held their values (or at least cushioned the blow compared with low premium products) even as the spot price has tanked in recent years. An example being the 2012 1oz Bullion Silver Lunar Dragon Coins I bought in late 2011 for circa $38-42 per coin (pre-ordered from various dealers before release), despite spot price falling some 40% lower since then I recently sold some rolls of these for around what I paid. Not a great return admittedly (break even over 4 years held), but still a far better return than on low premium silver bars. I like many of Perth Mint's silver bullion coins as a hedge against spot price downside as premiums increase with demand for the specific coin. Of course like any investment, there are no guarantees that premium holds and you do need to pick carefully.

I have not been that impressed with the koala coin designs from Perth Mint for some time. In many instances the illustration is fine, it just hasn't translated that well into coin from (the below is from 2012):


However, in my view the 2016 design is a cut above any others since 2010:



Furthermore Perth Mint is now limiting the mintage of the 1oz coin to 300,000, this is far lower than the declared mintage of some other recent years:

YearDescriptionMintage
20071oz Bullion Silver Koala Coin 2007137,768
20081oz Bullion Silver Koala Coin 200884,057
20091oz Bullion Silver Koala Coin 2009336,757
20101oz Bullion Silver Koala Coin 2010233,531
20111oz Bullion Silver Koala Coin 2011910,480
20121oz Bullion Silver Koala Coin 2012388,046
20131oz Bullion Silver Koala Coin 2013477,209
20141oz Bullion Silver Koala Coin 2014334,884

The 2015 coin has sales recorded to the end of 2014 of 96,297, obviously that will see a substantial jump once updated with more recent numbers. I would be very surprised if the declared mintage is lower than 300,000, my guess would be somewhere between 350,000 and 450,000.

These coins:

- Have a low mintage
- Sport an aesthetically pleasing design
- Are housed in individual capsules
- Have a quality finish
- Are produced by world renowned Perth Mint
- Come with legal tender status And are priced as bullion coins on release.

With the recent upgrade in facilities at Perth Mint to pump out their new low premium bullion kangaroo coin, this has resulted in higher coin sales (chart via Smaulgld) and ultimately wider distribution which I expect will bring more eyes and investor/collector interest to other bullion coin series they have, such as the aforementioned koala.


I have not purchased any myself as I'm lacking room in my safe deposit box/es, but it's likely to be the only silver bullion I buy in bulk quantities this year if I do so.

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Monday, January 4, 2016

Don't Live And Die Waiting For The Big Crash

I saw The Big Short recently and this quote flashed up on the screen:
“Everyone, deep in their hearts, is waiting for the end of the world to come.” ― Haruki Murakami, 1Q84
But my advice would be not to live your whole life waiting for, planning for, or even hoping for, the next "big crash" (either of the financial system or housing market, arguably the two are joined at the hip in many modern economies).

That might sound odd coming from someone who's analysis, speculation and investments led them to buy a lot of precious metals and write under a handle like 'Bullion Baron'. Some readers may picture me as a nutter with a bunker full of long life food, guns and Gold, just waiting to live out the financial apocalypse 'doomsday prepper' style, but the reality is far less intense.

I'm not saying you shouldn't be prepared for and insure yourself against financial catastrophe, but once you have done so, go out and live a little. The last significant purchase of Gold I made was in late 2014 (after accumulating in the dips periodically in the 6 years prior). I have recently felt comfortable buying a home again in my local property market, Adelaide. I have also been spending a fair amount of time and capital over the last several months working on a new business venture (one reason my posts here have been less frequent) and with the recent news that the Australian government will be incentivising investment in startups I may continue to put money in this space.

In a comparison of renting vs buying (Rent vs Buy: An Adelaide "Cost Comparison" Revisted), the financial burden of buying has fallen substantially over the last half a decade as rents have increased (moderately), prices stagnated and interest rates fell. I still think Adelaide property prices have some tough headwinds ahead, the state economy is still struggling (highest unemployment rate in the country) and prices may yet fall again, but I expect them to outperform the likes of Sydney or Melbourne over the next 5 years (even if that means prices fall less in Adelaide).

Sydney house prices grew far more than in Adelaide over the last 7 years
While I'd agree with many housing permabears, that house prices are high in Australia (it is an expensive market, perhaps even a bubble in some cities/regions), they have also remained at elevated levels (relative to incomes) for well over a decade. Whether they correct back to past levels or not should be of no concern if you are treating housing as a consumption good.
I would never discourage others who want the stability of ownership and are prepared to treat housing as a consumable (rather than an investment) from buying. If you have a healthy deposit (preferably one that will help you avoid LMI), fixed interest rate (or able to service higher interest rates), protect yourself (income protection, cash buffer, etc) and expect to stay in the property you purchase for the long term (until mortgage paid off), then it shouldn't matter what prices do (rise, fall or stagnate). - Bullion Baron
Despite buying a home and investing in a new business, I still think the risks to the financial system are immense and I'm in no hurry to reduce my exposure to one of the assets that I still expect to flourish as financial instability returns.

By the way, I looked up the quote from The Big Short when the movie finished as I was interested to see where it came from and it's context. The book it came from, 1Q84, is a novel originating in Japan. The paragraph reads:
Sometime after that, Aomame happened to see the movie On the Beach on late-night television. It was an American movie made around 1960. Total war broke out between the U.S. and the USSR and a huge number of missiles were launched between the continents like schools of flying fish. The earth was annihilated, and humanity was wiped out in almost every part of the world. Thanks to the prevailing winds or something, however, the ashes of death still hadn’t reached Australia in the Southern Hemisphere, though it was just a matter of time. The extinction of the human race was simply unavoidable. The surviving human beings there could do nothing but wait for the end to come. They chose different ways to live out their final days. That was the plot. It was a dark movie offering no hope of salvation. (Though, watching it, Aomame reconfirmed her belief that everyone, deep in their hearts, is waiting for the end of the world to come.)
Wikipedia describes Aomame (and another character in the story) as 'long-lost lovers who are drawn into a distorted version of reality'. I don't think it would be wise to live by the beliefs of this fictional character, rather you should ensure you are prepared for the worst case scenario, but once you have done so live life to the fullest.
 
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