Are rising property taxes killing the golden goose?

I have often been accused of being anti-property and pro-shares – most commonly by my wife.

It is not actually true, although I will admit that the minutia of real estate and particularly those endless television shows bore me to tears.

To prove I am not anti-property, I think real estate has two absolutely unrepeatable qualities that cement it as an excellent investment.

Two great things about property

The first is that banks will lend you a very high proportion of the value of a house or apartment – up to 90% and beyond sometimes – and that loan is usually not subject to any form of instant recall or repayment even if the value of the property drops significantly.

The second is that from a taxation point of view real estate is treated as a very special case – your own home is absolutely free of capital gains tax when sold.

I literally can’t think of another asset class that has those two features and they are both really important positives, particularly in the long term which I think is the best way to think of property.

Two not so great property issues

My only caveat to what could otherwise  only be characterised as an unbridled and uncharacteristic enthusiasm for property can also be expressed in two factors as well.

The first is that pro-property spruikers almost universally and conveniently forget to include the significant and rising costs that accompany property investment.

The second is that property is almost always – apart from the mega-rich – an incredibly lumpy, large and inflexible investment that often must be made to the exclusion of all other asset classes.

On that first point, you don’t have to look very far to see how quickly the costs of property investment have been rising.

While those simple and frankly highly misleading slogans such as “property values double every seven years” or “property prices never fall” slide out of the mouths of the many self-interested property spruikers like butter, what is not quite as palatable is the inflationary rise of many property costs.

Property costs are rising fast

Insurance is one area that has been astronomical and while it is not unique to property (think memorabilia, rare cars and art), the costs and necessity for insurance are particularly pertinent for property ownership and investment.

Another rapidly rising property cost – this one unique to the sector – is the cost of state government taxes such as stamp duty and land tax.

While it is true that property enjoys unique advantages in relation to Federal taxes such as capital gains and is also helpfully usually not included when assessing eligibility for payments such as the age pension, the state governments with their very narrow tax bases have been chiselling money out of property owners and investors with incredible enthusiasm.

A recent analysis by PropTrack and the highly regarded economic research e61 Institute found that in Melbourne property owners are being charged almost six times as much for stamp duty as the previous generation.

To buy a median priced home, that cost has risen by an amazing $42,500.

That means a full-time worker earning an average $85,000 yearly wage spends the equivalent of six months’ income on stamp duty when buying a typical Melbourne house worth $790,000.

By contrast, in the 1980’s, a home buyer paying $65,000 for a house would fork over just one month’s worth of post-tax income for stamp duty of just $1300.

The stamp duty situation is better in some of the other states but all have seen stamp duty rise dramatically over time due to a lack of indexation of the stamp duty tax scales and inaction on any tax reform.

Investors being hit with massive land tax bills

The situation is even worse for property investors, who are now being hit with really rapid rises in land tax, again, particularly in Victoria which has greatly broadened land tax.

Indeed, the land and stamp duty tax situation is so bad in Victoria that surely one of the greatest of property enthusiasts, Cate Bakos who is the former Real Estate Buyer’s Agents of Australia president and owns 11 properties in Victoria, recently rated the state’s investment policies as 3 out of 10 and called Victoria “unfriendly for investors”.

She said if policies like the “temporary” ten-year land tax increase were not changed, “I think property investors will turn to other asset classes and it’s understandable.’’

I couldn’t agree more and the evidence of property investors increasingly selling out is fairly obvious, to the extent that this could be one of those situations in which the state government might have shot itself in the foot by failing to consider the overall impact of its tax increases on the sector.

Perhaps they just don’t care, figuring that the selldown of investment properties will increase the potential for owner occupiers and yield even more stamp duty.

Property values so high yields are sharply negative

As for my second point about property being a lumpy, large and inflexible investment, this is actually a consequence of two things – the success of property over time which has pumped up prices to such a high level in real and nominal terms plus one of the defining characteristics of property being that you can’t sell half of your investment if you need to, except for unusual cases such as subdivision.

This has led to the somewhat bizarre situation of gross property yields being well below interest rates – substantially below once you fact0r in the costs.

That means that most property investors with loans are actually losing money over the long term, with the only advantages of that situation being the tax advantages of negative gearing along the way and the lower capital gains tax that will apply on what will hopefully be a sizeable capital gain as the only way to actually make money.

Long wait for the property pay day

Using historical gains and also factoring in strong immigration, those capital gains are probably still likely to happen.

However, it is a long time to wait paying large and increasing holding costs in one non-diversified asset that is a sitting duck for state governments which literally know where you live to keep applying ever higher taxes.

When even property enthusiasts are straining under the weight of increasing state taxes, it could be that even the generous federal tax holidays that property enjoys might not be enough to overcome the disadvantages.