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What will happen to Australia's property market if negative gearing is scratched? Will the market crash? Or is it just a storm in a teacup? This is everything you need to know about negative gearing and the effects the loss of it could have on the Australian property market. I'm Junge Ma, the lead research analyst at InvestorKit.
Let's jump into it. First, let me show you a brief history of negative gearing in Australia. In 1936, it was introduced to encourage investment, increasing rental properties and address the housing shortage problems at that moment. Then in 1985, the government tried to put restrictions on negative gearing by not allowing rental property losses to reduce tax on other sources of income. But in 1987, there was a shortage of housing and rent rose a lot over the two years it was abolished.
As a result, in 1987, negative gearing was completely restored. So what happened after each of those milestones? In 1936, after it was introduced, no significant changes happened to the house prices. In 1985, after it was abolished, price first increased a bit and then slightly declined. In 1987, after it was restored, price actually surged for a few years.
However, it was unlikely just because of the restoration of negative gearing. It was more because of a combination of the financial deregulation, the steady economic growth at that time, and as a result, the steady growth in household income. So let's come back to now. Will the market crash if negative gearing is banned? We can look at it from three aspects.
First, from historic experience, the answer would be no. As we remember, in 1985, it was partially banned for two years. And during the two years after the ban, did the property market crash? No. And then the second aspect would be a more logical point of view.
First, we need to understand that negative gearing is not a wealth building fundamental. According to the ATO, in the financial year from 2021 to 2022, 41. 3% of property investors reported rental loss in their investment properties. So negative gearing is basically a tool for these investors to recover some of their loss. However, as property investors, we know that the real wealth building fundamental in property investment is actually the long-term compound growth or the capital growth in your investment property.
Negative gearing, it's a useful tool. However, it's not the fundamental. And secondly, just as any other policies, negative gearing ban would have transitional effects. If it was banned at the shock of the change, we could see lots of investors leaving the market because of one, lower confidence and two, the poor cash flow they would be seeing. And that is more likely to happen in large cities with really low rental yield, such as Sydney and Melbourne.
And given high rental demand in these cities, the reduction in rental supply would very likely push rents up. And then that would result in one, a better cash flow for landlords and two, more suffering for the tenants. And I don't think that's something the politics would like to see. And three, over the past 20 or 30 years, we have seen a lot of policy changes and cash rate changes, but none of these changes have stopped Australians' property market to grow in value. Over the past 20 years, Australia's average house prices have increased by 188% while all those changes were happening.
Some of the policy changes include in 2008, a first home owners grant boost was introduced and then two years later in 2010, it was removed. In 2017, because of the high foreign investors activity, APRA has actually put on lots of restrictions on investment lending and foreign investment lending. And at the same time, cash rate decreased all the way down to 0. 1% and then in the two years since 2022, surged all the way back to 4. 3%.
So when each of these changes happened, in the short term, we did see a decrease in either owner-occupiers activity or the investors activity. But eventually, after one or two years, they would come back to the usual level. And the same happens to the price trend. When either the owner-occupiers or the investors or both of them became less active, price may grow slowly or even decline a bit. However, in one or two years, as the buyer's activity recovered, the price would always go up again.
So any policy change or financial environment change would, in the short term, have effect on the property market. However, in the long term, price growth always converged back to the long-term average. So that was the three ways we could see it from a logical point of view. And the third thing that's making me think that a negative gearing ban wouldn't affect the property market much is actually a model made by Grattan Institute. So in September 2024, Grattan Institute updated their model, initially made in 2016, about what would happen to Australia's property market if the labor government went ahead and changed the tax breaks.
According to the model, house prices would only fall about 2% if that all happened. 2% to me sounds like a very slight drop. So in summary, negative gearing ban doesn't mean property market crash. We can tell it from the history, basically what happened in 1985 to 1987. We can tell it from logic.
It's not a wealth building fundamental. It has transitional effects and push rents up. And no policies in history has stopped the property market from growing. And then this is also backed by a model made by the Grattan Institute. So if you are interested in property investment but are concerned about the potential effect of the negative gearing bans on the property market growth, I hope this episode will calm you down.
I have written a blog about negative gearing, the potential ban of it, and how that won't affect property investment. I'll put a link below. If you are interested, feel free to check it out. So that's about today. If you have any questions or you agree or disagree with this episode, feel free to leave a comment below.
Arjun and I will try our best to reply to every comment. I'm Joma, the lead research analyst at InvestorKit. Thank you for your time and I'll see you next week.
