With the Federal Budget scheduled for May 12, it is becoming increasingly likely that changes to negative gearing will be introduced. While this has sparked concern among property investors and uncertainty across the market, the broader question remains: will such reforms genuinely improve housing affordability for everyday Australians?

Conventional wisdom suggests that restricting negative gearing should dampen investor demand and ease upward pressure on property prices. However, a closer examination of investor behaviour and long-term tax outcomes reveals a more complex reality. In fact, there is a compelling argument that these changes could produce the opposite effect—tightening housing supply and potentially accelerating price growth over time.

Understanding the Investor Mindset

At its core, the objective of most property investors is straightforward: to build a portfolio that generates sustainable income and long-term capital growth. Negative gearing has traditionally been viewed as a supportive mechanism in achieving this goal, allowing investors to offset property-related losses against other income.

But what if this perceived benefit is, in practice, working against the investor’s long-term objective?

To understand this, consider a typical investor journey.

A Long-Term Investment Scenario

Imagine an investor who begins building a property portfolio at the age of 30. They purchase their first investment property—either a new build or an older property with substantial renovations. In both cases, the investor benefits from significant depreciation deductions.

Over the next decade, the investor steadily expands their portfolio, acquiring one property every one to two years. By the age of 40, they own approximately six properties. Due to high depreciation and interest costs, these properties are initially negatively geared, generating tax losses.

However, an important distinction must be made: depreciation is a non-cash expense. While it reduces taxable income, it does not represent an actual outflow of cash. As rents increase over time—typically in line with inflation—and loan balances gradually stabilise, the portfolio begins to generate positive cash flow.

By their early to mid-40s, the investor’s properties may be producing real, positive income. Yet for tax purposes, the investor continues to report losses. This is because accumulated losses from earlier years are carried forward and offset against future income.

The result is a prolonged period—potentially spanning decades—during which the investor earns income from their properties but pays little to no tax on that income.

The Tax Timing Effect

This phenomenon highlights a key feature of the tax system: the timing of income recognition and loss utilisation. While negative gearing allows immediate tax relief, it also builds a stockpile of losses that must eventually be absorbed.

In practical terms, this means that an investor may enjoy tax-free or tax-reduced income well into their later years. For someone focused on retirement planning, this can be highly advantageous.

However, this benefit comes with an important condition: the investor must retain ownership of the properties.

Why Investors May Hold Properties Longer

If an investor sells a property, particularly under a reformed capital gains tax regime, they may trigger a significant tax liability. Not only would they lose the ability to utilise future carried-forward losses, but they could also face higher capital gains tax obligations.

As a result, investors are incentivised to hold onto their properties for extended periods—often until retirement or beyond.

This behavioural shift has broader implications for the housing market.

Impact on Housing Supply

One of the key drivers of housing affordability is supply. If properties are actively traded, new buyers—whether owner-occupiers or investors—have opportunities to enter the market. However, if existing investors choose to retain their properties for longer periods, the available supply of housing effectively decreases.

In a market already characterised by supply constraints, this could exacerbate the imbalance between supply and demand.

Rather than increasing affordability, the reduction in available properties could place upward pressure on prices. Over time, this may lead to stronger capital growth, benefiting existing property owners while making entry more difficult for new buyers.

Rethinking Negative Gearing Reforms

The intention behind negative gearing reforms is clear: to reduce speculative investment and improve access to housing. However, policy outcomes are often shaped by behavioural responses.

If investors respond to these changes by holding assets longer, the policy may inadvertently reduce market liquidity and tighten supply. This is particularly relevant in Australia, where population growth and urbanisation continue to drive housing demand.

It is also worth noting that many property investors are not short-term speculators but long-term planners. Their decisions are influenced by tax structures, financing conditions, and retirement objectives.

Key Assumptions Behind the Analysis

The scenario outlined above is based on several reasonable assumptions:

• Negative losses are no longer immediately offset against other income but can be carried forward to future years
• Rental yields begin at approximately 4.5% of the purchase price and increase by around 3% annually
• Interest rates average 5% over the long term
• The strategy is applied to new or substantially renovated properties, allowing for higher depreciation benefits
• Investor’s borrowing capacity allows for him to avail loans to add 6 properties in 10 years

While individual circumstances will vary, these assumptions reflect common conditions observed in the Australian property market.

A Contrarian Perspective

While much of the public debate around negative gearing focuses on reducing investor demand, it is equally important to consider the long-term structural effects on supply.

From a contrarian perspective, limiting negative gearing may not discourage investment altogether. Instead, it may alter investor behaviour in ways that reinforce long-term ownership and reduce property turnover.

In this context, property could become an even more tightly held asset class, with fewer properties entering the market over time.

Conclusion

As policymakers consider changes to negative gearing, the broader implications for the housing market should not be overlooked. While the goal of improving affordability is commendable, the interaction between tax policy and investor behaviour is complex.

If reforms lead to longer holding periods and reduced property turnover, the resulting supply constraints could outweigh the intended benefits.

Ultimately, housing affordability is influenced by a combination of factors, including supply, demand, taxation, and economic conditions. Any policy change must be carefully evaluated in the context of these interconnected dynamics.

As the May 12 budget approaches, both investors and policymakers would do well to consider not just the immediate impact of negative gearing changes, but their long-term consequences for the Australian housing market.