COMMENT: With the Government finally releasing the details of its new tax rules for property investors this week, we now have a clearer idea of what the property investment world will look like going forward.
Under the rules, which came into to force on October 1, investors will be unable to deduct interest expenses from existing properties bought after March 23. Properties bought before March 23 will lose deductibility over a near four-year period.
However, investors will still be able to claim interest deductions on new-build properties for up to 20 years from the time the property’s code compliance certificate was issued.
The Government has, in effect, split the buyer’s market, strongly pushing investors towards new-builds. In theory, this will weaken competition for “existing” homes, making them potentially more accessible to first home buyers. In fact, it would seem prudent for property investors to at least investigate selling any existing homes in their portfolio and replace them with new-builds assuming the benefits aren’t hit too strongly by the bright-line test (talk to your accountant about this).
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The question now is: how will the banks react to the tax changes on rental property income? In the olden days - six months ago - almost all lenders scaled rental income by approximately 75%. For example, if you earned $20,000 per year in rental-property income, the banks calculated what you could afford receiving just $15,000. This scaling allowed for costs such as rates, insurance and potential vacancies.
But for properties built prior to March 27, 2020, that $20,000 will increasingly have tax costs, regardless of the interest paid from lending. So the banks, who are already under heavy pressure to address responsible lending practices, have to factor that into their calculations.
Banks moved earlier in the year to adjust their policies and have made some changes to their calculators already. At least one bank has a different scaling percentage for new investment properties versus existing ones. Now that the market has a clearer idea of what constitutes a new-build, I would suggest this is the rational approach to take. For example, it would make sense to continue scaling rental income at 75% for new-build properties but scale existing rental properties at 60% to account for tax paid.
Some banks, however, have changed the percentage of rental income scaling to a much lower 60%, regardless of whether the properties are new or existing. It’s certainly the bank’s prerogative to do this and points to them wanting to be seen as responsible with how they calculate affordability. Now we are seeing the tax rules in clearer detail, we may see adjustments made to these calculations.
More importantly, we are in a market where applicants may see their borrowing capability between banks differ by significant amounts, often hundreds of thousands of dollars. This has always been true to a certain extent: for a typical couple with two kids, an average income and small credit card debt, the difference in affordability can be up to $140,000. But now that same couple with one or two investment properties in their portfolio could see an affordability difference of around $250,000 between banks.
This is important because $250,000 can buy a significantly different type of investment property. It could be closer to the city meaning potentially less prone to vacancies. Or it could be closer to schooling districts which could attract families as tenants.
It’s highly likely the banks will adjust the way they treat rental property income depending on whether the property is new or existing but, in the meantime, investors will want to shop around and clarify how each bank treats their income.
- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.
