Why property investors are feeling the pinch


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Australia's landlords, battling steep rises in interest rates, are at the same time being labelled as 'greedy' as they try to recoup some of their increased outgoings by raising rents.

Because demand for rental properties is far outstripping supply, rentals have skyrocketed but not by enough to cover landlords' rising costs, according to modelling by CoreLogic, the property data service.

This imbalance in supply and demand has been labelled a rental crisis and has become a political issue, with the Greens housing spokesman, Max Chandler-Mather, saying Australian renters are treated as 'second-class citizens'.

property investors forced to sell

The Greens have been campaigning for a two-year rent freeze, followed by a cap on yearly increases.

In the wake of this, state and territory governments agreed to tenant reforms at a national cabinet meeting in August, including a limit on rent increases to once a year and minimum rental standards.

Rising rents vs interest rates

Residential rents have increased by an average 9.4% across Australia in the year to July 2023, according to CoreLogic.

Rises were higher in the capital cities at an average of 11.3%. Perth (13.5%), Melbourne (12.9%) and Sydney (12.4%) scored the biggest gains.

But even this has not been enough to compensate landlords for rising rates. CoreLogic median rent values are estimated to have increased by $225 a month over the year to June.

However, the cost of a new investment loan is estimated to have increased by $948 a month on the median Australian dwelling value over the same period.

With further rental rises likely curtailed - not just by legislation but also because rental affordability is being stretched - more investors are likely to turn to negative gearing as they attempt to hold onto their rental properties.

Close to half Australian property investors (46.1%) were negatively geared, meaning rents were not covering interest payments on many investments even before interest rates started to rise, according to tax office data from the 2020-21 financial year.

Tax breaks for landlords are expected to be the fastest growing source of lost revenue to the federal government over the next four years, as rising interest rates push more investors to make use of negative gearing.

Treasury's annual Tax Benchmarks and Variations Statement released in February includes the value of rental property deductions for the first time, estimated to have been responsible for $18 billion in lost revenue in the 2021-22 financial year.

This figure is expected to increase by 35% this year to $24.4 billion because of higher interest rates, which are tax deductible, and total $101.6 billion over the four-year forward estimates.

The increase in lost revenue from rental deductions is more than any other tax expenditure.

Brendan Coates, the Grattan Institute's economic policy program director, said the budgetary effect of negative gearing would rise sharply in the future as higher interest rates forced more investors to record a rental loss.

In a sign that some investors are struggling, investor property listings have jumped sharply higher than the 10-year average in most capital cities - to 30.3% in May compared with the 10-year average of 25.1%.

The share of newly listed investor-owned residential properties across Sydney, for example, blew out to 36.3% in May, the highest level in two years, amid signs landlords are starting to feel the strain of the recent 12 interest rate rises, data from CoreLogic shows.

How tax deductions can boost cashflow

Investors who are finding it hard to manage cashflow can take advantage of a tax variation, which will give them the tax deductions from their investment property in their pay packet instead of their tax return.

A downward PAYG withholding variation reduces the amount of PAYG tax withheld as it accounts for additional tax deductions, such as tax-deductible expenses and depreciation available from an investment property.

Emily, for example, has a gross salary of $80,000, giving her an after-tax income of about $62,000 or about $5150 a month. She also has an investment property, which produces a loss of about $20,000 each year.

If she successfully applies to vary her income, she will receive an additional $13,000 over the financial year that she would have otherwise received as a tax refund through her tax return.

This works out to be an additional $1083 a month to boost her total monthly income to about $6233 a month. The extra money can be used to pay bills or as a buffer for a rainy day.

Tips for landlords to cope with higher interest rates

Strategies landlords can use to ease the pain of their passive income from property investments declining include:

  1. Make sure you claim the deductions you're entitled to throughout the year to increase your regular after-tax income rather than waiting until you submit your annual tax return.
  2. Use any cash you have built up in offset accounts.
  3. Cut discretionary spending as much as possible.
  4. Take a second (or third) job to boost your income.
  5. Enlist the help of a good mortgage broker to see if you can refinance, preferably to a longer-term loan and/or to an interest-only loan.

But at the end of the day, these strategies will not be enough for all investors.

While periods of higher interest rates and inflation are part of the passive property ownership lifecycle, it doesn't mean all investors will be able to withstand the financial pain, even if it usually leads to long-term gain.

If you have indeed over-borrowed and you can't formulate a plan to live with higher interest rates for a period, you will need to reduce debt, and this may include selling some or all your investment properties.

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Money's founding editor Pam Walkley stepped down in early 2015 after more than 15 years at the helm. Before that she was at the Australian Financial Review for 11 years, holding several key roles including news editor, chief of staff and property editor. Pam is now a senior writer for Money.