The property myth that made Australians rich

For decades, Australian property investors have benefited from a powerful combination of leverage, falling interest rates, population growth and favourable tax treatment.

Property was the vehicle for investment returns. Leverage was the engine.

The recent changes to negative gearing and the capital gains tax discount have weakened some of those tailwinds.

In broad terms, negative gearing will be restricted to established residential properties acquired before the Budget announcement, while the 50% CGT discount will be replaced by cost-base indexation and a minimum tax on capital gains from 1 July 2027.

While the Budget changes do not remove the investment case for property, they do reduce some of the tax advantages that previously supported these kinds of leveraged investments.

For some investors, these advantages outweighed some of the limitations of property investing, such as its illiquidity, but with the tax benefits removed, this may need rethinking.

Even without the tax benefits, property may still be an effective vehicle for building wealth.

However, as retirement approaches, reducing debt, contributing to super, improving diversification and maintaining access to capital can become just as important as growth.

Tax should be the tail, not the dog

Negative gearing was often promoted as a tax strategy, but nobody became wealthy simply because they received a tax deduction.

A $1 deduction does not produce a $1 tax saving.

Property investors must still fund the remaining loss, together with interest, maintenance and transaction costs.

For the past three decades, strong capital growth has often more than compensated property investors for these expenses.

But as we are currently seeing, capital growth can't be taken for granted. Ultimately, an asset must have an underlying reason to appreciate, whether that is rising income, increased demand or constrained supply.

The investment should work before tax. Tax concessions should improve a sound strategy, not justify a poor one.

For many investors, the numbers behind buying property may still be sound. For example, an investor who pays a deposit of $200,000 to buy a $1 million investment property has an asset worth five times their initial investment.

If the property value rises by 10%, the $100,000 gain represents 50 per cent of the original deposit, before interest, tax and costs.

This approach was particularly effective when borrowing costs were declining, property losses could reduce tax on salary and eventual gains received a substantial CGT discount.

But with less generous tax treatment and higher financing costs, future returns will depend more heavily on the property's rental income.

There are two key lessons here. Investors can't assume the conditions that supported previous returns will continue indefinitely. In addition, they need to remember that leverage works both ways.

A 10% fall in price reduces their equity by the same amount.

Concentration risk

Another consideration for investors is that many are unintentionally concentrated in their investments, with their family home, investment property and employment income all highly dependent on the Australian economy and property market.

That concentration may have helped build wealth while property values were rising and employment income was strong.

But it has also created a degree of risk which has been brought to the forefront by the Budget changes.

The tax changes therefore provide a useful trigger for reconsidering whether adding another leveraged property to an investment portfolio remains the best use of capital.

Super opportunity

A strategy that has successfully built wealth does not automatically remain the best strategy for funding retirement or transferring that wealth to the next generation.

As property concessions are reduced, superannuation is one of the few remaining opportunities to claim a personal tax deduction while building wealth.

Concessional contributions can reduce taxable income, subject to the applicable contribution caps and eligibility requirements.

Unlike negative gearing, these contributions direct money towards an investment for retirement rather than providing a deduction for an ongoing investment loss.

This can be particularly useful when approaching retirement, when investors may be earning their highest incomes and have fewer years remaining to build their super balance.

The strategy becomes less about taking on additional debt and more about placing savings into a tax-effective retirement structure.

Estate planning

Property's illiquidity may not matter greatly during the accumulation years. In retirement, access to capital becomes more important.

A diversified investment portfolio can generate income and allow investors to sell only the amount required.

Property will generally require refinancing or selling the entire asset, often involving significant costs and settlement delays.

Liquid portfolios can also be simpler to administer and divide between beneficiaries.

Property may create practical difficulties if beneficiaries disagree about whether to retain or sell it, or if one beneficiary wishes to take ownership but the others need to be paid out.

This does not make shares inherently better than property. It means flexibility, simplicity and estate planning should form part of the comparison, particularly later in life.

Warren Buffett once said, "Diversification may preserve wealth, but concentration builds wealth."

For many property investors, concentration and leverage did build wealth. But as retirement approaches, the objective often changes from building wealth to preserving it.

That is when diversification, liquidity and simplicity become increasingly important for funding retirement and transferring wealth to the next generation.

Get stories like this in our newsletters.