Market Update June 2017
In our last update, we discussed the unusual phenomenon of house prices falling in Australia’s largest housing market. A minor fall in property prices in Sydney created an overall fall of the same proportion for the entire country – highlighting, if nothing else, the pre-eminence of the Sydney market in the thinking of people setting the economic levers across Australia. Since then, the Government has delivered the 2017 Federal Budget. The Budget contained at least two measures linked to the residential property market. One of these links was pointed out by the treasurer, although the obvious link between the second measure and property prices seems to have been missed by most commentators.
Downsizing the Family Home
To take the obvious first: one of the measures announced in the 2017 Budget was that, from 1 July 2018, people aged 65 or over who sell their family home will be able to transfer $300,000 of the proceeds as a non-concessional contribution into their superannuation fund. If that fund is paying an income stream to the member, then earnings on assets within the fund are tax-exempt. Therefore, in most cases, anyone taking up this offer will be able to invest up to $300,000 tax-free within their superannuation fund. If a home is owned in joint names, then each owner can transfer $300,000 of the sale proceeds. The idea is that older Australians tend to hang onto their family homes because the family home is a CGT-free form of wealth accumulation. For example, if a 70year-old widow owns a home worth $1 million, and the home appreciates in value by, say, 7.5% per year, then the owner is effectively earning a tax-free investment return of $75,000 per year. When the home is eventually sold, there will be no tax paid on the increase in the value of the home. Under the new scheme, from 1 July 2018, the owner can sell her home, purchase a new (presumably smaller) property for around $670,000, pay stamp duty of around $30,000 and contribute the remaining $300,000 into her superannuation fund. If the returns on the new property are the same as that on the old property, then a 7.5% rate of growth will add $52,500 to the value of the new home. Because this is a principal place of residence, no CGT will be payable on this growth.
For the government plan to work, the $300,000 that is invested tax-free within superannuation will need to grow at a rate slightly above the rate of growth in the property market. This is to compensate for the money paid as stamp duty on the second home. In the long-term, the Australian share market and the Australian residential property market tend to perform in quite close concert (source: ASX Russell long-term investment report for any of the past five years or so). Therefore, people who downsize will likely suffer a little for doing so – and suffer rather more if they do not invest in property growth-matching assets within their super. Why would the Government encourage this? Well, in theory, encouraging people to sell their family home should reduce supply-side pressures on residential property prices. This should make it easier for people not currently in the housing market – that is, first home buyers – to enter. Certainly, this is what the Government hopes will happen. We use the word ‘hope’ deliberately here. It is highly unlikely that this will be the effect of the program. For a start, if people who downsize re-enter the market to purchase a new property, then the increase in supply will be matched by an increase in demand. What’s more, the increased demand will happen in a cheaper part of the market – a segment where first home buyers are most likely to be trying to buy. Secondly, anybody receiving an aged pension is unlikely to take up the offer. As most people know, the value of the family home is exempt from the assets test used to calculate the aged pension. But superannuation benefits are not. Therefore, swapping wealth from a home to a super fund makes people more vulnerable to the assets test. The $300,000 additional non-concessional contribution is not subject to other rules preventing people making non-concessional contributions into super. For example, people with more than $1.6 million of superannuation benefits generally cannot make non-concessional contributions (as of 1 July 2017). But they will be able to contribute money derived from selling the family home. People in this situation (with more than $1.6 million in superannuation) won’t have their aged pension affected by the movements: they are not getting the aged pension in the first place. That’s why some commentators have observed that moving up to $300,000 into superannuation may benefit wealthier people for whom Centrelink planning is not relevant. Unfortunately, the houses that such people are likely to be selling will be worth more than first home buyers could afford anyway. Even more unfortunately, the houses that these downsizes might then want to purchase may well be in the section of the market in which first-time buyers are more likely to be active. For that reason, it would be very surprising if this measure has any material impact on house prices, and even more surprising if first-time buyers were to receive any benefit from it.
The new bank tax
The second Budget announcement – and one that will have a bigger impact on the property market is the imposition of a new tax on Australia’s five largest banks (that is, banks with more than $100 billion in liabilities). A tax of 0.06% is applied to the value of specific liabilities owed by these banks. These liabilities are generally those at the higher risk end of the bank’s activities (for example, deposits above $250,000 held by the bank – a bank deposit represents a liability from the bank’s perspective).
The tax has been scheduled to last at least four years – but if it works, what do you think the odds of it being removed in year five are? The government expects that it will raise around $1.6 billion per year from this new tax. In announcing the measure, the government pointed out that the banks to whom it will apply all make substantial profits. For example, the Commonwealth Bank reported a $4.9 billion profit for the six months to December 2016. Perhaps the government is hoping that the banks will simply ‘wear’ this additional tax and their profits will be reduced accordingly. But that’s not the way banks normally operate. Banks enjoy a ‘very strong market position.’ Everybody needs a bank and moving from one bank to another is a hassle. This creates a somewhat captive market. This gives banks substantial ability to pass costs on to these ‘captive customers.’ In our last newsletter, we reported that banks had been able to increase interest rates on certain kinds of property lending (particularly for investors) without much public backlash. They could do this because (i) most people are not investors; and (ii) most people blame investors for at least some of the demand currently pushing housing prices beyond the reach of many. Increasing the cost of borrowing for investors should weaken their demand for property and take some pressure off prices. That certainly seems to have been the case in May. It would seem very likely that banks will similarly pass the cost of this new tax on to certain customers – customers who don’t enjoy much public goodwill. Property investors – that means you! Therefore, the imposition of this new tax on the banking sector may well reduce demand in the property market, by increasing the costs of participation in that market for purchasers. Strangely, there has been relatively little media commentary about this likely result. There is, of course, a chance that all interest rates will be affected – even for non-investors. In a blog article we posted last year, we encouraged clients to use the current low interest rate environment to retire as much debt as possible – especially if that debt is non-deductible has been used for private purposes, such as a family home. Following this Budget, we simply reiterate that advice: the best way to cope with rising interest rates is to owe less money.
Share Market Update
It’s now been six months since America voted for its new president. That six months has seen world equity markets perform radically differently to what many people anticipated when Donald Trump was first elected. The Australian market tends to take its cue from the US one and the ‘Trump effect’ was no exception. Indeed, from a starting point of 5,156 points on November 9, 2016, the ASX 200 rose to a high of 5,956 points on 1 May 2017. That is, in 25 weeks, the market rose 800 points or 15.5%. Add in dividend returns, and that meant a total share market return of around 17% for a period of just under six months. 1 May was the high point of the Australian share market for the entire month of May. The market closed the month at 5,724 points, representing a fall of 3.9% for the month. Here’s how Google and Yahoo Finance saw it:
May’s fall may have various explanations. One is that it could be a natural correction following a period of abnormally large growth. A second is that it was driven by concerns about the US presidency – especially whether this particular presidency will run its full course. You may remember that Trump fired the director of the FBI, James Comey, on 9 May. From our position, down here in the world’s happiest place, we have no idea why that was done or what the likely outcome is going to be. But it seems that many people in the US are concerned that Comey was fired to stop him finding things out about the US administration. This concern has led investors in the US share market to worry that the President may not be able to continue in office. If Trump being President raised market prices, then Trump ceasing as President should do the opposite. I guess we need to watch this space. Whether a fall in the share market is good or bad news is not always obvious. If you need to sell shares when prices are low you will be unhappy: you get less cash for your shares. But buyers get a better deal: they pay less for the shares they acquire. So, whether the adjustment to prices in the month of May is good news depends on your plans for June. If you’re a buyer (or if contributions are simply being made into your superannuation fund, from where they will be invested into the Australian share market) you should be happy. If you’re a seller, less so. Remember, though, that these monthly variations highlight something that has always been true of the share market: it is hard to predict in the short term. When James Comey turned up at work on May 8 not even he knew he was about to be fired. But in the long run, share markets tend to do as well as the economy in which they participate. And in the long run, economies like Australia’s tend to do well. The one thing we do know is that sometimes share markets fall. In that sense, the performance in May was predictable. Our focus when providing investment advice is always to help you plan for these regular ‘bad months’ so that no particular month is all that important to your wealth.