My thoughts on abolishing negative gearing + Why we need to start hoarding chocolate!

Hi everyone,

Happy Friday and good luck to anyone with a team in the footy finals this weekend.

A big week for the economy with inflation figures and a Reserve Bank board meeting giving us an insight into how the economy is going in this cost-of-living crisis.

So let’s get into it. In this week’s newsletter, the most important things I reckon you need to know are:

• The Reserve Bank keeps interest rates on hold, but is in no mood to change anything soon

• Inflation down to within RBA target range - because of Government manipulation

• Negative gearing ... stupid to abolish but does need reform

• Why private credit could be a good alternative to falling term deposit rates

• Chocoholics need to start hoarding before prices skyrocket

• How to get a great borrowing rate from ‘green loans’

Reserve Bank keeps rates on hold and is in no mood to change anything soon …

The rates/inflation week for the Australian economy started off with the Reserve Bank board meeting over Monday and Tuesday. Rates unchanged at the 12-year high of 4.35 per cent was absolutely expected and is the seventh consecutive meeting where the RBA has sat on its hands and bucked the global trend.

Central banks in the US, Canada, Europe, UK and New Zealand have already started cutting rates as economies slow and inflation has come back down organically, instead of being artificially pushed lower by government subsidies as has happened here. But our RBA won’t be hoodwinked by an artificially lower CPI (more on that impact shortly).

A resilient labour market and sticky housing and services inflation continue to force the RBA Board to retain its higher-for-longer interest rate stance.

In the all-important commentary around the decision, the RBA said it’s not "ruling anything in or out" and that "policy will need to be sufficiently restrictive until the Board is confident that inflation is moving sustainably towards the target range".

A comment obviously aimed at the Government handing out cost-of-living relief which temporarily flows through to lower CPI figures, the RBA commented: “Headline inflation is expected to fall further temporarily, as a result of federal and state cost-of-living relief. However, our current forecasts do not see inflation returning sustainably to target until 2026.”

The message from the RBA is pretty clear that they’re in no hurry to cut rates. So the financial pain from these higher rates will continue for a while.

That pain is so much more severe than that being experienced by most other Western countries. To put that in perspective, this graph shows Australia’s household debt compared with household income is the highest in the world.

I know that looks scary, but remember the reason for the higher household debt is because we have amongst the highest home ownership in the world and those property assets behind the debt have been rising strongly.

So, as I’ve been saying for a while, Australians are asset-rich and cash-poor. Mortgage payments are at record highs as property values rise and bigger loans are needed to buy them.

That’s why any interest rate cut will make a massive difference to household budgets.

While the RBA is reluctant to cut rates immediately, most of the big banks are predicting rates to fall 1 to 1.5 per cent before the end of next year. So, we just need to hang in there and wait.

Not only will a rate cut help with putting more cash into household budgets but history tells us it will also be good for property prices.

Real estate giant Ray White issued a report this week on how interest rate cuts have affected the property market during previous rate cycles.

Interestingly, property prices seem to have been solid over a long period of time, no matter whether interest rates have gone up or down. It’s a testament to the resilience of the property market. The pessimists would argue that it cannot go on like this forever and to remember the adage that “the bigger boom, the bigger the bust that follows”.

Understandably, the property markets with the highest values and the biggest mortgages are the major beneficiaries of any rate cut.

Inflation down to within RBA target range ... thanks to Government manipulation

As I said earlier, the RBA will not be fooled by August’s 0.2 per cent fall in the monthly CPI figure due to temporary government rebates on electricity and a drop in petrol prices.

Electricity prices dropped a massive 14.6 per cent in August and 17.9 per cent in the last 12 months - the largest annual fall since the electricity price series started in the early 1980s.

The ABS reported: “The combined impact of Commonwealth Energy Bill Relief Fund (EBRF) rebates in all States and Territories in addition to State rebates in Queensland, Western Australia and Tasmania drove the annual fall in electricity prices.”

To make the point, the Bureau of Statistics added this chart to the CPI pack which graphically shows the impact of the Government measures. Take them out and the blue line shows there would be little change.

But there are some other good signs in the CPI basket of prices easing:

• The drop in global oil prices flowed through to fuel prices dipping 3.1 per cent last month, and down 7.6 per cent on a year ago.

• The lack of school holiday demand pushed holiday, travel and accommodation prices down 1.4 per cent in August, and domestic travel prices down 2.6 per cent. Public transport fares fell 5.2 per cent because of the introduction of the Queensland Government’s 50 cent Public Transport Fares initiative.

• The big inflationary drivers remain rents (up 0.6 per cent), meat and seafoods (up 0.6 per cent), fruit and vegetables (up 0.7 per cent), alcoholic beverages (up 0.9 per cent) and gas and household fuel (up 0.9 per cent). Costs all remained sticky.

Why negative gearing is stupid to abolish, but needs reform

Abolish negative gearing at your peril. That said, there is no doubt it needs reform because the system is being rorted.

Negative gearing was introduced into Australia in 1936, in the midst of the Great Depression, to encourage investors to buy property and then rent them out to those who can’t afford to buy their own home. The intention was to ease the financial burden of the large upfront and ongoing costs of buying a rental property when compared to other more traditional investments.

Negative gearing tax concessions were designed to subsidise those early losses until the property became profitable for the investor.

Since then, negative gearing has become a national obsession as the best way to build assets and reduce your tax. Instead of being used to soften the financial blow of early losses until it became profitable, investment properties are now continually refinanced so they remain permanently unprofitable, and the tax concessions claimed ad infinitum.

Overlay that with the 50 per cent capital gains tax discount when an investment property is sold, and you can understand what a great deal it is for investors.

According to the Tax Office there are 2.2 million landlords and 1.2 million have a negatively-geared property. Those negative gearing tax deductions are worth $5.7 billion, plus another $5.22 billion from the capital gains tax concessions.

That’s almost $11 billion in tax concessions a year to property investors, which is ultimately funded by every other taxpayer. That’s a lot of tax revenue handed out and why governments have constantly considered abolishing it.

The reason they don’t is that they’d probably lose 1.2 million votes from disgruntled investors. Which could include the 20 of the 23 Labor Cabinet ministers who own an investment property and the 18 of 23 Shadow cabinet ministers.

It is a myth that property investors are moguls - they’re more likely to be a next-door neighbour or friend. Just over 71 per cent own just one investment property and 19 per cent own two. They’re ordinary Australians trying to build a nest egg. And while 12 per cent of these property investors are aged 65-74 years old, the others are spread pretty evenly across all age groups.

Back in the mid-’80s, then Treasurer Paul Keating fiddled around with negative gearing by limiting the tax break for interest costs to the rental income on property. The result was investors left the property market in droves, rental properties dried up, vacancies plunged and rents skyrocketed.

The Treasurer soon reversed his changes as low-income earners found it increasingly difficult to pay their rent or even find appropriate rental accommodation. So be careful what you wish for.

Having said that, there is no doubt the system is being rorted and has moved away from the original intention for which negative gearing was introduced.

I know this tax break is enormously popular because it has helped so many people buy an investment property, and many of those have made a lot of money as Australia's housing market has boomed.

Abolishing negative gearing completely would cause massive disruption in the property market (as Keating found), but subsidising loss-making properties just cannot go on forever.

The solution is to revert to the original intention of the policy back in the 1930s.

Five years should give property investors enough time for the property to increase in value, for rents to rise and move into positive gearing where rents cover the mortgage. From that point, the tax concessions should be scaled back or stopped completely. An investment property can’t be constantly refinanced to maintain the negative gearing tax concessions.

An upper limit could also be imposed to limit the number of properties which can be negatively geared by any one taxpayer.

Sure, negative gearing helps create a greater supply of residential property for rent, but it also distorts the property market, pushing up prices more than they would without government intervention and creating an uneven playing field, to the point that it makes more financial sense to buy an investment property than it does to buy a home to live in.

More importantly - and dangerously - it legitimises investing in a loss-making asset, purely for tax purposes, even where there is little hope that the property will ever turn a profit.

In other words, it encourages banks to lend, and buyers to invest, in assets that make a regular loss from the moment they are purchased. That just can't make sense in the long run.

And the bigger the shortfall, the bigger the tax break.

If you buy a house and the mortgage interest is $1,000 a month, but your rental income is only $500, the government will refund you part of the monthly loss up to the level of your marginal tax rate. So, if you pay tax at 30 per cent, you get $150 back from the government each month. But pay tax at 45 per cent, and you get back $225.

Negative gearing is terrific in encouraging investors to provide much-needed rental properties, but it has become a tax rort for some and limits need to be applied to take the whole policy back to its original intention.

Why private credit is becoming an alternative to term deposits

With interest rates on term deposits now sliding in anticipation of falling interest rates in the future, last week I promised I’d look at ‘private credit’ investments as a possible alternative for those wanting better income returns.

Term deposits have long been a popular option for Australians who want a safe investment harbour for their savings. But now that interest rates on term deposits have started to slide, many investors are wondering if there are better options out there.

How, exactly, can you get the most bang for your buck?

If you’re a perennial term deposit investor, here’s some sobering news: interest rates on term deposits have been slowing down ever since they peaked back in July 2023, and this downtrend trend is only expected to continue.

The rates might still look half-decent when compared to what was being offered a couple of years ago, but they’re starting to fall short of the returns many Australians expect, especially in a high-inflation environment.

So, what’s the alternative? You might want to start looking at private credit investments. With returns in the vicinity of 10 per cent, private credit funds are turning the heads of savvy investors who are willing to look beyond the safety of term deposits.

What exactly is private credit?

Private credit refers to loans that are given by non-bank lenders, usually through private credit funds. Think of these funds as places that pool money from investors and then lend it directly to businesses or property developers, usually at higher interest rates than what the banks are offering. Unlike traditional bank loans, private credit loans don’t come from deposits but from capital raised by the fund. It’s a structure that allows for much more flexibility for borrowers, while investors have the chance to earn much higher returns.

The appeal of private credit is simple: you’re lending your money at a higher interest rate, which means a higher return. While term deposits might have a fixed rate of 4 per cent, private credit is returning up to 10 per cent or more. That’s a big difference – especially when compounded over several years.

Why term deposits are falling out of favour

For years, term deposits have been a go-to for Aussie investors looking for low-risk, reliable returns. But as interest rates on these products dip, their appeal is starting to wane. Sure, they’re safe. Term deposits are protected by the government’s Financial Claims Scheme, which guarantees up to $250,000 in deposits per account holder per institution. But in exchange for that safety, you’re burdened with a lower return. And with inflation running hot, even the best term deposit rates aren’t keeping up with the rising cost of living.

Let’s say you lock in a one-year term deposit at 4.3 per cent. You’re barely keeping pace with inflation at this rate, and your real return (after accounting for inflation) could be next to nothing. So, while term deposits are great for risk-averse investors, they’re no longer ideal for those who want to earn a substantial income from their investments.

The case for private credit

Why, then, should you consider a riskier option like private credit over term deposits? It’s simple: higher returns. Private credit funds are delivering returns of more than double the rate of term deposits. And with interest rates expected to stay elevated for the foreseeable future, these returns are likely to remain competitive.

Beyond the attractive returns, private credit also has a level of diversification that term deposits simply can’t match. Investing in a private credit fund means you’re spreading your risk across multiple borrowers and sectors, rather than putting all your eggs in one basket. Plus, private credit funds tend to offer variable-rate loans, meaning the interest you earn increases as rates rise, something that’s especially appealing in the current economic climate.

Of course, higher returns also mean higher risks. Private credit is far less regulated than traditional banking, and there’s less transparency around the health of the loans being issued. Some funds have been known to delay disclosing bad loans, and others charge hefty fees that can eat into investor returns. That’s why it’s so important to do your own due diligence and choose your private credit fund carefully with the help of a financial advisor.

Is private credit right for you?

Private credit won’t be the right fit for every investor. If safety and guaranteed returns are your top priorities, term deposits should still have their place in your portfolio. But if you’re after higher income returns and are willing to take on a bit more risk, private credit stands as an enticing alternative.

The private credit sector in Australia is growing fast, and while it’s loosely regulated, many investors are being drawn to the strong returns. With term deposit rates continuing to slide and inflation eating away at real returns, private credit might just be the answer you’ve been looking for. At the very least, it’s worth taking a closer look.

Chocoholics, you need to start hoarding!

I warned everyone just before Easter that a surge in cocoa prices would start seeing chocolate prices skyrocketing around the world. They took a bit of a dip after my warning but now cocoa prices are heading back to their highest levels in 50 years.

Since January 2023, cocoa futures have peaked at nearly $US12,000 per metric ton due to a disappointing harvest in West Africa, the source of 70 per cent of the world's cocoa.

Retail prices are on the rise, and a much bigger impact is set to come.

In the recent June quarterly Consumer Price Index data, year-on-year inflation in the Snacks and Confectionery category - of which chocolate is part - was running at 4.6 per cent. But, because of the lag in the supply chain and existing contracts, the steepest price hikes are anticipated in the second half of 2024 and into 2025.

This would inevitably lead to higher prices for consumers, particularly for dark chocolates with higher cocoa content.

Stock up now to beat the price rises.

How to save money on energy bills and increase your property’s value

Did you know you could get a lower interest rate and improve the value of your home while making it more energy efficient as well?

According to a Compare the Market analysis, borrowers with a $750,000 loan could reduce their monthly repayments by $170 when they refinance from an average variable rate of 6.3 per cent to a ‘green’ home loan rate of 5.95 per cent.

Green home loans aim to reward borrowers who invest in sustainable properties.

Aside from reduced interest rates, these types of loans may come with added benefits such as reduced fees, cashback rebates, and the option to borrow additional funding for energy-efficient upgrades.

As long as the property you’ve either purchased, built or recently renovated to be more energy efficient passes the lender’s green home eligibility criteria, and you meet any other loan eligibility requirements, you could be eligible for a green home loan rate.

Who is offering green home loans?

Residential buildings are responsible for around 24 per cent of overall electricity use and more than 10 per cent of total carbon emissions in Australia. The average Australian household emits around 18 tonnes of greenhouse gases annually, with significant contributions from heating, air conditioning, ventilation, appliances, and hot water systems.

Reducing these emissions can be costly, but green home loans help bridge this gap by providing financial incentives for eco-friendly upgrades like solar panels, improved insulation, and energy-efficient appliances.

By making these investments, homeowners not only reduce their environmental impact but also potentially reduce their energy bills and possibly increase their property’s value. That's a win-win situation.

According to recent research, sustainable properties sell faster and at prices at least 10 per cent higher than non-sustainable ones.

So how do green home loans work?

While different lenders will have different qualifying criteria, it is often underpinned by criteria set by the Nationwide House Energy Rating Scheme (NatHERS) and the Clean Energy Finance Corporation (CEFC). To qualify, homes usually need a minimum seven-star rating under NatHERS, which evaluates energy efficiency based on the home’s design. This rating goes up to 10, and a rating of seven is above the average efficiency in most homes today.

Homes may also qualify if renovations improve the energy efficiency rating by at least one star, or if the property incorporates features like:

• Solar panels and energy storage systems

• Battery power and wind power

• Improved insulation and double-glazing

• Solar hot water systems

• Water-saving technologies

In addition to home loans, there are green personal loans and green car loans available for smaller eco-friendly purchases like solar panels and energy-efficient vehicles.

Commonwealth Bank, RACQ, Westpac, and Suncorp offer green personal loans to fund energy-efficient home improvements, with rates starting from as low as 2.79 per cent.

But there are pitfalls with green loans.

The criteria for qualifying can be strict, and the loan’s restrictive nature may make switching to a better deal challenging. Additionally, upfront rates and fees can be deceptive, so it's essential to review the comparison rate and the product disclosure statement to understand the loan's true cost.

Overall, green home loans are a valuable tool for Australians looking to reduce their environmental impact while saving money. With energy efficiency becoming an increasingly important factor in home buying, and a growing number of lenders offering green loans, the market is expected to become more competitive, making it easier for homeowners to access affordable financing for sustainable upgrades.