If negative gearing is wound back, could it hurt ASX bank stocks?

Negative gearing is a contentious topic and Australians are heavily divided on it.

What is negative gearing? Why is it in the headlines again?

It is a strategy that allows investors to claim a tax deduction for a ‘rental loss’ when interest repayments and other expenses exceed income. It was used by 2.27m taxpayers in 2021-22 according to ATO data.

5 years after proposed changes to negative gearing allegedly lost Labor the federal election, the prospect is back on the table again with calls to abolish the tactic or perhaps restrict it. These calls come amidst the cost of living crisis and speculation of a hung parliament in next years’ federal election.

When this discussion comes around, there is debate about the impact it would have on rents and perhaps property investing generally. What few are focusing on are the impact it could have on ASX bank stocks, with a few exceptions. And it may not look good.

Negative gearing might hit the property market

Investment bank Citi released a report earlier this month talking about the impact it could have on bank stocks. Banks make their money on interest charged to mortgagees. And wherever rates are, they are almost always higher for investors, with the view being that investors can pay a higher rate because they can claim a tax deduction. 

Theoretically, if negative gearing was abolished, investors may be forced to sell their properties, thus drying up interest income for the banks. Obviously this would only be seen if it was a significant number of investors. Another concern would be the impact on renters – rents would rise if there was less supply and/or property investors raised rents to compensate.

Citi examined these questions, looking on past precedent. In the 1980s, negative gearing was abolished in Australia by the Hawke government in 1985, only to be quickly brought back. Similarly, New Zealand got rid of negative gearing in 2021, only for the Luxton government to bring it back upon succeeding the Ardern-Hipkins government.

‘History tells us that when these incentives have been removed, it has seen investor capital withdrawn and housing shortages get worse,’ Citi’s note said.

‘Curtailing negative gearing would improve housing affordability putting the 100,000 new first home buyers annually in a better position’.

‘However, for the 30% of the population that live in a rental, it risks shrinking the rental stock and driving rents higher’.

And perhaps bank stocks generally

Citi’s note told investors banks may be impacted, particularly CBA and Westpac because their incomes are more skewed to mortgage lending relative to its peers – ANZ and NAB have bigger business banking units. The note did not mention Macquarie, and we are not surprised because it makes a higher proportion of its income from offshore investments.

Any tax changes like the abolition of limitation of negative gearing would lead to investors exiting the market and putting downward pressure on credit growth. The exact extent? Citi did not take a crack at it, but it noted that taxes can have an impact – pointing to the example of Victoria and how its high stamp duties and land taxes have led to investors turning to other states.

Conclusion

If Citi’s analysis is correct, CBA and Westpac investors would be the most at risk of an impact from negative gearing being abolished or curtailed. Nonetheless, its one thing for investors to sell property in one state with high taxes – it is unknown if a ‘Victoria effect’ would happen nationwide. Would investors seriously consider buying properties overseas? Or might they look to other asset classes instead. The only thing for sure right now is we’ll only have to ask these questions if these changes actually happen, and it remains to be seen if they will.

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