The proposed changes appear to alter timing and liquidity more than long-term investment economics

One of the biggest misconceptions emerging from the recent budget is the idea that negative gearing on established property is being abolished entirely.

That doesn’t appear to be the case.

Based on the budget announcement, investors would still be able to claim losses associated with established investment properties. The difference is that those losses may no longer be immediately offset against wage income.

Under the old structure, if an investor owns a negatively geared property, the annual loss can generally be offset against PAYG income immediately. In practical terms, the government subsidises part of the holding cost each financial year through the tax system.

Under the proposed structure, the losses would instead accumulate and be carried forward to offset future rental profits or future capital gains when the property is eventually sold.

In other words the tax benefit still exists, the investor simply receives it later.

Importantly this means the policy is not destroying the long-term economics of property investment. What it really changes is holding costs during the early years of ownership.

And that is where the entire conversation becomes much more nuanced than most of the headlines currently suggest.

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The Market Is Still Solving The Same Equation

At a basic level, property investment returns are still driven by the same underlying variables they always have; rental income, rental growth, capital growth, leverage and time. Nothing in the new policy changes those drivers for the worse.

What changes is the timing of the tax benefit attached to the losses.

To better understand the mechanism, I built a rolling IRR model this morning comparing a newly constructed property retaining immediate negative gearing benefits against an established property operating under quarantined or deferred negative gearing rules.

The assumptions were intentionally designed to reflect how many real-world investment properties currently behave.

The new property assumed:

• lower initial yield,
• slower long-term growth,
• stronger depreciation benefits,
• and immediate tax offsets.

The established property assumed:

• a lower purchase price,
• stronger initial yield,
• faster early rental growth,
• and deferred losses that could only be offset against future rental profits or capital gains.

The results were fascinating.

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What Is IRR And Why Does It Matter?

IRR stands for Internal Rate of Return. In simple terms, it measures the total annualised return of an investment after accounting for leverage, holding costs, tax treatment, cash flow and the eventual sale value of the asset.

It is one of the best ways to compare different investment structures because it captures both how much money is made and when it is made.

That timing component is critical.

A dollar received today is worth materially more than a dollar received ten years from now because it can either reduce holding stress or be reinvested elsewhere.

This is why the proposed changes matter even if the long-term tax benefit still exists.

The rolling IRR model then takes this one step further. Rather than only modelling the investment outcome after 30 years, the model calculates the IRR if the investor sold the property at the end of every individual year.

In practical terms, it asks:

• what does the investment return look like if the property is sold in Year 5?
• Year 10?
• Year 20?

That becomes extremely useful because it reveals how the structure behaves through time rather than only showing the final outcome decades later.

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The Short-Term Impact Is Real

During the early years of ownership, the difference in cash flow can be significant.

Under the current system, investors receive an immediate tax refund each year while the property remains negatively geared. Under the proposed structure, that refund effectively disappears in the short term because the losses remain trapped inside the asset itself until later.

The result is lower after-tax cash flow during the early years of ownership, which in turn reduces holding capacity, weakens serviceability and makes portfolio scaling materially harder.

For many investors, the challenge is not whether the asset ultimately performs well over 20 or 30 years. This biggest challenge they’re facing is how to survive the reduced cashflow in the first five.

What surprised me most was that the established property still produced superior rolling IRR outcomes across the entire modelling period despite materially worse early cashflow stress.

The new property structure produced a much smoother holding profile because depreciation and immediate tax refunds heavily subsidised the early years of ownership. However, the established property benefited from a lower entry price, stronger initial yield and faster rental growth, which ultimately overwhelmed the tax advantages attached to the new property structure.

Another important thing to note is that, while established property initially underperformed from a holding cost perspective, it eventually delivered stronger long-term returns as rental growth compounded and deferred losses were recycled through time.

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Cash Flow Is Where The Real Behavioural Change Happens

The cash flow modelling tells an even more important story.

New property produces a much smoother holding profile because depreciation and immediate tax refunds heavily subsidise the early years. Established property initially experiences significantly more holding pain under a quarantined negative gearing system because the investor must absorb the full cash deficit themselves while the deferred losses accumulate inside the asset.

Over time, however, the established property begins improving materially as rents compound against a fixed interest-only debt position. Eventually the deferred losses begin offsetting future taxable profits and the structure gradually self-corrects.

In other words, the long-term investment economics do not disappear. The only the only thing that changes is the timing of the cashflow component.

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The Policy May End Up Restricting Property Investment To High-Income Earners

The more I model these proposed changes, the more it appears that the real effect is not the elimination of property investment incentives.

Under the current system, the government effectively helps investors survive the most difficult holding years. Under the new system, investors in established property must survive those years themselves. The issue here is that it creates a notable difference in the accessibility.

Typically established property is available at a much lower cost and higher yield than brand new which has been an important pathway for younger investors to get into the market. It is now difficult for developers to build a one bedroom apartment for less than $600,000 and this is before land costs are layered on top.

A high-income household with substantial disposable income may still comfortably absorb years of negative cash flow, delayed tax benefits and rising holding costs.

Which means the practical effect of the policy may be to increasingly concentrate property investment among wealthier households, higher income earners, lower leverage investors and investors with large liquidity buffers.

Ironically, the policy designed to increase home ownership rates for the average Australian will simply concentrate assets in the hands of the wealthy while doing nothing to combat the supply issue.

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The Bigger Picture

The pre-budget system heavily subsidised the early years of ownership meaning that the holding costs were reduced from first day of ownership.

The proposed system delays that benefit for established property until later in the investment lifecycle which fundamentally changes investor behaviour.

But it does not change the long-term mathematics of housing scarcity, land repricing, rental demand and compounding rental growth nearly as much as many people currently believe.

As always, the important thing is not simply what the policy says on paper.

It is how the underlying mechanics behave once they interact with the real world.