Recent gyrations in world share markets aren’t unexpected and follow the warnings of major super funds that future investment returns are likely to be lower than they’ve been for several years

While unsettling for retirees already struggling to cope with historically low interest rates, a more important concern for many investors is the impact of the APRA crackdown on lending to property investors.

In the past, a strong property market has been associated with a growing economy and buoyant share market and investors flush with cash. Now, however, the situation is totally different.

The economy is slowing, the share market is struggling and the banking system is funding property investments at record low interest rates. The government has added to the general investment demand by limiting the attractions of voluntary super savings, reducing the maximum annual deductible contributions and subjecting higher income taxpayers to a 30 per cent contributions tax. Investors’ sensible response, especially in younger age groups, is to use the negative gearing tax shelter providing unlimited tax deductions.

Apart from these annual tax benefits from borrowing which generate tax losses, gearing also allows access to the net equity at any time whereas for most people, super is tied up and untouchable until at least age 60. When the investment is profitable, concessional capital tax provisions apply.

The profits from gearing come from the appreciation of the value of the investment funded by the borrowing. This is where the APRA intervention is likely to have its greatest impact, especially for off-the-plan apartment investors.

By forcing the major lenders to apply tighter credit standards including for high loan valuation ratios and interest only borrowings, APRA is making investors pay greater attention to the risks involved. While attention has been focused on the increase in borrowing costs for investors, this isn’t very relevant because of the tax deductibility of the borrowing costs.

Given how low after-tax borrowing costs now are, a much more relevant consideration for new investors is how the tightening of lending standards will impact on the growth in apartment prices. As is already happening in the oversupplied Canberra apartment market, investors with off-the-plan purchase commitments are being required to provide larger deposits than originally indicated in the loan pre-approval process.

This development adds considerably to the already high risks of off-the-plan purchases. Purchasers now need to deal with the uncertainty of the building completion timing and obtaining lender funding on the rules applying at the time of completion.

With apartment supply increasing and sharply tighter lending terms for investors, the easy and certain profits of heavily geared property purchasers are in fact disappearing. Time will tell but there are already signs that the party is ending for off-the-plan investors.

Daryl Dixon is the executive chairman of Dixon Advisory

Posted by Daryl Dixon – The Age on 4th September, 2015