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For the past three decades, the Australian economy has been defined by two different types of land. The mineral-rich land we mine and export to the industrialized, developing countries of Asia, and the plots of land we resell to each other at ever- higher prices. The first type made Australia incredibly rich, but the buying and selling of the second made Australians incredibly indebted. Australia has the second highest level of household debt in the world, and that's almost entirely due to how much people have to go to extreme lengths to buy a house that looks like this but somehow costs $7 million. The only country that Australia actually
lags behind in this dismal statistic is Switzerland, and this is largely a statistical anomaly caused by Switzerland's unique banking and land tax rules. Australia's property market has long been considered too big to fail, as it accounts for a large portion of our national wealth. But hidden beneath this wealth is a huge amount of debt, much of it on the balance sheets of our biggest banks, meaning that, apart from our mining giants, Australia's biggest companies make money in one of two ways: extracting minerals or financing it. And the assumption that Australian property can't crash may be starting to change. That's because about two months ago the
Australian government changed the very strange tax policy that made Australian real estate such a uniquely desirable asset, and we're already starting to see the results of that change as homes are starting to sell at a significant discount compared to what they were just a few months ago. So, if the goal is to make housing more affordable, falling housing prices might seem like a good thing. But when so much of a country's wealth and so much of its debt is tied to housing, deliberately driving down those prices is a huge economic gamble, and Australia is hardly the only country struggling with unaffordable housing.
Governments around the world have shelved this issue for years, in part because addressing it risks harming millions of people who already own homes. Australia, however, decided to take this risk. So, to understand why and what happens next, we need to answer three questions. Why was housing in Australia so uniquely inaccessible? What allowed Australia to actually take this economic risk? And finally, will falling housing prices drag the rest of the economy down with them? Before I founded Economics Explained, I was stuck in a
dead-end job. I hated going to work every day and knew something had to change. But knowing this and actually doing something are two very different things. It took many conversations with my closest friends before I finally decided to take the plunge and start Economics Explained. And that's why I like the idea of today's sponsor-career coaching strawberry.me. When you're stuck in your own career, it can be extremely difficult to look at your situation objectively. You can spend months contemplating quitting your job, asking for a raise, changing careers, or trying to figure out what you really want to do next. Sometimes what you need is a perspective from the outside. strawberry.me pairs you one-on-one with a proven professional career coach
who will help you take a step back, consider your options, and turn all those reflections into strategy and real next steps. And unlike talking to friends, a professional coach is there specifically to help you process these decisions and hold you accountable for following through. The answer is n't always to quit your job and start a YouTube channel, but if you know something needs to change in your career, another 6 months of thinking probably won't make much difference. So discuss this with a professional coach. Go to strawberry.me/economics-explained to find a coach and get a 50% discount on your first coaching session. So to understand how Australia got here, you need to understand the tax policies that have encouraged Australians to buy more
property for decades. And a lot of it boils down to two words: " negative gearing." We've covered the exact mechanics of negative leverage in several videos on this channel before, so we don't want to repeat ourselves, but there are a few key points you really need to know to understand what just changed. Firstly, Australia has quite high income taxes, especially for a high- income country. Anyone earning more than A $190,000, which is around $120,000 in the US, loses 47 cents out of every extra dollar after the Medicare levy is taken into account, which is a lot. But going back to our income tax laws of the 1930s and except for a brief 2- year hiatus in the mid-80s, people here could use negative leverage.
This meant that if you bought an investment property, you could deduct expenses such as mortgage interest from the rent it generated. And if these expenses exceeded your rental income, you could deduct the remaining loss from your ordinary income as well. So, if someone owned a rental property that brought in $50,000 a year in rent but paid $60,000 a year in mortgage interest on it, they could take that $10,000 loss and deduct it directly from their primary job income. And it got even better because investors could also write off the depreciation of the building itself. A new home could be written off at a rate of 2.5% per year for four decades, which translated into thousands of dollars in additional paper losses each year. The trick is that this
depreciation never cost the owner a single real dollar. And in a growing market, the building actually increased in value. So, investors received tax deductions for losses that did not actually exist. For a surgeon or mining engineer facing a 47 percent top tax rate, rental properties that generate paper losses were perhaps the only way to reduce their tax bill. So high-income Australians would be foolish not to take advantage of this. And many did so. According to the latest tax figures, about 2.2 million Australians owned investment properties. About half of them had negative investment, and together they declared over $10 billion in losses in one year. The reason why governments allowed this מל כאטקו was in the hope that it would encourage ordinary
people to invest in rental housing and take the strain off the public housing sector. Which, to be fair, is what happened. But once this " Pandora's box" was opened, it became very difficult to close it for several reasons. First, there really isn't that much land in Australia suitable for residential development. We don't have many cities, and those that do have strict restrictions on what and where you can build. So all this tax- stimulated demand mostly just inflated the prices of the same old houses. As more people invested, real estate began to take up a larger share of household wealth.
Our homes are now worth about $12.8 trillion, almost three times the value of the entire superannuation system, where most Australians' savings are held. Because such a large portion of the national balance sheet is accounted for by housing, changes in property prices have a disproportionate impact on When prices rise, people feel rich and spend more. When they fall, people hide their wallets and drag the rest of the economy down with them. And there are also banks. Apart from our mining giant BHP, the biggest companies in this country are the "big four" banks. And the biggest business for each of them is issuing mortgage loans. Together they control 75% of the mortgage market and are worth about $650 billion in the stock market, meaning a sudden
drop in housing prices would first hit household wealth and then start to absorb the collateral for hundreds of billions of dollars in bank loans. Worse still, a significant portion of retirement savings in this country are tied to the same banks. About $4.4 trillion is in pension funds, and a significant portion of it is bank stocks and bank financing. This partly explains why they had so much money to issue all those mortgages. So, the whole system was self- sustaining. The problem is what the hidden cost of this is. Every dollar invested in inflating the price of an existing home is a dollar that didn't go toward new technology, research, staff training, or anything else that grows a real business. Because real estate simply
offered a better return on risk, with a tax refund on top. Opening a business here was difficult for the same reason. Because before you could do anything productive, you had to first afford to buy the land on which to do it. In America, if a young person wants to get rich, they usually go into technology, finance, law, or medicine- high- skill fields that generally add a lot of value to the economy. Ours is a well-trodden path to wealth- financing, promoting, or selling real estate. Land has effectively displaced other factors of production, and this has become noticeable. The decade leading up to the 2020s was the slowest for productivity growth in Australia in 60 years. We also were n't producing enough skilled workers ourselves, so we
relied heavily on immigration to fill the gaps. With net external migration peaking at 538,000 people in one year. They all needed somewhere to live. Most economists would hesitate to call this an intergenerational financial pyramid, but it naturally benefited those who were able to exploit the entire system during its growth. And yet for decades, no government has wanted to touch it until now. At 7:30 p.m. on Budget night, May 12 of this year, the government announced that over. Along with reviewing the capital gains tax deduction, which we won't touch on today. From July 1, 2027, investors who purchase existing investment properties after the announcement of this policy will no longer be able to use losses from them to reduce taxes on ordinary income.
The loss can still offset rental income or be carried forward to future rental payments and capital gains, but it can no longer relate to income from the main job. However, there are some exceptions. New builds can still be used for negative leverage, as before. The hope is that if investors want to get the tax break, they will have to actually add new housing to the general stock, which was, in fact, the goal of this whole scheme from the very beginning. The obvious fear is that people will simply tear down old houses and build cheap new ones to meet the requirements, bringing in workers and building materials but not providing housing for anyone else.
The rules try to prevent this, as one-to- one demolition and rebuilding is usually not counted unless it adds new dwellings to the site. But such schemes are always tested by cunning accountants, and it's too early to say how it will all end. Another important and controversial exception is the exemption for anyone who already owned investment property. Every property owned before budget night retains the old rules indefinitely as long as it is held by the current owner, which seems rather ironic since the changes were presented as a way to address intergenerational inequality. Immediately afterwards, the government assured the mostly older group of existing investors that nothing would change for them. To be fair retrospective changes to assets
people already own are generally perceived as unfair, and " grandfathering" is the way Australia mitigates almost every major tax change. On the other hand, perhaps even more unfair is that the people who got there first can now " remove the ladder" and continue to receive benefits. However, it is worth noting that the benefits of negative gearing naturally disappear over time: as loans are repaid and rents increase, a loss-making facility eventually becomes profitable on its own. So even investors who fall under " grandfathered conditions" will still gradually lose these benefits. The obvious question is: why has Australia decided to do this now, after decades of inaction?
The reason was as much political as economic. Our current centre-left party, Labour, went into the 2019 election on a promise to limit negative gearing and lost an election they were predicted to win, partly because of this issue. The fact that they returned a few years later and still kept their promise may seem strange. And this is where the explanation from the standpoint of pure economics fails a bit. It was more or less the same policy that led to their loss in 2019. The difference was in the voters. By the 2025 election, an entire generation had been cut off from the market long enough for the political math to finally change. In a country with 18 million voters, there are only about 2.2 million real estate investors. And
as housing affordability has become a bigger issue for everyone else-renters, first-time homebuyers, and especially young Australians -protecting property investors has become a much more difficult policy challenge. So Labour won its largest majority since 1943, giving them the opportunity to start the fight they had previously lost. It is worth recognizing why such issues are so difficult to address in most other countries. Things like pensions, the national debt, and health care reform are usually protected by the votes of older people because they reliably turn out to vote, while young people do not. In Australia, voting is compulsory for everyone over the age of 18, and turnout in the last federal election was 90.7%, meaning that young renters
who usually ignore elections are counted here, whether they are enthusiastic or not. This issue had finally reached a critical mass of voters who were willing to take the plunge and address it before it went too far. So, now that they've done it, will this change drag the entire rest of the economy along with it? The first signs indicate that the market has cooled down considerably. According to CoreLogic, which runs the main national home value index, national figures fell 0.7% in July, the biggest monthly drop since December 2022, leaving prices about 1.4% below the peak reached in March before the budget was passed. In Sydney, prices have fallen by 4% in 3 months, in Melbourne by 3.4%, the successful auction rate in Sydney has fallen below 50%, and there are
significantly more houses on the market than usual, with listings 6% above their 5-year average. It is also quite clear that it is investors who are leading the retreat. New loans to investors fell 5.3% in the March quarter, and preliminary data from brokers suggests mortgage commitments fell sharply again in June as soon as the changes were on the table. Many buyers and sellers are simply taking a wait-and-see approach to see what happens next, so auctions are constantly being canceled and new listings are becoming fewer. Of course, a major correction from here would still be very risky, but there are some mitigating circumstances. Ironically, given all we've said about intergenerational inequality, much of the housing wealth here is
concentrated in the hands of elderly homeowners with very small or no mortgages. At the time of these changes, less than 1% of households with mortgages had negative equity, and loan debt was at pre-pandemic lows, giving the system a reasonable margin of safety to withstand a downturn. It also helps that the declines are so far concentrated in the expensive segment of the market, where investors have been, while the cheaper segment, where the majority of first-home buyers are actually located, remains relatively stable. However, as always, the ones who will be hit hardest by this are those who bought their home most recently, perhaps with a 5% down payment under the government's expanded first- home buyer program, and are now watching the
most expensive purchase of their lives depreciate in value. To be fair, the Treasury's own models predicted that these changes would only slow price growth by a few percentage points over a few years, but the market has reacted much more sharply so far. So even those who developed this policy are partly in a state of waiting. In the short term, this looks like a gradual slowdown rather than a crash, but it is too early to draw conclusions, and both the government and banks will be watching the spring sales season with anxiety. So, yes, Australia is currently conducting an experiment that no other high-end real estate market in the world has dared to do- deliberately removing tax fuel from its market to see what happens. And for those without an investment
portfolio, cheaper housing, all else being equal, means fewer mortgages and more money for those sectors of the economy that actually create something. Even if it never feels like good news when prices drop in your own neighborhood. But the real question is whether we can withstand this correction, which we ourselves consciously initiated. Because every month of falling prices will be a test for a country that for 30 years believed that housing prices could only move in one direction. We've already made a separate video about why it's so difficult to build more homes in Australia and why property prices have become so skyrocketing in general. So we didn't want to repeat ourselves, but if you're interested, you can click on the link on the
screen now. Thanks for watching, friend. Goodbye.
