Australian housing was already cooling before the budget – but how cold it gets depends on two key factors

Most economists believe the chronic undersupply of homes will eventually push prices higher once interest rates ease and the tax changes are priced in

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The government’s property tax changes have become one of the defining political issues of Labor’s second term, drawing fierce criticism from opponents who argue they represent an “assault on aspiration” that will destroy home values.

In the three weeks after the negative gearing and capital gains tax changes were revealed in the 12 May budget, housing data has begun to show how they may affect Australia’s property market. Here’s what the data shows, and what could happen next.

Impact on house prices ‘comparatively modest’

A lot of the heat was already coming out of the property sector leading into May due to interest rate hikes, constrained household finances and an oil crisis, all of which tempered buying activity.

This was especially true in the country’s two biggest housing markets, Sydney and Melbourne, which had recorded modest price falls.

Prices in the state capitals started to tick up in early May, before reversing after the budget, leading to a flat month overall, monthly pricing shows. Sydney and Melbourne went negative.

The budget date is significant because investors buying after 12 May will not be able to negatively gear their properties beyond mid next year, with the notable exception of those buying new homes, a feature designed to encourage more supply.

While Treasury expects the tax changes to create a two percentage point drag on property prices over two years, AMP chief economist Shane Oliver is forecasting a 5% hit over 12 months.

That is to say, in Oliver’s model, if prices were going to be flat over the coming year without Labor’s changes, they will now be down 5%.

“The impact will be fairly quick, it won’t be occurring over 10 years, it will happen over the short term,” says Oliver.

“Investors will hold back in the near term until rental yields improve.”

The market reaction to the budget changes has been faster than expected, according to Commonwealth Bank economists, which increases the chance of a sharper near-term slowdown in prices.

But CBA says the impact is “modest” compared with interest rates, housing supply and population growth, making the tax changes a secondary, or even third or fourth ranking influence on prices.

Low housing clearance rates

There’s strong early evidence to suggest Sydney will suffer the bulk of any price drag caused by the tax changes because investors are so active in NSW.

Investors take out more than 43% of housing loans in NSW, which is well above the national average. At the same time, Sydney rental yields – rents as a percentage of a property’s value – are the lowest in the country.

Without negative gearing, the investment thesis is no longer so attractive in parts of Sydney, which is exactly what the reforms are supposed to achieve. This will allow more room for first home buyers to compete in a market they have largely been priced out of.

Rental yields are also modest in Melbourne, which might help explain its May price drop, although investors aren’t nearly as active in Victoria as they are in NSW.

“Sydney is a high-priced market, which means the yields are very, very low,” says Nicola Powell, chief of economics and research at Domain.

“Overnight, the budgetary changes have completely morphed investment decisions, because it means that investors will be now be looking towards more positively geared homes,” says Powell, referring to properties where income exceeds expenses.

The pullback from investors has pushed already low clearance rates – the percentage of properties successfully sold – to levels not seen since the early pandemic, at below 50%.

Tim Lawless, executive research director of Cotality’s Asia-Pacific division, says it’s rare to see clearance rates this low.

“Clearance rates were easing well before the budget; we’ve seen interest rates rising and confidence eroded substantially because of the oil crisis,” says Lawless.

“The budget then probably amplified that lack of positivity.”

Interest rates and housing supply

Any price pullback caused by the tax changes won’t be uniform, with homeowners in areas of previously high investor activity expected to record larger falls in value.

Those properties with limited interest from owner occupiers may see double-digit falls, as they will be largely un-investable until values drop materially. Parts of Adelaide and Brisbane, as well as Sydney, have been bid up by investors, making them susceptible to price drops.

This will contrast with homes sought by owner-occupiers, which should see strong demand that will limit any price weakness.

What happens next will largely be determined by interest rate movements, which are acting as a headwind, and supply shortages, which should limit any price falls.

Most economists believe Australia’s chronic undersupply of homes will eventually push prices higher once interest rates ease and the tax changes are priced in.

There have been three interest rate rises this year, and two out of the “big four” banks expect at least one more increase in 2026.

While the national market has shifted in favour of buyers, Australian homes have not suddenly become affordable after 25 years of price growth that has far outpaced wages.

Elevated mortgage rates are reducing borrowing capacity, making homes more difficult to buy, and mortgages more expensive to repay, even if the property has had a price cut.

Jonathan Barrett is Guardian Australia’s business editor