ABC The Business on Negative gearing

[VYBerlinaV8]

Negative Gearing will decline in popularity as property prices continue to soften for the next decade or two.

What is the point in making a negative return on a devaluing investment.

Decade or two? Nope, you've got maybe 5 years, 7 at the most.

 

[Francesco]

But you beat the tax man. I know, people think they still win, even if they lose.

If you are on high income you can come out ahead on a negatively geared property.

 

[lyndon01]

You're only ahead if the asset increases in value more than your income loss. If you're on a high income then you might be halving your loss, but you're still losing money. If the value of the asset doesn't rise more than that income loss you're still losing.

 

[flatout81]

Here is how negative gearing works as explained by Paul Clitheroe -

Lisa, a property investor, buys a unit for $300,000, putting in $50,000 of her own money and borrowing the remaining $250,000. The interest of 7% each year is $17,500 and the weekly rent is $300 or $15,600 a year.

Financial flexibility

Ongoing costs including rates, water, insurance, maintenance and depreciation allowance are $2600 each year. After expenses, income for the year will be $13,000 ($15,600 minus $2600), equivalent to a net rental yield of 4.3%. However, annual interest repayments are $17,500, so she has actually lost $4500 during the year ($17,500 minus $13,000 = $4500).

In this example, the investor can reduce the tax liability on her other assessable income by the investment property’s loss of $4500. If the investor is on the highest marginal tax rate of 46.5% (including the Medicare levy) this tax deduction would have the ultimate effect of reducing the real loss on the property from $4500 to $2408 ($4500 x 46.5% = $2092; $4500-$2092 = $2408). This is a good saving.

If an investor is on a lower rate of tax of 31.5% (including Medicare levy) the after-tax loss on the investment would be reduced from $4500 to $3083 ($4500 x 31.5% = $1417; $4500 - $1417 = $3083). The saving is still quite attractive.

Most people accept a loss in income because they believe it will be more than compensated for by a capital gain down the track. But you need the financial flexibility to fund a cash-flow deficit while the property’s gain accrues. You don’t want to get 18 months into a property investment to find the cash deficit is intolerable.

Compensation need

The calculations are helped by the fact that long-held capital gains are only half assessable. In addition to the simple income deficit, based on the excess of loan interest over rental yield, the investor also needs to be compensated for what they would have earned if they had simply put their money in the bank.

If they deposited the $50,000 into a bank term deposit at 6% and paid tax they would earn $1605 net. So the investor needs a net capital gain of $4013 ($2408+$1,605 = $4013). For the 46.5% tax payer to net a gain of $4013, the property needs to appreciate by $5228 (4013 divided by (0.5 x 46.5%)). This is equivalent to an appreciation of 1.7%. For the 31.5% tax payer the similar calculation gives 2.1%. What does this mean?

Well, if the property market is flat or only slightly positive, the strategy is no better than putting the deposit in the bank. But if property is appreciating healthily the strategy is sound. Over the long term property prices have tended to stay a little ahead of inflation, which the Reserve Bank strives to keep in the zone of 2%-3%. So normally you could count on enough price appreciation to make it work.

One caveat is to avoid optimistic property markets, characterised by low rental yields and inflated prices. Buying at an inflated price will make the strategy go pear-shaped. The rental yield will be low, necessitating a higher break-even rate of appreciation, but the future price trend from an inflated level is often flat or down, at least in the short term. This is the bind that some investors over recent years have fallen into.

Conversely, after property has declined and when rents are tightening, negative gearing is more likely to be effective, as long as interest rates don’t get out of hand. The break-even rate of capital appreciation is directly linked to the rate of interest on the loan, so as interest rates go up, the property market needs to move ahead more quickly.

http://finance.ninemsn.com.au/pfproperty/investing/8123730/negative-gearing-explained



A loss is a loss. Negative Gearing reduces that loss which the investor "hopes" will be offset by an increase in asset value.

So is NG gambling or investing .....

 

[Aaron_C]

A loss is a loss. Negative Gearing reduces that loss which the investor "hopes" will be offset by an increase in asset value.

So is NG gambling or investing .....

So businesses who start up with the hope of making a profit, but incur losses in their first few years of operation are potentially 'gambling'? I suppose you can say everything is a 'gamble' with such a loose definition.

 

[flatout81]

Definition Gambling - An act or undertaking of uncertain outcome

A investment which income exceeds it's expenses can be certain it will make a profit.

NG property is uncertain if it will increase in value which it requires to turn the operating loss into a profit which makes it gambling per the above definition.

 

[Aaron_C]

Definition Gambling - An act or undertaking of uncertain outcome

A investment which income income exceeds it's expenses can be certain it will make a profit.

NG property is uncertain if it will increase in value which it requires to turn the operating loss into a profit which makes it gambling per the above definition.

And business is....certain? Far from it. The only thing certain in life is that you will die.

 

[flatout81]

If I buy something for $1000 and sell it to you for $1200 I am Certain I will make a profit.

 

[turk]

If I buy something for $1000 and sell it to you for $1200 I am Certain I will make a profit.

Not if I don't pay you

 

[Ed Barton]

Definition Gambling - An act or undertaking of uncertain outcome

By your definition any investment is gambling.

I own properties, shares and other assets. Regardless of whether I have borrowed to buy them I can not be certain of the outcome. My properties might sit vacant or burn down or the companies I invest in may go broke.

 

[flatout81]

Not if I don't pay you

That is where a contact comes in

Without going off on a tangent, the comparison is between an operating profit making venture versus an operating loss making venture that relies on external factors for it to make a profit.

 

[The Fence]

You are not certain about selling that product to anyone, let alone make the $200 profit. You think there are no external factors influencing your scenario...?


I can say I neg gear an IP and in five years time it will increase in value to above and beyond my losses. Im actually certain about that.

Anyone can say anything.

 

[flatout81]

By your definition any investment is gambling.

I own properties, shares and other assets. Regardless of whether I have borrowed to buy them I can not be certain of the outcome. My properties might sit vacant or burn down or the companies I invest in may go broke.

Not my definition -
http://www.thefreedictionary.com/Gambling


Products that suit their specific market will either not have these problems or have risk mitigation strategies to negate these issues.

Quite easy to insure a property against fire however I am yet to find someone that will insure against property devaluation.

 

[Angel]

Not my definition -
http://www.thefreedictionary.com/Gambling


Products that suit their specific market will either not have these problems or have risk mitigation strategies to negate these issues.

Quite easy to insure a property against fire however I am yet to find someone that will insure against property devaluation.

Quite easy for an insurance company to refuse to pay out when there is even a smidgeon of a chance the fire was suspiciously caused.

 

[flatout81]

You are not certain about selling that product to anyone, let alone make the $200 profit. You think there are no external factors influencing your scenario...?


I can say I neg gear an IP and in five years time it will increase in value to above and beyond my losses. Im actually certain about that.

Anyone can say anything.

The structure for a profit based venture is certain. If you sell the product for more than it costs, you will make a profit. That is not to say the product is or isn't certain to have demand.

You have no certainty or control over a NG property making a profit.

 

[Angel]

You have no certainty of any product making a profit.

 

[flatout81]

Again my point isn't about the product, it is the structure.

 

[Ed Barton]

Not my definition -
http://www.thefreedictionary.com/Gambling

It's the definition you put forward. Would you like to change it? According to the definition you put forward any, and all investing is gambling.

Products that suit their specific market will either not have these problems or have risk mitigation strategies to negate these issues.

Markets change, often very quickly. "Products that suit their specific market will either not have these problems" - until they do.

Quite easy to insure a property against fire however I am yet to find someone that will insure against property devaluation.

Quite easy to insure a property against flood too. Tell that to the people who thought they were covered but weren't.

Let me guess? Gold as an investment is not gambling?

 

[flatout81]

You can't help those that won't to listen.

If you don't get it I wish you the best of luck with an operating loss making structure that requires high growth to make a profit when at best we will be in the current low / negative growth conditions for the foreseeable future.

Those who realize the faults with this type of structure whom have a good product and adapt to an operating profit structure (of any type) will have a prosperous future regardless of the level of growth.

 

[Aaron Sice]

You can't help those that won't to listen.

indeed.....you can't.