Is negative-gearing really worth it?

Discussion in 'Property Investment - Other' started by 1c3m@n, 19th Jun, 2008.

  1. 1c3m@n

    1c3m@n Member

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    hi, i'm new to this forum as well as to the world
    of IP so pls bear with me...in other words, 'be gentle':D

    actually wanted to start posting about something more basic, but this is one
    of those that i've been really curious about for some time so thought i might
    as well jump into it.

    in fact, i don't even know how to best phrase this, but here it goes...

    if i buy an IP and it turns out to be negative-geared, will the advantages
    outweigh the disadvantages? actually apart from owning a property in the
    end and reducing my taxes for several years, what other advantages does
    it bring? and what i mean by disadvantages is, for example, will the interest
    that my loan earned be (possibly) so much more than the value of my IP?

    i currently don't have an IP, but i'm strongly considering getting one with
    the help of my friendly-neighborhood-lender of course. as you probably can
    tell, i'm not knowledgeable on most of these things yet so i'd really appreciate
    any help i can get.

    lastly, is there some sort of calculator that would allow me to simulate IP
    scenarios, particularly negatively-geared ones? thanks in advance!

     
  2. Token Funder

    Token Funder Token Funder

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    Personally - and I suspect I am in the minority - I have never believed that it is worth spending $1 to earn $0.50.

    Negative cash-flow is not something I have ever been particulary confortable with.

    That said, if you're betting your bundle purely on cap gain, the taxpayer provided subsidy helps you hold your breath while you await pay day.
     
  3. jaycee

    jaycee Member

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    Most pple have to borrow money to buy a house (got a psare $100k cash lying under the mattress !)

    So people borrow & pay the shortfall not covered by rent, yes, hoping the property will go up - but why would you buy it otherwise with a view to selling it or living off it in one form or another ?

    The tax return on the yearly losses make it more manageable along the way
     
  4. troyhunt

    troyhunt Member

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    If it's a buy and hold style investment you need to put it in perspective. For simplicity sake, you might buy a $200k property which is negatively geared with a net negative cash flow of $2k annually. At a 5% growth rate that first year achieves $10k of capital growth. Assuming you can fund the $2k deficit you're now ahead by $8k in real terms. The perception of spending of spending $1 to earn 0.50c usually ignores the capital growth component.

    Over time the cash flow deficit decreases as rents increase and the capital value compounds so the value increases more each year (again, simplistic view as not all years are going to grow equally if it all). You might find the negative cash flow state of the property only lasts for 5 years.

    There are a lot of variables which change things either up or down but you get the idea. Negative gearing can certainly be extremely beneficial if you're comfortable dealing with a short term cash flow deficit in order to make a larger long term gain. Start by educating yourself and being comfortable with the strategy before diving in and I'm sure you'll be fine.
     
  5. cgw

    cgw Member

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    Hi,

    I know how you feel. I was exactly the same 2 years ago. Read, Read, Read, Invest in real estate, blue chip shares, and Super - long term it is better than leaving your money in the bank or spending it on things that can wait for a few years. In 10 years time you will see the rewards.
     
  6. 1c3m@n

    1c3m@n Member

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    Thanks! Your reply gave me a different perspective. I agree that people tend
    to forget about the capital growth component, but maybe some are just less
    of a risk-taker than others.
     
  7. WillG

    WillG Member

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    You also need to look at each property in the perspective of your whole portfolio. Some may be cashflow+ while others might be CF- or neutral. You need to balance/manage your cashflow and get growth at the same time
     
  8. jaycee

    jaycee Member

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    Looks like 6 years for my first to become cashflow + (4 down.. 2 to go)

    A bit long ? (I did borrow 100% though, with my ppor as collateral, which has since been removed)
     
  9. Bon

    Bon Member

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    Historically, it shows you can expect an average growth of ~10% p.a on your property.... you have the benefit of leverage through property - e.g. ~10% growth compounding on $300k for only an initial deposit of $30k, plus holding costs to cover the rent shortfall.

    In 10 years time if a $300k house is worth $600k, do you reckon you would have been able to make that $300k difference from your original $30k through saving and investing, etc.? It would take a LOT of time and effort to do so... Even if you combine your $30k with margin lending you have about $100k in the market, that is still far less than the value of your property.

    I say buy your property(ies) and then draw down on the equity to stick it in the market, to diversify your portfolio and have the best of both worlds.

    You don't buy properties to "negative gear" or for "tax breaks"... you buy for the capital growth on a large amount of money you couldn't possibly summon up on your own... cash flow properties are a nice thought, but I am not so sure good, long-term prospects are easily obtained in the current market with interest rates sitting at close to 9% and average gross yields of around 5-6%... you can buy out bush for a higher yield, but that would break one of my golden rules of buying in a capital city since they have the economy and population to support the growth that smaller cities may not.
     
  10. Ana

    Ana Member

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    It should come down to what you are trying to achieve.

    One of the main points of difference is whether your primary objective is to create CASH or CASHFLOW.

    Let me put it another way.. There are many strategies that an investor may utilise in their investment journey. Some of the main ones are:
    Buy
    Buy/Reno
    Buy/Subdivide
    Buy/Develop

    and many combinations of the above as well as other creative variations. Any of these strategies can be applied with a Hold or a Sell at the end.

    If a person is interested in creating CASHFLOW through generating income they are more likely to go want to HOLD after their chosen strategy.

    They might also initially have negative gearing, which can be made positive or netural through using ADD value strategies to then increase their return, as well as depreciation schedules, and like mentiond the natural increase in value over time also will play a part here.

    The investors that are chasing the straight out CASH return favor SELLING after their chosen strategy. These are more often then not negatively geared due to the high profit margins they can generate in a small period of time.

    Let me give you a real life example. A deal is bought for $400,000 which has two street frontages and two houses already on it. The return is not great, combined they return $430 per week. However after the first 6 months, $20,000 was spent renovating them which increased the rent return by about 30% and increased the valuation of the deal to $540,000.

    Then on top of that there is the option to subdivide, or there is the option to demolish the existing dwellings and build 5 townhoses on the block which has already received a nod from the council. Those could then be sold or rented or a combination of the two. Or it can be sold with its potentials to another investor. There are many valid choices each with their own set of advantages and disadvantages.

    So would you not consider doing such a deal, just because it is negatively geared to start off with?

    I'd like to suggest that there is no true right or wrong strategy. There is only the right and wrong strategy for a particular deal within a particular set of circumstances.

    Sifting through the duds to find the dimonds requres detailed analysis. To build ongoing and repeatable success, you should get in the habit of doing number crunching for each deal that makes it past the initial pre-inspection analysis and aligning it with your investing goals.

    There are a number of tools out there that will help you analyse and number crunch deals to work out their profitability. These are well worth investing in and using to help decide on and compare deals for all strategies when you get past Buy/Holds.

    I would also like to suggest that if you spend the time to define what you are trying to get out of investing and set some firm investment goals, you will naturally start to align your search criteria for finding and assessing deals to fit within actually meeting your goals.

    I hope this has helped.

    Ana Stankovic
     
  11. normailson

    normailson Member

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    Great question!

    Hi 1c3m@n,

    This is an incredibly pertinent question given the current tax changes and slowing of capital growth. A sensible question and I don’t think it’s basic at all.

    The question perhaps should be “will negative gearing work for me” rather than “Is negative gearing worth it?”

    Firstly, as has already been pointed out, you don’t negatively gear for a tax break. It is a tool used by property investors to create wealth. If you do it just for a tax break without focussing on the fundamentals of property investing, it will most likely not be worthwhile.

    Secondly, you must have, or expect to have, capital growth. I negatively geared a property for ten years and because the CG was so poor, it was barely worthwhile for me on that one property.

    Thirdly, because tax deductions are calculated at your marginal tax rate, it depends on how much you earn. If you are in the highest tax bracket, you get the maximum deduction.
    A lot of people have no idea how the lowering of marginal tax rates will actually create a shortfall as deductions are decreased when they are no longer in the higher tax bracket. This shortfall means that investors need to look for higher returns or wear a bigger cash flow shortfall in their lifestyle. (And since you are still to buy property this gets harder to do if interest rates go up and rents trail behind)

    The more you learn, the more you can decide on your risk strategy because at EOTD the reward has to be worth the risk. A $200K investment loan at an interest rate of 8% and a marginal income tax rate of 30% provides a deduction of $4800. (200K * 8% * 30%)

    Read the forum. Read Jan Somer’s books – her “More Wealth” one is very comprehensive. Also, do some research on "depreciation".

    Your question shows that you are thinking the right way.
     
  12. jingo

    jingo Long Term Investor

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    Hi,

    Many good thoughts have been expressed above. As has been explained, negative gearing is a tool which can be used to build a property portfolio over time. When I first started investing in property, I thought that negative gearing was the best thing since sliced bread. I was attracted to the idea of reducing my taxable income. I managed to buy an investment property which has produced excellent capital growth. That investment is almost neutrally geared now. The growth in the property has enabled me to buy more properties. These are currently negatively geared.

    In order for a negatively geared strategy to be successful, I think careful consideration must be given to your goal, and where you want to end up. My own goal is to build up an income producing portfolio that will enable me to have either an early retirement, or a comfortable retirement later in life. Negative gearing will not achieve that goal in itself, but it will help me to build up a portfolio of growth properties.

    My own personal goal now is to invest in asset classes that will produce a high yield. Mostly to offset the my -ve gearing, and enable me, over time, to wind down my work.

    Regards Jason
     
  13. Lukey13

    Lukey13 Recently Retired

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    Hi jaycee

    Can I ask, do you mean that after you had sufficient equity in the revalued IP, that you transferred the second loan against your PPOR (as collateral for purchase of the IP - I'm guessing 20% to avoid LMI) to be secured against your IP, thus not tying down your PPOR?

    Just curious as I've got two loans for my IP; one secured against PPOR (20% of IP cost). I'm guessing after a year or so it might be better to change the security of this to the revalued IP itself to free up my PPOR (or next PPOR) to use for other IP purchases. Although, does it really matter if I can just borrow the "new" equity from my revalued IP to purchase other IPs anyway? :confused:

    Might just get a bit messy after a while though!!
     
  14. evand

    evand Member

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    10 years!! Who wants to put money into a house with for 10 years? To me thats madness.

    You should only negative gear a property in a rising market. Property prices can stay flat or even negative for a looong time (look at the 90s) and most people sell out waiting for growth, sick of the constant drain on their cashflow and limiting life choices due to the negative cashflow.

    Is it investing? Or hoping?



     
  15. troyhunt

    troyhunt Member

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    This seems to be a very black and white discussion; you're negatively geared or you're not. The reality is there is a hell of a difference between being geared so you're shelling out $10k a year as opposed to $2k a year. If you're risk averse, don't take the $10k option!

    The fact that prices can flatline is as much an issue with negative gearing as it is positive gearing. Neither structure is affected by capital prices until you either refinance or sell. Investors waiting for cashflow are waiting for rental increases, not capital increases.
     
  16. evand

    evand Member

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    I disagree. If you're positive geared it doesn't matter what price growth is doing as its not costing you a cent and you are actually making money.

    In the meantime you know that property prices will eventually rise as they always do long term.

    At least with pos. gearing you have the choice to hold or sell, it doesn't matter as you wont be forced to sell. You could be at some be at some stage if you are neg gearing. And possibly have to sell into a flat or falling market with little liquidity and have to take a loss as has been seen a few times on the forum lately.

    If those guys were pos geared or even neutral they wouldnt have had to sell and take a big financial hit.

     
  17. topcropper

    topcropper waffleing speculator

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    So evand, let me get this right, your going to wait till you can buy property that is positively geared? So at current interest rates, we would need say 13% rental yields? Is this correct?
    edit. hmm. Maybe less than 13% with tax benefits.

    When did you last buy positively geared property and where was it?

    I think it's not rational for investors to be able to buy growth assets that are positively geared. Growth assets should be negatively geared in an efficient market I would think. The few times growth assets are also positively geared are a bit of an anomaly I believe.



    Even farms? Farms only have a low return historically. History would show farmers returns at only say 5% of assets. So farms are negatively geared. The only thing that makes farms an investment is the capital gain of the land. Farmers and everyone knows that agricultural land will always go up [in the long term], so they buy land priced so that it has a low return. A 5% income return, with a 7 to 10% capital gain on the land, and a farm is a nice investment. If farms were not a growth asset, the land would be cheaper. If agricultural land had zero capital gain, then the market would adjust the land prices, and the income return might be 13% or higher.



    Plenty of resi property could be positively geared in the late 90's. I think this was an anomally. It was caused by the high interest rates 10 years earlier. It took 10 years for the horror of that time to be forgotten by investors.

    I just think positively geared quality property shouldn't really happen. Maybe it will again with a massive recession?


    I'm not saying your strategy is wrong mate. Just looking for a discussion. You might be right.

    See ya's.
     
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  18. buzzlightyear

    buzzlightyear Member

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    Worked in property management in the mid 90's in the Preston, Northcote, Thornbury area, most properties were returning around 5%-7%. Some larger homes were less.

    At times, people have made commentary about positively geared property in the 90's, but I still believe it was still the exception rather than the rule, even then.
     
  19. topcropper

    topcropper waffleing speculator

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    Thanks buzz.

    Property in the rural towns near me would have been say 10% rental yields in the late 90's. Little crappy houses in the bad side of town maybe 15%. Today in these same towns the rental yields would be lucky to be 5 or 6%. If rents keep going up in Sydney, soon the rental yield of Sydney will be higher than bush towns..!!

    Go back to the 80's and 70's when interest rates were higher, and rental yields would have to have been 16% or more at times for positive geared property.

    I would like to know how often quality property has ever been available in Australia that allowed positive gearing? Not very often I would think.

    See ya's.
     
  20. handyandy

    handyandy Member

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    Hi tc

    As you say the +ve property was an aberration where an OK return at maybe 7-10% and a low interest rate met. It was only the low interest rate that created the positive return as really the returns from property have not moved much until recently.

    Just to put a bit of anecdotal history on the table. From '85 through to now. We saw standard return
    '85 at about 10-12% but the interest rates were approaching 13-14%.
    '89 returns had fallen to 10% interest rates were up to 17%.(one of my loans went up to 24%)
    early '90's returns fallen to 7% maybe even down to 5% interests rates about the 15%

    Its only the late '90's where we then had interest rates hitting the single digits that we now start getting the appearance of positive properties brought about by the convolutions of the returns and ;lower interest rates coupled with a long term depressed market desperate to sell properties that hadn't moved in nearly 10 years.

    These comment reflect the general market and obviously anomalies existed which created opportunities.

    Cheers
     
    Last edited: 20th Jun, 2008
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