Negative gearing - WHY???

[rugrat]

Ok, so I am new to the world of property, having only just bought my first PPOR five months ago. But I have been doing my research, and am begining to understand some of the basic principles. My hubby and I are literally 'mum and dad investors'. Although don't let the title fool you - we both hold commerce degrees and I also have a law degree, so we also have some formal education to back us up.

Now I understand all of the tax benefits of Negative gearing. But my question is it really all that everyone makes it out to be?? So far EVERYONE I have come across has gone on and on about the benefits of negative gearing, and how a good strategy with property investment is to use the equity in one property to finance another (or variations of this). Now I can certainly see some benefits.

BUT surely, if you are not looking to get rich quick, but rather a stable longterm investment for your kids education and your own retirement (doubly important to me being a SAHM with little or no super contributions thus far), then would it not be better to pay off your properties, so that after maintainance, REA, tax, etc, all rental income goes dierectly into your own pocket.

Yes you are missing out on some tax benefit (quite substantial ones sometimes), but if there is no debt then the income is 'profit'. So looking at it this way, would it not be better, more stable and secure to own say 3 IP's outright, then own 5 heavily mortgaged?

Like I said I am new at this, so maybe I have missed something important???

 

[Nathan]

negative gearing is old school with these interest rates...

negative gearing is sold by sharks who only have that tool to use to flick an investment that has no other atributes....

i do not like negative gearing....

I had a twirp the other day when i was buying a video camera, for business purposes, he goes oh you will get 70% back from tax... 70% back, i looked @ him and told him not to use that line as he will get himself into ****... point being people dont do their sums and throw out stupid lines as the above to sell an item...


Only time where i see neg gearing decent is when the out of pocket expense is minimal, or you have exuberant income, where your not structurally set up correct, and you end up paying heaps in tax, and you decide to buy a prime peice of real estate..

 

[wylie]

In the suburbs we have chosen to invest, we have always ended up negatively geared. Over the years, this turns to neutral and then positive and we go again.

I don't really think about it. It works for us and has given us the opportunity of having a very comfortable retirement.

It is not for everyone, and we could have used different strategies to get ahead, but we like to stick to what we know.

 

[rugrat]

Nathan - That is what I have been thinking. It just seems that when I 'talk' to anyone about property investment, everyone scoffs at the idea of paying off/down one mortgage before investing in the next property. And so many have ranted on about the benefits of negaive gearing, over and over and over...

I have been told on numerous occasions that I shouldn't pay off my mortgage over any IP or put extra onto the mortgage, but rather to use an offset account - then main reason being so that I can use that money to invest further. But whilst I can understand why others may do this to build up their property portfolio - I cannot see how it would benefit me more then owning the property outright. If I own it outright (or close too) the risks are greatly reduced, not to manteiont the benefits of interest saved - I have time on my side, being in my mid-20's and am not looking for an income atm, DH has a good, stable, well paid job. This is purely an investment for our later years, when the kids are going off to uni and we are looking to retire and probably travel.

BUT whilst my logic makes sense to me, with so many touting the benefits of multiple mortgages and the tax benefits of negative gearing, I cannot help but wonder if in my inexperience I am missing something...

 

[LynnH]

rugrat

As far as negative gearing goes, I believe it is a case of what suits each individual given their own unique circumstances and taking into account the general economic climate at that particular point in time. As Nathan has pointed out, with the current low interest rates, negative gearing has gone out of fashion, so to speak.

We have used NG quite aggressively in the past to buy undervalued property in near-city locations and have been rewarded with excellent CG. We have used equity from other properties to finance these purchases. At present, our strategy is to pay down these loans, reduce LVRs (which are not high) even further, and position ourselves to purchase again when we see value.

You make a very good point about 'paying off your properties so that the net income goes directly into your own pocket'. Certainly, that would be best for some, given the individual's income level, SANF, other commitments (e.g. childrens' education) etc. Others (ourselves included) have no need of the property income and are happy to reinvest it and build their portfolios.

Negative gearing is certainly not the only answer to building a property portfolio. It works for some of the people, some of the time. It certainly does not work for all of the people all of the time.

Cheers
LynnH

 

[sash]

I am largely with Nathan on this one. Whilst I don't mind a property being slightly negative geared....having large negative gearing shortfalls is a wealth hazard as it kills your serviceability and thus the ability for your to borrow more.

For example I bought a property at Deception Bay fro 235k and borrowed 226k (LMI capitalised). This is negatively geared ....but technically it is positively geared due to depreciation.

The numbers and expenses are as follows:

Rent at $270pw - $$14,040

Loan Interest (at 5%) - $11300
Rates (council & water) - $1850
Mgmt Fees (7.15% all incl.) - $1005
Repairs (estimated) - $400
TOTAL EXPENSE - $14,755

Thus the shortfall is $715 but once depreciation of $1500 is factored in, it is positively geared to something like $5 per week.

The rent goes up $10 in another 2 months...so is almost self funding even without depreciation....by year end it is self funding with just a $5 increase.

 

[stumunro]

Let's be honest, up until 6 months ago how many of you were buying positive cashflow property on 106% finance and interest rates.

At best western suburbs property were still short $100 per week.

It's not as if you guys were kicking in bigger deposits to gear the loan positive, which is what the original post is about.

 

[Dazz]

don't let the title fool you - we both hold commerce degrees and I also have a law degree, so we also have some formal education to back us up.

Fear not rugrat, I'm not fooled one iota by your formal qualifications. They mean absolutely diddly squat in the harsh reality of investing. Flash CV's mean nothing in the bullpit. I suspect the vast majority of wealthy people in both Oz and the world have no qualifications at all.....if anything, they may be a hindrance to you both.

IMO, the answers to your questions are ;

1. No it would not.

2. No it would not.

3. No, you are not missing something, you are missing a bunch of stuff.

 

[Witzl]

Rugrat,

I think you are looking at this wrong.
You are looking at it as:

• Paying off the IP mortgages, OR
• Negative gearing.

You are not recognising that there are many many ways to invest in residential property beyond these two methods.

The method that I use (and many others) is neither of the above options. I dont rely on negative gearing at all - neg gearing is just a nice little "bonus" you might get back at the end of the financial year

I do all my sums prior to tax advantages. When i look at a property, i look at it's cashflow and decide if i can afford the cashflow on it - and if it is negative, do i see some significant CG to more than make up for the cashflow drain.

I dont pay off my mortgages. Rolf Latham made a VERY good post on the "pay off mortgage VS interest only with offset account" argument.
Please read post #8 in this thread - http://www.somersoft.com/forums/showthread.php?t=50708

Growth in equity through CG is going to be much faster and greater than what i can achieve out of my own AFTER tax dollars... so i just pay interest only, and any extra cash i have goes into an offset account to help reduce that interest repayment.
This allows for maximum flexibility, so that when i find another property that is a great deal - i can almost instantly pull my offset account money out and purchase it.

Also - when a property i own goes up in value significantly, i refinance it at the new higher value, and put the extra cash into the offset account. This means i am still paying the same interest bill... but i now have that "drawn down" equity available in an instant if the deal of the century comes along..... or as a risk management strategy should i lose my job or interest rates go thru the roof.


there is much more to property investing than negative gearing or paying off a mortgage
How you do things exactly depends on your sleep at night factor (SANF)

 

[Aaron Sice]

i feel neg gearing is great for lowering a tax bill - that said, for me i'd want to be paying stupid high tax to want to do it - at least you're getting something for your money, even if it IS only 30% of what you paid out.

gone are the days of neg gearing because values are increasing out of sight. i remember in late 06, the average Perth median was increasing $100 a day. if you were neg geared less than that - then it was considered "profit".

i see, and have always seen, CF+ deals as a better alternative. use OPM (ie the renters) to pay down your debt further with the surplus income and get your LVRs down nice and low then go for it again. no impact on you at all - you could lose your job and still hold the properties.

i see CF+ deals GREAT for SMSFs - and with a fixed rate below a property's yield then you're laughing all the way to 55.

 

[BayView]

Personally, I would always choose pos gearing if it is possible. But, this is very difficult to do with property from day 1; especially in an area with good prospects for cap gain.

Those who know me know I will espouse the benefits of pos cashflowed after tax, as opposed to neg gearing.

Why?

Because neg gearing is making you run your IP's at a CASHFLOW LOSS when there is absolutely no need to. Just because you can do it, doesn't mean it is smart financially.

However, if you are a person who is just starting out and only knows about neg gearing, then it is not such a bad thing. It is better than doing nothing.

Neg gearing means you are required to inject some of your after tax income into the IP to pay back some of the loan after rent and tax deduction shortfalls.

Call it a forced saving if you like. The alternative is to put the money into the bank in some sort of savings account, and we all know how cr@p that investment is, or put it into your super or shares.

To be neg geared instead is a far better long term option than savings and for most people they are happy to do it.

We are all gunna spend $100 per week on some other type of doodad otherise, so we may as well put it into an IP and slowly get rich off it.

But, much of (successful) investing is about knowledge. The more you know, the more you can increase your investment returns.

Why would you then continue to choose neg gearing if you can be pos cashflowed, and free up those funds which would otherwise be used to service the shortfall? This does not make sense to me.

If you are pos cashflowed after tax, that $100 per week is suddenly yours to do whatever you like with; debt reduction, another investment of some sort, a holiday etc.

We have used these funds for debt reduction. This was our choice. It has been a very good strategy. It has allowed us to accelerate our equity wthout risk, and created extra cashflow with which to reduce debt further.

I don't agree with those who advocate never paying down investment debt.

It is still debt.

Yes, it is tax deductible, but it is an expense, and expenses eat into your cashflow and slow down your ability to create wealth.

The counter-argument to this is "oh, but you can put the money you would use to pay down the debt into another investment that will make more than what you will reduce the debt by"...

This may be true, but it is not a guarantee. Paying down debt is a guarantee. You will only get richer from it. And it is safe.

Don't forget; when you pay down debt, not only do you increase the equity and increase the cashflow, but you also save on future interest.

 

[Dazz]

What you are all talking about Marc is simply leverage, and the scale along that lever. You advocate a small lever that you can easily control. No worries. Others prefer a huge lever that is unweildy at best, and downright dangerous at worst.


More buckets out in the weather, to catch rainfall when it rains. Having holes in the buckets is a necessary evil to have the good buckets in the first place.


Having 5 little buckets with no holes in the bottom, is nowhere near as good as 10 big Olympic sized pools with a few cracks in the bottom slowly leaking away. When it rains, guess who collects the most water ??


Just make sure you buy your buckets in the Amazon, not in the Sahara.

 

[rugrat]

Bayview - I think you have hit the nail on the head. This is what I was trying to get at - although I was not quite as articulate at what I was saying.

I am a big believer in 'horses for courses', and like I said, am only just feeling my way into property investment. I am by nature a very cautious person and when analysising risk, look at worst case senario as my guide.

I am very interested to read this thread and everyone's different perspectives. I am trying to educate myself, before taking any steps in any direction. And the more that I learn, the more I am learning that there is to learn.

 

[rugrat]

What you are all talking about Marc is simply leverage, and the scale along that lever. You advocate a small lever that you can easily control. No worries. Others prefer a huge lever that is unweildy at best, and downright dangerous at worst.


More buckets out in the weather, to catch rainfall when it rains. Having holes in the buckets is a necessary evil to have the good buckets in the first place.


Having 5 little buckets with no holes in the bottom, is nowhere near as good as 10 big Olympic sized pools with a few cracks in the bottom slowly leaking away. When it rains, guess who collects the most water ??


Just make sure you buy your buckets in the Amazon, not in the Sahara.

But going off this senario, when those few cracks erode the foundations, you are just left with one huge messy swamp.

 

[Witzl]

yeah but that swamp still has a crapload more water than those tiny little buckets

 

[Dazz]

But going off this senario, when those few cracks erode the foundations, you are just left with one huge messy swamp.

Knee knocking scary....ain't it.

 

[BayView]

What you are all talking about Marc is simply leverage, and the scale along that lever. You advocate a small lever that you can easily control. No worries. Others prefer a huge lever that is unweildy at best, and downright dangerous at worst.


More buckets out in the weather, to catch rainfall when it rains. Having holes in the buckets is a necessary evil to have the good buckets in the first place.


Having 5 little buckets with no holes in the bottom, is nowhere near as good as 10 big Olympic sized pools with a few cracks in the bottom slowly leaking away. When it rains, guess who collects the most water ??

Just make sure you buy your buckets in the Amazon, not in the Sahara.

Totally agree Dazz.

And even for us; we have never stopped accumulating, but there has always been that strategy in place as well.

It's a question of balance; being as aggressive as you can, but as safe as you can.

We could have done more; for example while we were in the USA (3 years) we were sitting on over $500k in (useable) equity, but it was not the time - we felt it was too dangerous if things went wrong. Talk about burning a hole in the pocket though!

So while we have continued to expand, and will continue, the same fundamental will be applied

My message was more to do with that; being in better control of the "shizen hitting the fan" factor, even though the zeros on the bottom start to stack up.

Again; it comes back down to knowledge, but even the big boys should heed this basic fundamental of finance, and we all assume they do, but often even they don't.

Centro, for example, probably could have done a bit better following this simple strategy.

 

[Dazz]

It's a question of balance; being as aggressive as you can, but as safe as you can.

Excellently put. She's a fine line to tread.

 

[kaf]

Hi Rugrat

I'd suggest you add some of Bill Zheng's stuff to your reading (all available for free on the net). His writing about finance is a bit different and if nothing else it'll give you another view on finance / debt etc. I'm not one of his clients or otherwise associated with his company.

As others have said, your SANF and your goals and timeframe will very much determine how you go about investing so there is no right or wrong as long as your strategy suits your needs.

Happy investing

kaf

 

[Ms Jade]

Now I understand all of the tax benefits of Negative gearing. But my question is it really all that everyone makes it out to be?? So far EVERYONE I have come across has gone on and on about the benefits of negative gearing, and how a good strategy with property investment is to use the equity in one property to finance another (or variations of this). Now I can certainly see some benefits.

I'd be interested to know all these people going on & on about neg gearing. I certainly haven't seen that here. Negative gearing is not an investment strategy per se but a consequence of a strategy. Speaking for myself, that investment strategy is to buy well-located property that I anticipate will have superior CG in the medium to long term. More often than not the yield on this type of property is sub-optimal resulting in costs to the investor to hold the property. The gamble is that the property will rise enough in value over time to more than repay the holding costs. It makes no sense to just lose money for the sake of paying less tax. It sounds like you are lumping in "negative gearing" with the concept of gearing altogether - i.e. You speak of using equity in one property to finance another. This does not necessarily involve negative gearing at all.

... So looking at it this way, would it not be better, more stable and secure to own say 3 IP's outright, then own 5 heavily mortgaged?

This is just about your SANF and if you feel better with less leverage this is a perfectly fine way to invest. Is it "better?" It is less risky. As TPFKAD pointed out so colourfully, more risk usually means more potential gains. So if your end goal is to have as much equity in property as possible, you can control a larger portfolio - thereby creating more wealth - through increased gearing.