Negative gearing - WHY???

[pully]

i to agree with the views expressed by bayview.
as i have said on previous posts not keen to pay anymore interest than necessary.

of course everyones situation is different because we are all at different stages/places in life.

another thought i have is to question who is really benefiting when a person is highly geared?
certainly lenders want to make a profit and they do, plus those who make a living from that process. no offence to anyone reading.

but i wonder if the people who become/chose to borrow a lot in terms of LVR are truly well advised that it is in their own best interests to go down that path?
those offering the money may have a conflict of interest. how many get independent advice or even look at other options before proceeding?
is it a matter of hoping for the best?
regards

 

[sash]

Having a large portfolio does not translate into more equity down the track. You can have the same efficiencies with a smaller portfolio.

Why have larger portfolio and thus larger borrowings when serviceability, cashflow, and risk management becomes an issue. As Margaret Lomas pointed out....CG is the icing on the cake..just like depreciation is to cashflow.

The trick is to get an asset that gives you both cashflow and growth. That way you don't have the case of having a great cashflow with 80% LVR or poor cashflow and lower LVR but have difficulties with serviceability.

These principles are just common sense business ones. Why would you have a large revenue say $100m with $1m in profits when you can have a $10m business with $1m in profits. Less headaches and more efficiencies. Just like in business some people's egos get in the way.

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.

 

[Ms Jade]

You can have the same efficiencies with a smaller portfolio. Do you mean that having a $2m portfolio now compared with a $10m portfolio will see you with the same amount of equity in 10 years? That $10m would have to be pretty poorly located. Or have I misunderstood?

Why have larger portfolio and thus larger borrowings when serviceability, cashflow, and risk management becomes an issue. As Margaret Lomas pointed out....CG is the icing on the cake..just like depreciation is to cashflow.
Agree that larger borrowings = larger risk but for some people CG is not the icing on the cake but the cake itself.

The trick is to get an asset that gives you both cashflow and growth. No argument here
That way you don't have the case of having a great cashflow with 80% LVR or poor cashflow and lower LVR but have difficulties with serviceability.I assume you mean this the other way around

These principles are just common sense business ones. Why would you have a large revenue say $100m with $1m in profits when you can have a $10m business with $1m in profits. Less headaches and more efficiencies. Just like in business some people's egos get in the way.
I'm with you on prefering the latter. But you are talking revenue - which is cashflow, and not equity. If you invest the $100m into property or the $10m into property, and it doubles in value in 20 years (have to be conservative in this market!) I'll take the extra $180m thanks.

 

[BayView]

1. Having a large portfolio does not translate into more equity down the track. You can have the same efficiencies with a smaller portfolio.

2. Why have larger portfolio and thus larger borrowings when serviceability, cashflow, and risk management becomes an issue. As Margaret Lomas pointed out....CG is the icing on the cake..just like depreciation is to cashflow.

1. A larger portfolio will leverage the return. If I own $1 mill worth of property and it goes up 10%, I'm $100k richer.

If I only own $500k, I'm only $50k richer.

Meanwhile, unless the interest rate increases with it, the debt remains the same level (or decreases if you listen to me ).

So, the more exposure to the market I have the better I can accelerate my wealth, as long as the cashflows support it.

2. This is the crux of the matter. It's not much value getting into huge amounts of leveraged debt to increase your exposure to the market if the cashflow and nett financial position is precarious. Risk management should always be a very close second to making money.

In the end it should always come back to percentages, and this applies to all factors; LVR, DSR, cap growth etc.

I would be quite happy to be $1 billion in debt (hope to be one day), but with a nett return after tax on that billion that is pos cashflowed by a few percent.

I think I would draw the line at at least 10%

 

[Token Funder]

Spending a dollar to obtain a 50 cent tax deduction has never made sense to me.

I see lots of distressed borrowers that got to that stage, at least in part, because negative gearing was seen as an objective.

I can't remember a single instance of managing out a borrower with a positively geared portfolio.

 

[wylie]

The thing is that once you have a few properties in your portfolio, the risks of negatively gearing a new one is much less than if it is your first. You have the equity of the portfolio stacked up behind you as a buffer.

 

[Ryan Love]

Negative gearing is a fancy word for a loss. Losses aren't bad as long as you can afford to meet them by other means (e.g. your regular wages). The key is that over time you want these losses to turn into gains with rental increases = positively geared.

With interest rates where they are we shouldn't loose sight of the fact that debt is still risky. It sounds too good to be true when you are borrowing at 5%pa. When (not if) the economy turns, inflation will spike and we will be back to high intererst rates. If the Government keeps printing money to fund spending then there is a risk that rates could be back to the early 90s levels. Trust me, nobody will be saying how good negative gearing is when interest rates are >10%...

There are too many promotors and spruikers encouraging "Mum and Dad" investors to take on too much debt. We must remember that these promoters are usually paid from the amount of property that they sell. The fiasco with the stock market over the last 18 months has been related to excess leverage. Every person owes it to themselves and their family not to over committ themselves with debt.

Simply put if you are comfortable in taking on more risk, then you can further leverage your equity and negative gear. If you cant sleep at night with the financial committments then play it safe.

Ryan Love
Director
Apex Partners

 

[rugrat]

There are too many promotors and spruikers encouraging "Mum and Dad" investors to take on too much debt.

This is what I was referring to in my original post. Maybe it is because we are new to the world of investment.

I must say that I have found this site a breath of fresh air (after having visited a few others), and I like the fact that everyone here will offer advice, opinions and debate but has so far not appearred to be pushy or judgemental.

 

[pango]

Rugrat,
There are very few opportunities for 'average " people to accumulate wealth and have that plan supported by government policy and assisted by the ATO.

The Negative Gearing scenario is where the taxman allows you to offset all the costs associated with "growing" your retirement fund including the finance.
Now one of the great misconceptions out there is that a property has to be running at a loss for the associated costs to be deductable. Most people starting out actually look for a property that is going to cost them something each week to hold so as to qualify for Negative Gearing benefits. This is not the case. Look for a positive geared property if you want, it will just mean that you are likely to get less capital growth(grow slower). This is due to a number of reasons which I will not go into here.
As for why you would not pay them off one at a time should be obvious to you and those others that support this idea if you had done any research at all.
You must start reading the bibles of property investing. ie. Jan Somers and Michael Yardney publications to name just 2. You will then understand why it is fundamentally wrong to assume that it is good to "own" a property investment as opposed to have the maximum amount of debt associated with it as possible.
For you and your husband, having properties that have debt associated with them and all the other holding costs that go along with it, and then the depreciation benefits to boot, you will find yourselves having a reduced taxable income and therefore be the beneficiary of a nice cheque every tax time.
This will assist in those holding costs (probably cover all of the next years) or allow you to get another deposit together for your next purchase.
For all that is said, please understand one thing.
If you are averse to being in debt, Property investing is not for you. Stick your money in the bank where you will earn pathetic interest where the taxman will help himself to at least a third.
If you are not averse to debt, go as big as the bank will let you as they are averse to risk and will rarely allow you to go too far.
When you get to the stage where you owe a million or more, what difference does it make how big your debt is.
As they say, you might as well be hung for a sheep as a lamb.

Good Luck.

 

[handyandy]

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.

By using the offset if in the future you decide to move retaining your current PPOR as an IP you can utilize the money in the offset toward the new PPOR and have the full amount tax deductable against the old PPOR. Its all about what you use the money for in regard to the deductability of interest. This is important even if you were positively geared.

If I own it outright (or close too) the risks are greatly reduced, not to mantion the benefits of interest saved -

Unless you structure your investments correctly there is hardly any situation where the risks are reduced just because you own your PPOR (ignoring the fact hat you should have equity to draw on). In most cases the bank will be able to enforce payment of debts and this may involve liqudating (or at the least remortgaging) your PPOR.

Cheers

PS one of the most secure things is to ensure that there is a registered mortgage on every property owned to thwart fraudulent access to the property. It is very easy to get hold of a property title much harder to get hold of one which has a registered mortgage.

 

[jingo]

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.

Hi rugrat,

As a property investor I like to equip myself with a tool box full of useful resources to lead me closer to financial independence. The box is full of many difference tools that I need on my journey. It includes loans from banks, investment properties, term deposits, home loan interest saver accounts, insurance policies, share certificates, investment contacts including real estate agents, accountancy firms, negative gearing etc....

Each of the tools is there for a specific purpose in my quest to reach my destination of financial independence.

The benefit of using negative gearing as a tool to create wealth is that it enables an investor the opportunity to utilize an area of their income that would otherwise be taken by the government in the form of tax. As time goes on, negatively geared assets will become positively geared. The equity built up inside those assets can then be tapped to invest in further investments. Using this strategy diversifies the investor's asset base which in turn reduces the risk of holding too much of one's weath in one or two assets or asset classes.

No doubt care needs to be taken as to how an investor uses negative gearing. It may be used agressively to kick start a portfolio and toned down over time according to one's own objectives.

 

[Dazz]

Having a large portfolio does not translate into more equity down the track.

This makes no sense to me at all. Could you explain your reasoning behind this statement ?

 

[jaycee]

easy

borrowing say 80-106% per property without Capital growth means yo dont move forward as much as somone who borrowed less but bought better and therefore got more growth

but what if somone borrowed that much, but bought OK investments, which did give growth, what would happen then ? Does building a large portfolio automatically mean growth is lower ?

 

[Aaron Sice]

but 20% of a sh it load is better than 60% of fk all....

 

[jaycee]

agreed...

the only conclusion I could come to where it worked differntly is if 1 person borrowed a lot and bought abismally terribly... and the other borrowed little & bought perfectly...

now I never do anything perfectly... but I usually dont always scrape the total bottom of the barrell each time either.... is there not a middle ground where one could borrow a reasonably high amount & not have to buy dogs which are losers 100% of the time ?

 

[sash]

Dazzling, Ms Jade, Blue Card!, Jaycee

Let me clarify...I was all for a larger portfolio as the extrapolation is that over time with natural growth this will grow bigger than a smaller portfolio. But over time I have adjusted my thinking. Over the years I have come to the realisation the yield now and potential, CG now and potential, and risk mitigation in hard times is just as important. Otherwise, the chances of you losing the lot or the portfolio not performing is high.

A couple of recent examples:

1. I know a guy with over $8m property portfolio but he has just $1.8m in equity and the growth of hi portfolio has been dismal. Most of his portfolio dates back before 2006. His yield is about 5%.....thus he is struggling and in asset disposal mode before the banks move in.

2. In the recent API mamagzine article had Dave Dorian how has $13m with about maybe $3m in equity. The growth again has not fantastic.

My philosophy is not to concentrate soley on size but couple of factors, for convenience sake I will call it the Sash Philosophy of property investing:

1. Buy only older property as most new property has a premium on it in most instances.

2. Ensure when you buy the location allows a healthy yield now and potential of at least a 10% increase yearly.

3. The numbers on the property need to nearly neutrally geared - no more than $20pw loss (the pizza princple!).

4. Over time (within 5 years) your property needs to return a positive cashflow of 2.5% of the value of the property. So if you have a $4m portfolio you should ideally be getting $100k pa in cashflow depending on where your properties are in the 5 year cycle.

5. Don't get to caught up on the inner suburb is better than the outer suburbs argument....there are properties in all locations in Australia that will perform.

6. Mitigate risk, the better you do this the better your future sanity!
In another wards keep LVR under 50%, spread properties around Australia,
do not buy one property for $1m instead buy 3-4.

7. The properties you buy should ideally return a minimum of 7-10% growth.

8. Shoot your dogs if they have not performed to expectations within say 5-7 years.

I have lived by these principles. My portfolio is a fraction of some on this site but my plan is to head to the $80-90k positive cashflow mark in the next year....this will be done via a combination of interest rises and smart acquistions. Any CG will be the icing on the cake.

Who needs LOE when you can do this....

Bye the way...I am also modifying my strategy slightly to suit the current conditions of the market. Will post when I have made the relevant acquisitions based on this strategy.

1. A larger portfolio will leverage the return. If I own $1 mill worth of property and it goes up 10%, I'm $100k richer.

I think I would draw the line at at least 10%

but 20% of a sh it load is better than 60% of fk all....

agreed...

the now I never do anything perfectly... but I usually dont always scrape the total bottom of the barrell each time either.... is there not a middle ground where one could borrow a reasonably high amount & not have to buy dogs which are losers 100% of the time ?

 

[Aaron Sice]

great comments there sash - and in tit-vs-tat it's good to understand one's reasoning behind an argument.

why avoid newer props though? i find new properties are costing the same as an (old one + renos) at present - with a better yield and depreciation.

but my thinking is much along the lines of yours. make income with the rent, use an LOE to acquire more or for emergency funds if rents fall.

no offence Rick!!!

 

[sash]

Bluecard!,

In reference to new properties...I am finding that the best yields in the areas I am investing in are at 5%...the older properties are at about 6.0-7.5%. Note that these are properties are mostly houses. The new ones are priced at 260k when I bought wheres the older one I bought was at 170k. The depreciation simply paid for the 90k differential at 6.5% interest rate. Also the land component on the newer property was 450sqm valued at about 110k whereas the older property has a 570k block worth about 130k. Bear in mind depreciation is an artificial deduction...if you lose your job on an income it is pretty much useless and it is tiered to your marginal rate of tax.

Rick's strategy is sound....but it will go through ups and downs particularly if asset values drop or banks tighten credit or ask for equity top-ups. Recently, I read contract of a major bank and it mentioned that the person taking the loan needs can have their asset valued at anytime! So if you are in Perth and your property drops say 20%...what are the impacts on your LOE?

The CF+ property is like a never ending packet of Tim Tams.....the CG is just extra chocolate!!

My thoughts anyway.......time will tell....

 

[kaf]

Bluecard!,
Recently, I read contract of a major bank and it mentioned that the person taking the loan can have their asset valued at anytime! S

I saw that in our CBA contract recently as well but I think they just spelled out more clearly what they've always been able to do. I thought any bank had always had the right / option to revalue anytime if they were worried their security wasn't sufficient to secure the loan. "Margin" calls on properties are possible, it's just very rarely done.

Banks can also call in their loan whenever they want, as some people with multi million $ properties have found recently, even though they've not fallen behind with payments.

kaf

 

[sash]

I think they have reworded the contract to be alot clearer. The reason I picked it up is because CBA converted me from an old Colonial LOC to theirs. The wording from a legal sense leaves no doubt!

You are right about muti-million properties...this is only the start. Like Bill Zheng said watch-out if your borrowings are over $1m with one bank and your LVR is less more than 80%!

I am in the process of spreading my risk and keeping all loans across all bans to less than 600k. The one to watch out for is Commercial Property...that is where the action is going to be in the next 12 months.

I saw that in our CBA contract recently as well but I think they just spelled out more clearly what they've always been able to do. I thought any bank had always had the right / option to revalue anytime if they were worried their security wasn't sufficient to secure the loan. "Margin" calls on properties are possible, it's just very rarely done.

Banks can also call in their loan whenever they want, as some people with multi million $ properties have found recently, even though they've not fallen behind with payments.

kaf