Why?

From: Even Steven


Why is it that negatively geared IP usually have high capital growth and positively geared IP usually have low capital growth?
 
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Reply: 1
From: Robert Forward


Cause your not negotiating the price of the negatively geared properties down enough to make them positively geared.

I picked up a deal mid last year that has gone up by 80% in value (cause I purchased it at a very good price) and it was positively geared from word go.

Cheers
Robert

The Sydney "Freestylers" Group Leader.
 
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Sim

Administrator
Reply: 1.1
From: Sim' Hampel


Okay, now for a theoretical explanation after Rob's chest-beating explanation ;-)

It all comes down to supply and demand.

You actually have it the wrong way around. High capital growth properties usually do not produce enough income to cover interest payements and expenses (hence are negatively geared) because they are high capital growth properties !

In other words... the growth of the properties is driven by demand... people want to live there, or at least want to own that particular property. Therefore, the price goes up in response to that demand (this is basic economic theory of supply and demand).

For an investment property, you are relying on the tenant to pay as much of your costs as possible. During periods of high capital growth, rental growth won't keep up with the capital growth, so the gap between the income and the costs (ie. interest) increases - to the point where it costs you more to pay the interest on the loan than you get in income - hence it would be negatively geared if you bought it at that price. Prices/rent in Sydney have been in this situation for quite some time.

The main reason rents don't keep up with prices is that tenants are generally not as fussy as home buyers in which particular house they live in. If there is another unit or house nearby that is similar but cheaper in rent, they will most likely choose that.

There are also usually more places available for rent than there are tenants to rent them, as shown by the vacancy rate figures published in the media. During periods of high vacancy, where investors are competing with each other just to get a tenant into their house, rents tend to drop in real terms, sometimes significantly.

Exactly this is happening right now in parts of Sydney... continued growth in prices as well as falling rents serve to increase the gap between income and costs even further. Rental yields in some areas are now down well below 4%. Some people use a rough figure of needing yields of at least 2% above the current interest rates for an investment to be cashflow positive. So with yields at 4%, we would need interest rates to drop to 2% before these would become cashflow positive (personally I'm not holding my breath waiting for that to happen !). So as current interest rates are at around 6%, you will need properties with at least 8% yield to perhaps be cashflow positive. Just watch out when interest rates rise !

Now in country towns and the outermost suburbs of cities, there is less demand from people looking to buy property, which keeps prices subdued. Because there are also fewer investors buying in these areas looking for capital growth, there are usually fewer places available for rent. Thus demand tends to outstrip supply and rents stay relatively high. Stronger rental demand coupled with lower prices means that it is more likely that your income will cover your costs... hence investment property you buy will be cashflow positive.

Of course, you do not always get strong rental demand in these areas of low growth... which tends to indicate a severe lack of demand... perhaps a falling or cyclical population. It pays to look beyond just the capital growth and rental yield figures when investigating an area... also check out things like the vacancy rates !

So as you can see... in general, growth, rental yields and gearing are all closely linked.

Now, you can always buck the trend by getting creative with your purchases... both with good negotiation and with clever post-purchase improvements or alterations... which may mean that you are able to take a property in a growth area and make it cashflow positive.

It also helps to have a property boom coming soon too !

So what is best ? Capital Growth or Cashflow ?

As someone well known to all of us once told me... "I'll take great lashings of both please" !

Hope this helps.

 
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Reply: 1.2
From: J Parker


I'm no expert but I would have thought that, as it's easier to achieve positive cashflow on lower priced properties, those more expensive ones have more chance of being negatively geared. For example, an $80K house in a rural town can return $160 a wk in rent, yet a $250K unit in a major city would be struggling to obtain $300 a wk, let alone $500. That's not to say that capital growth isn't attainable on a +vely geared property, but if you're getting income from it and not having to incur any cash loss then it becomes attractive as an extra source of income, doesn't it? (passive income) In this case, then cap growth is just the icing on the cake, so to speak.
With -vely geared places, you are counting on the cap growth to increase, to make up for the intial losses. In time, or so the theory goes, the value increases, along with the rent (though Sydney isn't looking too wonderful at the moment as far as that is concerned!) and it eventually becomes a +vely geared place.
Of course the ultimate is to have a property that has both, and I do believe that they are out there. I haven't come across one yet (in my very limited experience) but people like Robert obviously have- well done Robert! You must keep your ear to the ground at all times and have more time than I. Sigh... one day I'll be able to make property investing my fulltime leisure activity....!
Cheers, Jacque :)

"All we know is still infinitely less than all that still remains unknown"
De Motu Cordis et Sanguinis 1628
 
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Reply: 1.1.1.1
From: Michael Croft


OK Guys, since I am about to become landed gentry I've been reading 'The Land'. Now there's a different world view for you, literally right in our own backyard.

They were lamenting and applauding the fact that city buyers were pushing up prices. They used valuer generals figures to back up their claims; Years 1978 to 1999, Bathurst 8% p.a., Moss Vale 11% p.a., and Nowra 12% p.a. !!! compound. This is for the 5 to 40 acre bush blocks and not including the anecdotally outstanding last 2 years.

So much for no cap growth in the bush.

Michael Croft
 
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Reply: 1.2.1
From: J Parker


Thanks Sim- I only posted my reply before yours came up! Yours is so much more eloquent- well done!
Cheers, Jacque :)
 
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Sim

Administrator
Reply: 1.1.1.1.1
From: Sim' Hampel


Welcome back Michael... have a good Christmas ?

 
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Reply: 1.1.1.1.1.1
From: Michael Croft


Yes thanx Sim I had an outstanding Christmas, how was yours? - we exchanged on our small house and land package at 2pm Christmas eve. Spent a couple of weeks at the beach house - sweeping the roof, cleaning the gutters, racking a fire break (it's on a cliff in the bush on the south coast). Generally ate and drank too much and managed to catch a few fish too - no trout ;-).

Michael Croft
 
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Reply: 1.1.1.1.1.1.1
From: Mark Laszczuk


Michael,
My partner and I are dreaming of the day that we can write a post like that. Thanks for your contribution in keeping the dream alive!

Mark
'no hat, some cattle'
 
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Sim

Administrator
Reply: 1.1.1.1.1.1.2
From: Sim' Hampel


Mine was good thanks Michael... quiet, but productive in that it finally gave my wife and I some good time to nut out some of our dreams and put a timeframe to when we want to achieve them.

Now that we know where we are going, it is time to work out how best to get there !

 
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Reply: 2
From: Michael G


Hi Even,

That question of your's is a bit too broad, what if I had a Sydney Harbour waterfront property with a 10% mortgage on it and rented it out?, it would be geared and may generate positive cashflow.

Whereas I may have a 100% geared somewhere which is generating negative cashflow.

When we talk about gearing we really need to factor the equity/debt ratio.

But to give you a generalised answer. Properties of high capital growth are ones located in areas of demand and limited supply, this pushes prices up. But at the same time, rental demand is not compariable and does not move up at the same time. (i.e if a property jumps by 50% in two years, rarely will the rent do the same).

This causes the negative gearing effect. Also, because our government gives tax concessions for these losses people don't jump and scream about such losses. But if this concession didnt exist, then rents would be adjusted to cover expenses (more than likely).

Michael G
 
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Reply: 2.1
From: Even Steven


Thanks, Michael. Appreciate that.
By the way, the name is Steven - Even Steven is a nom de plume.
 
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