Saturday, 22 September 2012

The Myth of Negative Gearing

I remember when I was younger, asking my mum what Negative Gearing was. I had seen it advertised everywhere, from free seminars on television to articles in magazines and newspapers, it seemed to be the buzz phrase of the day. My mum explained that negative gearing was when you buy a house and rent it out to a family and let the rent pay for the mortgage. I guess she kept it simplified because I was not even a teenager at that stage but even still, it sounded like a good idea to me, you basically get a house for free! So what could possibly go wrong?
A few years later, when I really started to look into investing, I began to see the “negative” part of negative gearing. I guess the answer was always in the name, if something is called negative, then it is never going to be a good thing, right?
So, what is negative gearing? Put simply, negative gearing is purchasing a property as an investment, where the money coming in (rent) does not cover the money coming out (loan repayments, maintenance, agent's fees etc.) and you are forced to use your own income to cover the difference.
But so many people have made so much money out of negative gearing, "how can it be a bad thing?" I hear you ask. Well to make money out of a negatively geared property, the value of the property needs to rise consistently over the medium to long term of the loan. Back when negative gearing was really popular, this was the case but in the not-so-flash property market of today, you need to give things a second and third look before jumping in. In a rapidly rising market like Australia had during the 2000s, it was next to impossible to lose money investing in property. In the end, all these people who invested in negatively geared property were able to still make money despite an unsustainable investment strategy.
So, what makes it so unsustainable? Well it is a fact that the majority of property investors own 2 or less properties, I cannot remember the exact percentage, but I believe it is something like 90% of property investors 'only' own 1 or 2 properties. The reason for this is simple, the majority of properties are negatively geared; they cannot afford to hold any more. 

As an example, let’s say you have $1,000 extra cash flow a month. Because a negatively geared property is taking money out of your pocket, assume it costs you $500 per month to maintain the loan (cover the difference between the rent and the loan repayments). Already you can see that you are only able to cover 2 properties, as after that, you are out of extra cash flow.
So why do people negatively gear into property? Well again, the answer is simple. They have to. They want to invest in property because according to a lot of people, it is a great way to invest, just about risk free, just about a guarantee to make a return and the saying “safe as houses” does come from somewhere after all. 

As it stands now, if you want to invest in property as part of your portfolio, you will see that almost all of the available properties are negatively geared. This is mainly due to the extremely high house prices in Australia, particularly in the major cities. House prices rose dramatically over recent times, and the increase in rent simply did not keep up. I remember when I was renting back in 2009; we paid $550.00 per week for a 3 bedroom house in Sydney. Looking at comparative sales nearby, the house would have been easily worth about $800,000. Assuming an interest rate of 7.00% per annum, that gives a weekly interest repayment of $1,076.00. Repayments at this level don't even begin to "eat" away at the principal amount as the rent is nowhere near the amount needed to service the loan. This is the situation across most of Australia, rent prices just do not come close to the loan repayments and all the properties have to be negatively geared.
Another reason that people invest in negatively geared property is to reduce their tax bill. People are under the illusion that they can end out better off because they're paying less in tax. Of course it is true that you can claim expenses on the house on your tax return, but this is offset by the money out
of your pocket to service the loan, so you still end up out of pocket. Let me show you an example:

Your initial taxable income is $150,000 per year

Tax rate of 45%

Rent collected of $600 per week

Interest repayments of $1,100 per week

Other deductions of $5,000 per year (property maintenance, fees etc)
Option 1 – Not investing in property
Taxable Income = $150,000

Tax Paid = $150,000 - [$150,000 x (1 – 0.45)] 
               = $67,500 (approximately)

Net Income = $150,000 - $67,500
                   = $82,500
Option 2 – Investing in property
Taxable Income = $150,000 + $600 x 52 - $1,100 x 52 - $5,000
                         = $119,000
Tax Paid = $53,550
Net Income = $119,000 - $53,550 
                   = $65,450
So as you can see, your net income is almost $20,000 less in this example, so just to break even with a negatively geared property, you need to ensure there is at least $20,000 in capital gains over the course of a year. Now as I said earlier, when the property market was going well, this was fine, but without the large rises, negative geared property should be heavily scrutinised before committing to buy.

Disclaimer: By viewing this website, you acknowledge that it is for informational purposes only and does not imply any contractual agreement, promises of returns or legal expertise. All investors should consult with legal representation and appropriate accountants before making any investment and should ensure that individual due diligence is done. Any information provided here is for educational purposes only and should not be taken as financial advice.

Tuesday, 18 September 2012

The End Of Our First Tenant

We got the news the other day that our tenant at our first US property has left. They had signed a 12 month lease, and yet they have vacated the property after little over 3 months.

According to our property manager, the husband's grandmother had fallen sick, and the family moved to a different state to be by her side and help her out. It is unfortunate for us because not only have we lost our tenant that had so far been quite good to us, they also left in such a hurry, that the property was left with a lot of rubbish and a lot of cleaning required. I was hoping to be able to get some photos of the state the property was left in, because one person's definition of trashed could be another person's definition of perfectly acceptable.

Regardless of the condition of the property, we have had cleaners go in and fix up the property, and it is back on the market and hopefully we will be able to find a new tenant in the coming weeks. The tenant did pay a bond of one month's rent, so this should more than cover the cleaning bill required, but there are still other costs that leave us out of pocket.

Firstly, the tenant had not paid rent for the month of September, and they had left halfway through, so we are out of pocket a couple weeks' rent there. Also, the property management we have, charge a fee of one month's rent for finding a new tenant.

Sometimes there is a benefit of a tenant leaving in that you can justify in raising the rent for the next tenant, which can sometimes be a little difficult with an existing tenant. But unfortunately, in this situation, the market has not really moved significantly enough and it looks like we will have to stick with aiming to get a tenant in there paying $700 per month.

So at the end of the day, this is the the end of our first tenant, I am sure it could have gone a lot worse but also it could have gone a lot better. Hopefully our next one will be able to stay on to at least fulfil the end of the lease they sign on for.

Friday, 7 September 2012

Tips and Tricks to Help You Get Ahead of the Pack

Property investing should be fun. It’s by no means an easy task but making money should at least be enjoyable. To help ease some of your stresses, we here at Streamline Investing have come up with a few key tips and tricks that will put you in front of the pack.

Time is Money – no matter if you are planning on renovating, investing for a high rental yield or purely purchasing a property as your primary place of residence, time is money. Over-runs can cost you thousands of dollars. Delays in finding a tenant or commencement of renovation work can severely eat into your profit. You must be ready then to start doing what is required immediately after settlement takes place.
To assist with this, it is always good practice to put a clause in the contract which provides that the seller will give you access to the property before settlement at reasonable times and upon reasonable notice. A suggested clause could be the following:

"The seller will allow the buyer or the buyer's trades people and manufacturers access to the property, at reasonable times and upon giving reasonable notice to the seller in writing before settlement, to allow the buyer and its trades people and manufacturers to take measurements and obtain quotes for the cost of carrying out work for the buyers following settlement."

A clause such as this will allow you to progress with your plans for your new property without delay, while maximise any potential profits.

Another reason to agree on a long settlement period is to reduce the time it takes you to find a tenant. If you can agree with the seller to show people through the place during the settlement period, it can mean you gain an extra 4-8 weeks’ worth of rental payments. This is something that is easily forgotten during the purchasing phase.

Conditional Clauses – These can be double-edged swords and must be used with caution. I’ve heard of dodgy buyers adding “subject to building inspection” clauses in their contracts and subsequently asking the seller to agree on a lower price due to a negative building inspection. This is fine when it’s true but if you use this as a way of bargaining down, it won’t be long before the seller catches on. You don’t need an upset seller, especially if you’re also trying to get a long settlement or have the seller rent the property back from you. The key message here is to be honest and not to try and ‘pull the wool over the seller’s eyes’. Adding ‘subject to property inspection or valuation’ clauses can be a good strategy as long as you use them the right way.

Buying Off the Plan – This one is simple. Don’t do it. There are numerous reasons (and cases supporting those reasons) as to why buying off the plan is a bad idea. Over-stated prices, dodgy contract conditions and simply not knowing what the workmanship is going to be like are only some of the negatives. I really can’t see too many positives in this kind of purchase so my only advice is to not buy off the plan.


Disclaimer: By viewing and using this website, you acknowledge that it is for informational purposes only and does not imply any contractual agreement, promises of returns or legal expertise. All investors should consult with legal representation and appropriate accountants before making any investment and should ensure that individual due diligence is done. Any information provided here is for educational purposes only and should not be taken as financial advice.