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UNAFFORDABILITY INCREASING

Most Australians are familiar with housing unaffordability, whether it relates to the purchase or rental of a home. The payments required to place a roof over their heads has skyrocketed dramatically over the past decade and is now at an unsustainable level.

The situation in the rental market keeps getting worse. Rental prices continue to increase at greater rates than wage growth. Even the CPI (consumer price index) is being beaten in terms of growth as housing rental prices continue to rise at an alarming pace.

Unfortunately there is no relief in the rural and regional areas either. Traditionally, Australians looking for some rental respite have moved into the country areas where rental prices are much lower. But with the rent increases seen in these areas as well, it has become far less attractive as an option.

In late 2008, there were some startling figures released in NSW. They showed that the state had just recorded its largest yearly rent rise in history. The state average was around 10%, but some areas were particularly hard hit. One bedroom units in Botany Bay were possibly the most affected, rising by about 43%; while three bedroom houses in Canterbury almost cracked the 30% rise mark.

Western Sydney bore the brunt of the rent rises, experiencing an approximate increase of 16%. This was contrasted by a fall in property values of 5.5%. While this is bad news for renters, property investors will be rubbing their hands together with glee, as rental yields as a percentage of property value are at some of the highest levels they have ever seen.

Hit by a chronic housing shortage, further increases in rent prices can be expected across Australia. Many Australians are already taking drastic measures just to pay their rent, such as paying their rent with their credit card. The prices have also seen a vast number of people shift state just to move to a more affordable living area.

SPRAWLING OVER THE LAND

Our governments view the urban sprawl as a problem which they need to get under control. As they try and contain the outward expansion of cities with policies such as restricting land releases, the housing market is less able to respond to demand increases. This results in price rises and the housing market inevitably becomes unaffordable.

Another factor behind our unaffordability crisis is Australia’s obsession with owning large houses. The ‘Great Australian Dream’ has contributed to this line of thinking, where nothing short of a four bedroom house with a study and games room will do. Gone are the days of bunk-beds, with each child now requiring their own separate room.

Asian families are quite used to living together and emanate the true sense of a family unit. Children often sleep in the same rooms as their parents and rarely experience the luxury of their own room. Part of this is due to cultural aspects, while another part can be contributed to overpopulation and land shortage. With Australia having an overabundant land supply, we tend to spread our houses out and occupy as much space as possible.

Recent statistics showed that Australians tended to build their houses 55.8% bigger than their Japanese counterparts. Twenty countries including New Zealand, US, Canada, UK and a number of European nations had their average housing size statistics taken and analysed against the Japanese statistics.

Apart from Australia, only the US, New Zealand and Denmark built their houses bigger than the Japanese, which goes to show the extreme size of Australia’s constructions. Most of the countries were on average over 30% smaller, with the UK having the smallest average size, being 42.6% smaller than the Japanese dwellings.

The average Australian newly built house is 206sqm, which was closely followed by the US at 203sqm. UK was at 76sqm while the European average was 100sqm, which is less than half the size of Australian houses. Even notable countries such as Spain at 97sqm and Italy at 82sqm were well under half the average house sizes compared to Australia.

SURVEY SHOWS PROBLEMS

The International Housing Affordability Survey of 2009 confirmed Australia’s current problem with housing unaffordability. Based on data ending in the third quarter 2008, the survey covered a number of cities within six western countries: Australia, Canada, Ireland, New Zealand, UK & US.

The survey results attach a numerical value to each countries or cities affordability, with scores of 3.0 or less being considered affordable. Scores of 3.1 to 4.0 were rated as moderately unaffordable, 4.1 to 5.0 seriously unaffordable, with 5.1 and above being severely unaffordable.

The worst international destination on the affordability scale was Australia’s own Sunshine Coast, with a horrible score of 9.6. Gold Coast was close behind in 3^rd with 8.7, while Sydney in 5^th place and Bundaberg in 10^th were the other Australian locations making the top 10 list.

Adelaide, Melbourne and Mandurah ranked from 12-14, giving Australia half of the fourteen most unaffordable surveyed cities in the world. Overall, 24 Australian cities were ranked as severely unaffordable, more than any other country that participated in the survey.

At the other end of the scale, 77 cities were ranked as affordable by the survey. Youngstown in the United States was listed as the most affordable city with a score of 1.8, in a list that was dominated by US locations. Unsurprisingly, not one single Australian city was classed as affordable.

A total of 27 Australian cities were included in the data and none of these were classed as moderately unaffordable either. Apart from the 24 cities ranked as severely unaffordable, the remaining three were classified as seriously unaffordable, giving Australian a median average of 6.0 and the overall classification of having severely unaffordable housing markets.

The survey makers Demographia have given a dire warning for the Australian property market. They noted that while Australia has thus far been able to avoid a property price crash unlike the other markets, a fall in values will almost certainly occur. However, if we are able to maintain our property values, it would result in a fall in the standard of living for future generations. Either way, we are definitely in crisis.

Continued from Who really understands Negative Gearing? – Part 1

THE HIDDEN DANGERS

On the other side of the coin, pro negative gearing activists claim that property prices will escalate if negative gearing is banned, just as they did when Paul Keating tinkered with the formula in the 80’s. But this can be linked to the unnecessary bureaucratic red tape and interfering council policies. Government policies also contribute to the potential problems, with excess immigration linked to the housing supply problem and being the cause of rent and housing price increases.

But the negative gearing activists retreat into hibernation when the property market winter arrives. As the economic cycles flow, so does the positive performance of negative gearing. A number of property cycle factors make negative gearing an uninviting prospect.

When rental yields are at low levels, it is certainly a bad time to purchase a property for negative gearing. The gap at this point between rental income received and loan interest paid is significantly higher than normal periods, often being at an unviable level.Another danger is when the rents are dropping nationwide, as a fall in your rental income would equate to a widening of the income differential and increased out of pocket expenses.

The income differential can also be widened when interest rates rise. Repayments increase while rental yields remain the same. This situation is all too common and has been responsible for much grief in recent years. In both of these situations, many investors are no longer able to cover the shortfall and end up having to surrender their house, incurring a large loss in the end.

If investors are fortunate enough to ride out both of these occurrences, they face another problem when property values stand still or decline. Even a small yearly rise could mean an overall loss, with many negatively geared properties requiring a 2-3% value increase just to break even.

Other issues include tenant’s not paying rent, unexpected property maintenance and the property remaining vacant for an extended period of time. Basically, if you don’t have the income to ride out a rise in interest rates, falls in rents or property values, or unplanned expenses and rental issues, then you should steer clear of negative gearing.

ALTERNATIVES

I can never understand investors who rush like a bad bull to grab negatively geared property. They are often motivated by the desire to pay less tax, which is a ridiculous motivation to say the least. Whichever way you look at it, a loss is a loss; so they are effectively paying money to receive a tax deduction.

A more viable alternative exists and it remains located in the property market – positively geared property. The main influence behind an investment decision should be to make money. Positively geared property does this, since it occurs when rental yields and benefits exceed property expenses.

Whilst it is true that the majority of the properties on the market would only qualify for negative gearing, this does not mean that positively geared properties do not exist. There are many positively geared properties available across Australia and investors need to exercise patience instead of jumping on the first property scheme they see advertised.

There are plenty of other tax reduction strategies available, in addition to the numerous investment options. The problem is that many people prefer a tax deduction over making a profit, which is not a sensible financial decision. If their motivation for investment is to make a profit, then the other alternatives to negative gearing become more attractive.

POSITIVE MATHS

Once again using an example – lets says that a cheaper property was purchased for $270,000, once again with a 10% deposit. Rates are lower and the house is in excellent condition, requiring lower maintenance costs. As mentioned previously, depreciation isn’t a physical cost and can be added back, so we will assume the yearly expenses to be $2,000 with $5,000 depreciation.

Yearly interest payments on a 6% loan are $14,580. Adding the expenses, we have a total of $21,580 for the year. Securing rental payments of $330 per week would bring in $17,219 per year, which is a loss of $4,361. At the top tax bracket this equates to a tax deduction of $2,028.

Remembering that the $5,000 depreciation is not a tangible deduction, this is not an out of pocket expense. Balanced against the loss, the depreciation add-back leaves $639 of positive cash flow for the year. Adding the tax deduction already received, the property investor in this example has an extra $2,667 in their pocket at the end of the year and can still receive the benefits of capital appreciation.

It may also be possible to purchase a property where the rental yields exceed the interest and expense payments on the property. This is truly a positively geared investment in every sense, and generally occurs when the investor is able to purchase a property at well below market price or secures a very low interest rate on the funds.

THE END RESULT

If you do decide to jump on the negative gearing bandwagon, be aware that you are guaranteed to lose money. In fact, that’s the whole point behind negative gearing. Just make sure that you have enough cash to cover the expenses and don’t have to work extra hours or rollback life’s pleasures just to survive.

The only way you will ever get any benefit out of negative gearing is if you are fortunate enough to see your property rise in value much more than the expenses set you back. Unfortunately, the property value is not guaranteed, but the expenses are – meaning that there is a chance you will end up a significant loser at the end.

Negative gearing is definitely not a strategy which can be wielded in all property cycles. It does very well in the fast rising markets, but not so well at other times. The decision on whether to employ the strategy now all depends on whether the property market has bottomed out, which most indicators seem to suggest otherwise.

Basically, if you don’t have the income to ride out a rise in interest rates or falls in rents or property values, then you should steer clear of negative gearing. There is no point risking your financial wellbeing by gambling on the property market. At the end of the day – it’s an asset that’s purposely designed to lose money.

NEGATIVE GEARING – SAY WHAT?

CRIES FROM THE OPPONENTS

Negative gearing has had its detractors for a long period of time, claiming that it is responsible for a number of ‘negative’ influences on society. Some of the issues stem from property developer tactics while a number relate to the effects on the general population.

Firstly, it encourages investment in the property market, which is essentially an ‘unproductive’ asset. These additional investors inflate the property values, making it difficult for owner-occupiers to buy accommodation. The property value inflation has led to a housing affordability crisis. In 2003, the Reserve Bank of Australia even named negative gearing as one of the main reasons behind housing unaffordability.

It also favours the rich, as tax deductions are higher for those individuals in the high-income brackets than compared to low-income earners. The tax deductions are also effectively subsidised by non-investors and account for less government funds being available for other public service programs. Some individuals even get wrapped up in making a loss to receive a tax benefit, overextending what would be a satisfactory loss level in order to maximise their taxation reduction.

Devious tactics are used by property developers to trap unsuspecting victims, sometimes promoting negative gearing as a way in which the taxman and tenant can pay for your mortgage. A common problem is statistical misrepresentations and figure fuddling, which paint an unrealistic picture of expected profits. Ignoring capital gains tax in profit calculations, making no allowances for rental vacancies and inflating expected rises in value are the main complaints heard.

Adding to the deception, depreciation benefits are commonly misunderstood. Whilst depreciation can offer an immediate tax reduction, it must be repaid later when the property is sold. This can lead to investors being negatively affected if their income levels change over the course of owning the property, such as having a higher level of income in the year of the property sale.

Continued at Who really understands Negative Gearing? – Part 2