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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

The first four months of 2009 has seen Australia’s housing prices rise by an average of 2.9%. The figures are in stark contrast to the falls seen in other international property markets this year, and have raised many questions as to why the Australian property market is bucking the trend.

Housing markets all around the world have experienced losses in the last 12 months. No property market has been immune to the value reductions, with even Australia suffering a small loss last year. But we did not come close to seeing the gigantic drops in the two major world property markets of the US and UK, who suffered with losses of around 20%.

The Australian market was primarily brought down by the falls at the higher end of the market. The properties in the top 20% in terms of price have continued to drop in 2009. In fact these houses were responsible for keeping the overall price rises at modest levels, since their dramatic drop in value was offset by a rise in the lower 80% of properties ordered by price. Read the rest of this entry »

THE GREAT AUSTRALIAN DREAM

Home ownership is heavily promoted as being the great Australian dream. All throughout school we are force fed this belief along with numerous others such as ‘Study hard and you will get a good job’ or modern day values like ‘save the environment’ But do these teachings hold true in the real world?

Most of the super-successful Australians never even finished school, let alone studied hard. Many of the highest paying jobs are in the building and mining industries, where brawn and common sense are preferred to academic success. Not to mention the huge numbers of university graduates who cant even find work. It seems that ‘study hard and you will get a good job’ was an outright lie.

The modern day saving the environment campaign was based on the presumption that the world was heating up. They coined the phrase ‘global warming’ to describe the phenomenon. The theory was shot to pieces when in the last few years the world temperature has dropped; so they conveniently renamed it ‘climate change’. Similar to the ‘global cooling’ lie that was perpetrated in the 1970′s, the public are ready to accept any theory as fact as long as the seeds are planted while they are at school.

When the evidence for the belief system instilled at school is examined to determine its truthfulness, it overwhelming shows that the beliefs are false. But what about owning your own home? Surely there can’t be anything bad about that.

PRISONER INSIDE YOUR OWN HOME

Gone are the days of housing affordability. Housing prices have gone through the roof and housing affordability is at its lowest levels in Australia since the index started being recorded. Additionally, the purchasing price of a home should not be measured solely in monetary terms, but also in its true value of its effect on your life.

It is no longer possible to save up and purchase a house outright. Bank loans are essential to own your first home. Whilst the home loan is initially spread over a 30 year term, in reality it is generally much closer to 50 or 60 years to due the inevitable refinances over the years. Home repairs, renovations, extensions, improvements and even other purchases such as cars and holidays are usually tacked onto the loan once equity is established.

You don’t need a degree in mathematics to work out the average age of a homebuyer once they have paid off their home. If a first homebuyer is aged 25 and the retirement age is 65, considering the abovementioned real home loan term lengths, the average homeowner will die before they are able to pay off their home. Is it worth working like a slave all your life chasing this elusive dream?

WHOSE DREAM IS IT ANYWAY?

As the reality of owning a home slips further into the netherworld, we need to analyse just who is promoting this fantasy and what are their true intentions. Certainly the government is acting through the education system to reach the minds of schoolchildren while they are young and vulnerable, but for what purpose?

Generations of honest, hard working Australians striving to own their own home: sounds like a good plan. The public will stay off welfare support and pay high levels of tax from their jobs. Additionally, home ownership generally equates to an individuals feet becoming firmly planted in Australia; rather than someone who skips the country for greener pastures after the government has spent thousands in educating them. The financial benefits of home ownership are great for the Australian government, but what about the social consequences?

Many of the traditional cultures have a strong set of family values at their core. This is still evident in many of the Asian countries today, where families share a strong bond from growing up together in a limited space. These family values are severely lacking in Australian society, where children move out of home at a young age and it is the norm for every person to have their own room in a house.

In Asian countries, children will sleep in the same bedroom as their parents. Grandparents are not thrown into retirement villages, but instead live with their children and grandchildren in the same house. When a son or daughter is married, they do not move off elsewhere, rather preferring to build an extension to the family house and stay in close proximity.

Many experts link these simple values failing to be attained from the home environment to the degradation of society; to the point where rapes, murders, theft and thuggery are all common place. Separate home ownership needs to be considered not just from the monetary point of view, but from the potential social damage it may be responsible for.

WILL YOU REALLY EVEN OWN IT?

Owning property means that it is yours: at least that’s what the Australian government wants you to believe. The true reality is that the government actually retains ownership of the land and you rent the land on a peppercorn leasehold basis.

As depicted in the great Australian movie classic ‘The Castle’, we are living under a false assumption that the land can ever be considered ours. The government purports the power to be able to take our ‘home’ from us at any time and for any purpose that it sees fitting.

Then there are the courts, which have a long history of ‘stealing’ property for frivolous reasons. Local councils also stamp their authority over the homeowners, even though that authority has been revoked through referendums which deem council rates to be illegal and unenforceable. If you have to pay a fee for the privilege of owning your home, should that really be considered as true home ownership?

Yet even after considering all these factors, many Australians will continue to believe in the impossible dream.