Positive vs negative property – know the facts before choosing your strategy
There has long been ongoing debate among property investors, industry thought leaders and economists when it comes to positive and negative gearing.
Views are polarised over which strategy is best, which delivers the better return and whether negative gearing as a tax break should exist at all.
Many within the property investment industry remain steadfast in the negative gearing camp, but is it the right strategy for investors in the modern age?
Negative gearing is not an investment strategy, it’s a tax strategy – and a limited one at that.
Negative gearing is a strategy based on losses. It requires you to top up the rent you receive with your own money in order to pay the mortgage. The taxation office allows you to deduct these losses from your taxable income, thereby reducing your tax. BUT the tax savings, generally received upon lodging your return each year, DO NOT cover your losses.
Even with the tax benefits, you are still putting more of your money into the property – every single month. Simply, negative gearing is a deficit strategy that requires the constant and ongoing input of your own funds to keep the ‘investment’ going.
In contrast, positively geared property by definition generally services all the holding costs of the property and earns the investor a net profit.
While these points are the two obvious differences when considering negative or positive investing, there are several others that you should be aware of before taking the plunge down the negative gearing route.
Forget leaving the workforce. Stable, consistent income is vital in order to service loans on negative properties as the rental income isn’t enough. If your salary decreases or you lose your job, what position will you find yourself in? Is it likely you would default on your loan and potentially lose your property? During times of increasing job uncertainty, this can be a risky approach to your investment plan.
Positive property not only puts extra cash in your pocket every month, it also acts as a financial security measure. If you lost your job tomorrow, you would still have the passive income from your positive portfolio coming in.
Portfolio growth is reliant on capital growth cycles. After purchasing a negatively geared property the only way to continue to invest without injecting more of your hard earned cash is by using equity from an existing property. Equity is created when the value of your property increases. To use equity as a deposit on your next purchase, the value of your property needs to have risen substantially. Based on historical performance, long-term property growth in Australia is considered a sure bet, but it can take many years for a negatively geared market to receive substantial growth. This can dramatically impact your ability to purchase multiple properties.
It’s not flexible. A negative gearing strategy relies on capital growth to deliver a return to the investor – this makes it a long term strategy. You might be forced to hold onto a property much longer than you had expected to because of slow capital growth cycles. It reduces both the liquidity and flexibility of your portfolio. Positive property delivers you a cash return from day one – offering positive return on investment even during period of zero or little growth.
Portfolio growth is restricted by serviceability. Many new investors struggle to understand how some are able to build large property portfolios quite quickly while others are stopped in their tracks after just two or three. The difference – serviceability!
Even high income earners will eventually hit a ceiling if they pursue a negative gearing strategy. There is only so much of one’s salary that can be funneled into servicing loans on investment properties. Investors on lower incomes can hit this ceiling very quickly and portfolio growth will come to a sharp standstill.
With each purchase of a positively geared property, your passive income stream increases. You will continue to improve your financial position in the eyes of most lenders and your capacity to service your loans increases.
Whether an advocate of positive or negative, it’s important to remember that each strategy has a vastly different path and outcome. When deciding the best path for you, do your research. Review the stories of other successful investors to ensure the direction you choose will ultimately lead you to your wealth creation goals.
Maximise your equity to build a portfolio quickly
There are many factors that can impact your buying power when investing in property. Being aware of them and understanding how they can drive or limit your strategy is the key to fast portfolio growth.
Utilise LMI to get started sooner. If you are just starting out on your property investment journey you will either use a saved deposit or equity in your home to make your first investment. First time investors shouldn’t delay their wealth creation by waiting until they have a 20% deposit to get started – it’s common to borrow 90% and take out Lenders Mortgage Insurance (required if your deposit is less than 20%) to get into the market as quickly as possible. LMI is an acceptable and tax deductable method to get your portfolio started and growing. When your portfolio has generated sufficient equity you can start to buy properties with a larger deposit – without requiring LMI.
Maximise your buying power. Each lender has different assessment criteria and your approved amount could differ significantly between lenders so shop around to make sure you are maximising your borrowing capacity and getting the best interest rate structure.
As you grow your portfolio, you will want to diversify your lenders. It can be tempting to stay with the one lender for simplicity but there is ultimately a limit as to what a single lender can offer. Using different lenders provides greater flexibility of products, reduces risk and provides more opportunity to further build your portfolio.
The best way to make sure you’re getting the best deal every time is to engage the services of an experienced mortgage broker – one that specialises in investment property. A good broker will know which lenders are likely to be more flexible with their borrowing capacities and will offer a variety of products from different lenders. Developing a long term partnership with a broker is a key element of a successful investment strategy and rapid portfolio growth.
Create instant equity. Look for opportunities in the market that will deliver instant equity within six months of settlement. Instant equity might come in the form of a house and land package, renovating a well-located but older unit, or adding an extension, such as a granny flat. If a property can deliver at least $50,000 equity through one of these means you will be very well positioned to purchase again within 12 months.
Unlock value. As a property’s value grows, the equity in the asset increases providing a source of funds to borrow against. ‘Unlocking’ this value allows investors to buy more property quickly without needing to save for a deposit. Maximising the equity in the property will increase your borrowing capacity and could even generate enough for you to invest in more than one property.
Agents will often provide free valuations to give you an idea of the market price and can also offer advice on how to improve a property and which areas you should focus on. However, lenders will do their own valuations and investors should be prepared for these to come in under what they believe the market value to be. Keeping the property well maintained and making aesthetic improvements will ensure you achieve the highest valuation possible.