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.
How to find a hotspot… before it becomes a hotspot!
Imagine as property investors if we could predict the future!
We could identify the best hotspot locations around the country before they happen and hey presto – instant growth!
The problem with property hotspots is that once they become widely known as hotspots, investors flood in, prices rise and the best opportunities for maximising rapid growth have usually passed.
The key to finding a hotspot ahead of the rest is to identify areas which are experiencing a dynamic shift in population or growth trends, resulting in upwards pressure on rents and house prices.
How do you find such places?
Consider these factors when doing your research to identify the next hotspot before everyone else does.
Infrastructure investment. In metro areas, suburbs experiencing population growth are likely to be those undergoing urban revitalisation or new development. Regionally, large industrial infrastructure projects will bring with them large construction and ongoing operational and maintenance workforces.
Location. Look for areas with good transport connections – easy access to trains, buses, airports and key roads for example – close to schools or with good connections to the CBD. This will ensure the area is attractive to a wider population demographic.
Neighbouring areas. Areas already well known as hotspots, where demand continues to outstrip supply, pressure can cause spill over into adjoining suburbs and towns in close proximity. This means suburbs surrounding an area that’s in high demand may also start to benefit from house value and rent rises as buyers and renters overflow into these next closest locations.
Demographic appeal. Certain city suburbs will also appeal to certain demographics. In metro areas the FIFO worker population, for example, often prefers to live close to the airport, tertiary students close to universities and families close to schools, creating ongoing demand for housing in those areas. The best locations however are generally those that appeal to a wider demographic – from students to workers and families.
Industrial growth. In regional towns, strong population growth derives from industry growth. Towns on the verge of a population boom are those most likely to create positively geared property markets due to sharply increasing rents as demand for accommodation from the rising workforce outstrips supply.
New projects and workforce numbers. Look for areas where new projects have been committed and establish the proposed temporary and permanent workforce numbers. Identify where these workers will come from (how many will relocate from other areas) and how they will be accommodated. Consider that some companies may supply their own temporary worker accommodation villages which reduce the impact that workforce numbers can have on a town’s housing supply.
Multiple projects. For risk mitigation purposes, it pays to choose towns with multiple projects to reduce the impact project closures may have on the population. Consider the level and timing of future infrastructure spending and the size and diversity of the proposed projects in the area. Also investigate the financial strength of the key companies operating in the area and expected duration of any expansion works.
Population trend. It’s also important to examine the population trend to determine the sustainability of any increase. If a town’s population shows a historical downward trend then there is likely to be housing over supply which means the arrival of a new workforce will have less impact on the market.
Population trends and a variety of other useful information that will assist with your property research can easily be accessed from the Australian Bureau of Statistics (www.abs.gov.au).
Housing supply. Investigate the level of new housing development currently being undertaken in the area and if the current level could affect the demand/supply imbalance when it comes online.
Occupation and income. As a general rule, the more people earn, the more they will spend on housing. In metro locations, identify where there are growing populations of professionals and high income earners as they are likely to be contributing to increasing rents and house prices. Regionally, increasing numbers of FIFO and DIDO workers – one of Australia’s most highly paid groups – are a sure sign that rents and prices are on the rise, particularly if workers are being accommodated in town housing. Another precursor of a market increase within resource towns is whether major companies are offering subsidies to employees who purchase within the town. Company-backed home ownership is a sure sign of increasing strength and activity in the marketplace.
Landlord types. Look for areas where government housing is low. Areas with high numbers of owner occupiers can also be beneficial as it generally means better street aesthetics and neighbourhoods, helping to boost values.
Vacancy rate. Check the town or suburb’s vacancy rate. A low rate indicates an undersupply, a high rate indicates an oversupply. A consistent increase in population suggests that (if new development is constrained) supply will struggle to keep up with demand putting pressure on rents.
Beware the median price statistic. Rises and falls in average house prices can be grossly distorted. They can be dragged up by a handful of sales at the higher end of the market or dragged down by a string of sales of lower priced properties. Median house price growth/falls are not an accurate reflection of the market and do not mean that every house in that area has increased/decreased in value.
Property selection within a hotspot. Choosing a property that will appeal to the area’s demographic and the type of tenant you want is the final step. Talk to local property experts to determine what types of housing are in greatest demand and if there are any particular streets to avoid. In resource town hotspots there is an increasing trend towards new, well located properties such as luxury lifestyle apartments and large houses close to the ocean or town centre. Blue chip companies prefer this type of housing as it ensures they attract and retain their desired workforce.
Yield and capital growth. Gain advice from local property experts to gauge the rent you can expect for a particular property, the level of demand for the area and where the market is in its property cycle. This will allow you to determine what return you can expect over your intended holding period.
Each and every year hotspot towns emerge around the country with the ability to pay large dividends to investors willing to spot the signs, research the areas and ultimately purchase in a location that ticks all the hotspot boxes.
Take these factors into account when conducting your research and give your next investment purchase the best chance of featuring in the next emerging hotspot!
Five essential ingredients to investment success that the banks won’t tell you!
When it comes to financing your investment properties, choosing the wrong loan structure, lender or product can have a serious impact on your investment journey.
It’s important to consider that banks are more focused on their profits & products, than providing a personalized investment lending options tailored to your investment property goals.
Here are the top five ingredients for structuring a successful portfolio – which you won’t hear from the banks.
#1 Understand what impacts your borrowing capacity: Most lenders have specific policies that restrict or limit lending to those with lower incomes or those seeking to invest in properties in certain postcodes. Conditions will differ between lenders.
CBA, for example, announced this week that it will now cap rental yields at 8% for mining towns when assessing loan applications. The property might yield much more in reality, but the bank plans to only use 8% in its calculations as part of its risk mitigation.
In addition to rental income, existing debt, LVR, whether you are buying alone or with someone else, your age (and how this affects the term of the loan), your dependents can also impact your borrowing capacity.
#2 Find the best interest rate. Banks care about profit margins for their shareholders, so will generally not offer you their very best rate upfront. Shop around to make sure you secure the best deal. This is where a mortgage broker can really save you time; they will find the best deal based on your specific needs.
Regardless of the rate you secure, ensure you will be able to comfortably meet your repayments if interest rates go up (base on up to 2% increase).
#3 Choose the right product. How do you know you are on the right product to achieve your wealth creation goals? It is important that you research the products available to determine which meet the requirements of your investment strategy.
A low interest rate is important but securing the lowest rate will likely mean forfeiting other features that may be important to your situation such as the ability to make extra repayments when you want to.
#4 Avoid cross securitisation: Cross securitisation involves combining all of your properties in a single structure with one lender, and using the combined collateral to fund further investments. This structure benefits the lender by providing it with greater security should you fall into financial hardship or should you try to manipulate your portfolio either by purchase or sale. For the investor however having all properties tied up in a single structure can be a major disadvantage by reducing borrowing capacity and the ability to find better deals with other providers.
Avoid cross securitisation by separating your properties into standalone structures. Implementing a standalone structure for each property means that if one property increases in value it won’t be held down by another that may have decreased in value. You will still be in a position to build your portfolio by using a line of credit against the property which has generated equity.
#5 Diversify your lenders to secure the best deals – but be aware of fees. Further to #4, standalone loan structures give you the flexibility to take out loans with different lenders to secure the best deals available in the current marketplace. This is a great strategy on paper, but for big portfolios with substantial debt this usually results in more than one set of fees and higher interest rates overall. Compare the fees and rates of standalone structures within one lender with the rates and fees that would be payable across multiple lenders to find the most cost effective option.
Finance brokers who are property investment focused act as you’re representative to ensure the right loan, structure and rate is secured not only for a single purchase but with your ongoing portfolio growth goals in mind.
Is it a smart move to purchase a home before an investment property?
As Australians, we place a high importance on owning our own home. After a car, it is usually our next ‘big ticket’ purchase and is considered one of life’s major achievements – a symbol of a sound financial position.
But is it? Is buying a home as a your first property purchase really a smart move?
The old mantra of ‘rent money is dead money’ has been so entrenched in our culture that many of us fail to clearly assess the financial impact and consequences that can come with purchasing a home as your first property. The decision to purchase a PPOR first can weaken your financial position and servicing ability with banks, and increase your cost of living. More often than not, you will also find you have to live in an area that does not tick all your boxes due to affordability.
If you had the choice of purchasing your dream home in five years, or a lesser quality, poorly located home now – wouldn’t you wait?
A mortgage delays your wealth creation potential. Many first home buyers and beginner investors jump straight into buying a property to live in. In the vast majority of situations, it is going to cost you more to own your own home than to rent. To maximise your property investment potential, the best approach is to keep your living expenses as low as possible while you establish your investment portfolio; monthly mortgage payments on your PPOR will only hinder your borrowing capacity and slow your ability to grow a portfolio. Continue renting or live with family and resist non-essential spending while you improve your financial position.
How the living costs weigh up. An example of buying a PPOR versus renting and investing a $500,000 property in a positively geared market and continuing to rent:
- Deposit: $50,000
- Loan: $450,000
- Repayments (principal + interest, rate of 6%): $675/week
- Cost to you: $675/week
Positive investment property –
- Deposit: $100,000
- Loan: $400,000
- Rental income: $1,100/week
- Repayments (interest-only, rate of 6%): $461/week
- Profit: $639/week
- Rent a $500,000 property: $500/week
- Total profit: $139/week
All too often investors who choose to purchase a home to live in as their first property find themselves in a position where they have to wait a number of years to be able to purchase again.
While living in your own home may be tempting, the benefit of remaining in the rental market while you spend a few years developing your investment portfolio means you can fast track your portfolio growth and maximise your net worth.
A little sacrifice in the short term can mean a far better financial position and lifestyle in the long term!
Instant Equity ideal for first time investors – House & land packages
This third and final installment on ideal options for first time investors looks at house and land packages.
Over the past few years, house and land packages have become increasingly popular with investors as a way to enter the property market and kick-start portfolio development.
Many providers of house and land packages will partner with mortgage brokers to offer low deposit finance options. Vendor finance (covered in Part 2) may also be available.
Often, investors will only need a deposit of ten percent to secure a H&L package. The finance is then drawn down in stages, in line with each phase of construction.
On a $750,000 H&L package, for example, the finance would look something like this:
- land cost: $250,000 – deposit required of $25,000
- build cost: $500,000 – deposit required of $50,000, following settlement of land
- loan drawn down in stages over construction period (four to five months)
In addition to a low deposit, there are several other key advantages H&L packages can offer investors.
Instant equity. One of the greatest advantages of an H&L package is the instant equity that can be generated, allowing the investor to purchase again very quickly. Locking in construction and land prices through a fixed price contract means that in a rising market, any increase in the value of the property between when the contract was signed to completion and handover is to the benefit of the buyer. It is not unusual to see, following the typical five-month build time frame, that the completed property is worth an additional $100,000 over costs to construct, providing the investor with immediate funding ability to purchase another property.
Save on stamp duty. With H&L packages, stamp duty is only payable on the price of the land. On an established house, it’s payable on the cost of the land and the house. This can represent a saving of thousands of dollars.
Increased tenant appeal. The purchase of a house and land package also benefits the investor by offering a wide range of configuration choices – ideal if they are targeting the corporate leasing sector. For example, investors can add additional ensuites to the plan of the home, which will appeal to renters and significantly boost rental returns.
Low maintenance. A new property comes complete with a builder’s warranty and the additional benefit of low maintenance costs. Maintaining older homes can be quite expensive and they are less appealing to corporate tenants. A new home also offers attractive tax depreciation benefits that can significantly boost the property’s return.
With leverage and multiple property purchasing the key to building a successful portfolio, House & land package options can be the ideal selection for beginner investors starting with low deposit funds.
Get positive about wealth creation
Last week the ATO released data from the 2010/11 tax year which showed that two thirds of Australian property investors claimed a total of $13.2 billion in losses on property during the period.
It has renewed debate over the government’s negative gearing policy which essentially rewards investors for losing money (while draining tax funds) by allowing them to claim a deduction on their interest payments and other costs associated with owning a loss-making property.
It is unlikely the government will abolish the tax benefits associated with negative gearing after the last attempt in 1985 which saw it quarantined for a period. This allegedly caused rents to surge (although there is evidence to the contrary) resulting in a swift reversal of the decision. Nonetheless, it has highlighted the need for property investors to ensure their wealth creation strategies are in fact creating wealth.
Some investors are drawn to negative gearing solely by the tax advantages, giving little consideration to the capital growth potential of the property. Regardless of the tax benefits, while an investor holds negative property, they are losing money, putting them at financial risk.
Other investors are prepared to absorb the losses, relying on speculative capital growth to achieve a return, which will only be realized at the point of sale. By comparison, positively geared property delivers a cash return to the investor immediately, providing a passive second income stream and the opportunity to fund their lifestyle and further investments.
It the meantime, negative property investors must dig into their own pockets to supplement the shortfall in rent thereby reducing their monthly cash flow and reducing their capacity to funnel earnings into other investments. And while interest rates are currently at their lowest level in half a century, any future rate rises can impact on an investor’s ability to make payments.
A common belief held by negative gearing enthusiasts is that positively geared property does not deliver good capital growth; the resources towns of the Pilbara and central Queensland have proved otherwise. Investors in these regions have been able to build sizeable portfolios in very short timeframes by taking advantage of the equity generated and extra income available to them to acquire more positive property. For some, their portfolios provide enough passive income to fund their lifestyle, allowing them to shift their focus way from work and onto family, travel and other pursuits.
A negatively geared portfolio does not offer this option. If a negative property rises in value during the holding period, any equity generated can be used as a line of credit, but it cannot be drawn as an income stream to fund living expenses.
Furthermore, negative gearing benefits higher income earners (which are on higher tax rates,) the greatest. Yet, oddly, the majority of negatively geared property investors are in the middle income tax bracket.
Investors considering negative gearing should proceed with caution. Assess your financial goals and investigate the strategies that are available to you.
Benefits of buying positive property off the plan
There is significant new development occurring in some of Australia’s positive property hotspots such as the Northwest and Central Queensland, offering investors a variety of opportunities to invest off the plan.
Many consider off the plan property to be a high risk investment but with thorough due diligence it can generate excellent returns with low cost entry.
One of the major draws of buying off the plan is that a deposit of around 10% will secure the property. Pre-approval on finance will be required but the balance is generally not be payable until settlement.
With construction completion often taking six to 12 months, there is an extended timeframe for settlement and investors can take advantage of this to improve their financial position and benefit from any capital growth. As the property is purchased based on a fixed price contract, any equity the property generates between the deposit payment and settlement is the investor’s capital gain.
New properties also command top rents and investor profits can be further increased by taking advantage of tax depreciation, which is maximized for new properties. They also have minimal maintenance costs.
In addition to conducting comprehensive market research, it is vital that investors conduct due diligence on the developer. The developer’s track record, design and quality of projects, and capacity to deliver on schedule should be analyzed before committing to buy.
This includes investigating factors that can significantly affect a property’s value and rental yield such as floor plans, fittings, finishing’s and appliances.
Workmanship and products should be of high quality with suitable warranties. Ensure the process for rectifying defects is clear and assess the options for the customization of floor plans and fittings if it will add value and attract quality tenants.
Investors should review the contract carefully and seek legal counsel if they need clarification on the term and conditions.
Off the plan purchasing typically offers a low cost entry into the property market and in some states investors can avoid paying full stamp duty, making it a desirable option for first time investors.
What low interest rates mean for positive property investors
In December, the Reserve Bank of Australia cut interest rates to 3 per cent following the fall in the iron ore price. It marked the fourth interest rate cut in less than a year and equals the lowest level ever set by the bank in 2009 at the height of the GFC.
The RBA said in a statement last week that while low rates have had some positive effects on the housing market – increases in building approvals, higher rental yields and improving house prices – economic growth as a whole is still below trend. It indicated that rates are likely to remain low for a while and could even drop a little further.
This is good news for positive property investors.
Interest rates have a big impact on whether a property is positively geared or not. A low interest rate results in lower interest payments. If the interest payments become less than the rental income, a negative or neutral property can become positive (assuming the rent also covers other costs associated with owning the property).
This means low rates can open up more market opportunities for positive gearing. Investors also have the other current advantage of high rents, so with thorough research you will find properties that will generate a decent passive income.
For those already invested in a positively geared property on a variable interest loan, you will be enjoying the benefits of lower interest payments and increased profit.
Unfortunately though, low interest rates will not stay low forever. Investors should take this into consideration when making an investment to ensure they can afford a drop in income when rates begin to rise again. Taking out a fixed rate loan will reduce this risk.
Low rates and high rents may also mean it becomes cheaper to buy than to rent in some areas, creating an owner occupier market and reducing demand for rentals. However, with the ongoing housing shortage in Australia and rental market going strong, any increase in homebuyers is unlikely to have a significant effect on the rental market in most areas.
House and land packages – a strong start to investing
Over the past few years house and land packages have become increasingly popular with investors as a way to enter the property market.
House and land packages offer a number of distinct advantages when compared to buying an established home.
Firstly, they tend to be competitively priced and offer a lower cost entry into the property market. In addition to this entry advantage, investors can avoid paying stamp duty in certain states. This can be a saving of thousands of dollars when compared with the potential stamp duty payable when buying an established home.
The purchase of a house and land package also benefits the investor by offering a wide range of configuration choices, ideal if they are targeting the corporate leasing sector. For example, investors can add additional ensuites to the plan of the home which will appeal to renters and significantly boost the rental returns of the property.
In a rising property market, there is also the opportunity to lock in construction and land prices by using a fixed price contract and end up with a property worth significantly more than what it was purchased for. During the period elapsed from the contract being signed to completion and handover of the property, any increase in the value is to the benefit of the buyer, not the seller. In rising markets it is not unusual to see properties settling with instant equity, which the investor can borrow against to assist in future purchases.
The main advantage of a house and land package is that the property is brand new and comes complete with builders warranty and low maintenance costs. Buying older properties can eat into any cash reserves available, as maintaining older homes can be quite expensive and they are less appealing to higher end corporate tenants. A new home also offers attractive tax depreciation benefits that can significantly boost the properties return come tax time.
House & Land packages can serve as the ideal first investment to the cash-flow positive investor offering; increased rental return, lower maintenance costs, depreciation and the potential to capitalise on rising markets whilst protected by fixed price contract.
Crawford Property Group is currently offering a number of House & Land packages in Positive Property Hotspots.