EPI 007 | What you need to know about negative gearing

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In this episode we delve into negative gearing, looking at the pros and the cons of one of the most popular investment strategies around.

We have a listener question from Steph who asks whether she should jump in and get started or save more money to afford an inner city property.

And in our quick tip we suggest you check out the website of your tax office (in Australia – www.ato.gov.au)

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EPI007 | What you need to know about negative gearing

Introduction

This is Everyday Property Investing episode 7. The show empowering everyday people to create wealth and achieve financial freedom, so get on board! Everyone can be a property investor! It just takes a little knowledge, a little support and some action. So get started with us today!

Welcome

Kaz: Hello and welcome! I’m Kaz and this is episode seven of Every Property Investing – lucky seven! In this episode we’re going to find out all about negative gearing. We’re going to talk about what it is and what are the pros and cons of negative gearing. And in this episode’s Quick Tip we’ll find where to go to learn about your taxable income and your tax bracket. I’m here with Den and we’re here to help you develop your knowledge and ours and to share our experiences within our Everyday Property Investing community. So how’s it going Den?

Den: I’m great thanks Kaz, and yourself?

Kaz: I’m very well, thank you!

Den: Outstanding! Now Kaz what’s news with you this week?

What’s news

Kaz: Well this week, I went to the accountant. It’s the time of year again or it was several months ago and I’m just a little bit late to do tax returns. But while I was there I was actually asking my accountant questions, which I recommend everyone should do actually. Make sure you get your big list of questions that you’ve always wanted to ask accountants.

Den: Any questions or actually specific property questions?

Kaz: I actually ask just, well I only see the accountant now and again. I come up with a list of anything to do with anything that I want to know because I figure I’m getting the money out and I want the most out of my money for the visit.

Den: Fantastic

Kaz: So I asked this accountant all about buying property in your own name versus buying property in a trust or a company structure. Interestingly what I found was that:

  • Number one you should consult an accountant to find out that sort of information because boy, it gets complex.
  • Number two, is to actually make sure that the accountant you are speaking to is someone who understands that sort of stuff, because property investing is actually, accounting is a big realm and some accountants know things about company, business, and others know things about property, and others know things about commercial arrangements for retail organizations or whatever. So try and find someone who actually knows a lot about that specific area. So that’s my tip there. It’s a complex area and but there are different ways to buy property and you should visit your accountant to talk about what the best way is for you.

Den: Okay, so trip to the accountant for you

Kaz: Yes, that’s a long-winded story, what about you Den?

Den: Alright, for me this week, as you may know if you’ve been following through, we’re looking at selling one of our properties. I tried the cheap man’s way of selling without having to pay for marketing or anything like that. What I tried to do is get the real estate agent to go through their email list and look at people who were interested in certain properties and fire off emails. The news this week is that it hasn’t worked. We got one offer which was considerably under what we wanted, and not being desperate to sell of course we don’t have to accept it. So now we’re looking at putting together an entire marketing plan and how we’re going to manage to sell this property and all that sort of stuff. So I’ve had some very slick real estate agents who have far too much hair and makeup, speaking to me about how they’re going to put together a marvelous marketing plan that’s going to get billions of dollars for this property – or that’s what it feels like.

Kaz: And how much does it cost you the billion dollar marketing plan?

Den: Well the marketing plan seems to be in the vicinity of $2,000 to $3,000 for a property. So I suppose if they can get an extra $2,000 to $3,000 for the property, then it’s worthwhile. So you’ve got to go with someone and now it’s down to choosing who’s going to run this marketing plan.

Kaz: It will be really interesting episode for us to do actually, sometime Den, about selling a property and all the costs associated with it, and what you can bargain on, what you can expect to pay for certain parts of it.

Den: Yeah absolutely, I think you find that there are some certain standards for the industry, but I wish someone, somewhere had put together how to pick your real estate agent when you’re selling your property. Maybe it’s something we have to do when we’ve done it a couple of times because I have got no idea how to do it. I’m just using my best judgment.

Kaz: And did you interview a bunch of different ones?

Den: Yeah I did

Kaz: I think you mentioned that.

Den: Yeah I listed questions and I sat down I don’t know how many cafe-lattes I bought to sit down and try to interview these agents and I still don’t feel great about it.

Kaz: Oh okay, well I’ll be interested if it works to find out how the marketing plan goes, and the women with too much makeup.

Den: So will I.

Feature Segment

Den: Okay now, our feature segment of this podcast is about negative gearing and what you need to know about negative gearing. So Kaz I know negative gearing is a really popular investment strategy, in fact it’s probably the most popular investing strategy. So tell me, what is negative gearing?

Kaz: Basically Den it boils down to this. You buy a property and the cash outflow from that property in terms of the expenses, exceed the income from the property. Therefore you’re making a loss on that property, but that loss can then be used to offset other taxable incomes such as a wage or salary and that reduces your income tax.

Den: Ok, so hang on, I just want to get this clear. So negative gearing is about deliberately making a loss on property.

Kaz: Yeah pretty much.

Den: Ok. So you do that because if you make a loss you’re going to pay less tax?

Kaz: That’s right. A lot of people, particularly in high-income brackets, look at this as a strategy of reducing their income tax.

Den: Ok, so negative gearing is really a tax reduction strategy?

Kaz: Yes

Den: Ok

Kaz: However there are other potential pros to negative gearing?

Den: Yeah

Kaz: Other than just making a savings on tax which make it appealing.

Den: Ok

Kaz: And that would be that property values often rise overtime. Therefore we have a capital gain. So this is particularly good if you purchase a property which increases in value over time, and that increase in value is greater than after tax losses and inflation then you’re ahead of the game.

Den: Ok, alright. So your pros are about your income tax. Your pros are about getting a property that rises in value overtime, so if your rise in value beats your income tax you’re fine. Ok, now I want to talk a little bit about why properties that generally rise in value overtime more, and maybe make your loss seem to be better capital gains.

Kaz: Good idea

Den: So, let’s talk about this. Not every property will give you the same yield and therefore not every property will give you a capital gain or a capital loss; they are different. What generally happens is property values are generally related more to the land than to the building. So when there’s a new house sure there’s value in the building.

We talked last episode about depreciation, and over time property values have been more linked to the land they’re on than the building. So let’s consider an inner city property. Now these properties are generally on blocks of land which are highly sought after, so they’ll have a high value. Now that value will probably go up over time, you’d expect it to because the demand for inner city properties is quite high. Now on the other hand, rent is generally related to the house itself and the type of property. So the rent factor isn’t all about the size of land. But it’s about how many bedrooms, how many bathrooms, how well-appointed is the house. So, what you might find is an equal house near the city will get better rent than a house further out, but the land further out is worth far less. So, you’ll find that the yield on a place further out of town is probably better because the house costs less. Now, that means that the properties in near town will generally go up more but they won’t get as much rent relative to a property further out and therefore you’re looking at making a loss. But your capital gains will probably, not always, but probably be better.

Kaz: So Den, you’re saying then that an inner city property is probably more likely to have greater capital gains, but less yield?

Den: Ok. I think well yes, probably yes. Now there are a whole lot of factors obviously involved. And it comes down to demand, and it comes down to infrastructure, and a whole lot of these factors that I know we’ve now got a report on the website that we’ll go through. But your chance of a property going up in value is related to quite a few factors and one of them is the demand for that land. So if you have a property near a center, there’s a chance that it will have a higher push to go up than a property away from the center.

Kaz: Ok and so, with negative gearing then, we’re looking at saving in income tax but we’re hoping that our property will gain or have a great capital gain?

Den: Ok that’s right. So often you’ll hear people say, I invest in property because I’m going to make money it’s going to go up in value. And I know I recently had a conversation with a friend of mine who’s bought her first investment property and this is a negative gearing property. And she spoke to me about it and said, ok this is why I’m doing it, I’m going to buy this property, I’m going to keep it for a while, and I’m eventually going to sell it and I’m going to make heaps and heaps of money out of it because it’s going to go up. Now of course, no capital gain is guaranteed. You don’t know what the prices are going to be in ten or fifteen years time. But there are certain amounts of research and certain considerations you can make that will increase your chances of it becoming a positive investment for you.

Kaz: Now here’s a question for you Den. There’s a bit of a, is it a myth or is it fact that I often read how property values double every seven to ten years. What do you think about that statement?

Den: Well again, I’m not the expert. But all I can talk about is what I’ve read. If you look over time, you’ll find that there is a rough increase, something like that. I think what’s known is that property values overtime do go up. If I look at my portfolio, and I do a statistical analysis on my portfolio regularly, the portfolio over the last ten years on average in the areas that I’ve invested has gone up 10%, right, per year on average. So, if that’s the case then the portfolio doubles about every seven years if it goes up 10% per annum, because it compounds. So, you’re probably looking at seven to ten years that’s a reasonable sort of an estimate, some areas will go slower, some areas will go faster, some areas will have growth spurts and all that sort of stuff.

Kaz: So by no means is that a fact that that’s going to happen, so people can’t be guaranteed of that coming.

Den: It’s not a fact and if you buy a property for $500,000 right now, and you have in your plans that you’re going to sell it for a million dollars in seven years time, I think you’re taking a big risk.

Kaz: Fair enough

Den: Ok

Kaz: So with this negative gearing thing Den, it’s sounding pretty good; I’m saving on tax, I’m buying a house that could potentially double in many years time, so that sounds great and that’s the upside of it. What about the cons of negative gearing?

Den: Well look, I think there are obvious reasons. A lot of people are investing in negative gearing, and it’s a very tax advantageous way to invest. But ultimately you’re making a loss. And I think it doesn’t matter which way you look at it even if you’re saving paying tax, you’re making a loss. And if you make money, you pay more tax. If you lose money, you pay less tax. So if you’re happy with making a loss that’s fine. But what making a loss also means as an impact is you can’t invest in a whole lot of properties at the same time, because there’s going to be a limit to how much loss you can make and how much loss you can handle. So it limits your ability to buy a lot of properties. It limits the extra income you have available now because you do have some money going out that essentially you could be using somewhere else although you are investing, so you’ve got to think about it that way. So that can impact the lifestyle that you lead.

Kaz: So if I’m, say I buy a property and it’s taking, I buy this as an investment and it’s negatively geared, and it’s taking say $500 a month from my pocket as well as there’s rent coming in from a tenant but that’s not enough to cover the expenses. So it’s taking $500 a month from my pocket and then I’m going to buy another one that’s the same, so there’s another $500 suddenly I’m up for an extra $1000 a month from my pocket, so there’s sort of a, there’s a limit to what you can, the extra money that you can have.

Den: There’s a limit…look in every type of investing and this is where, I think the obvious next question is, what’s the best one and the answer is what do you want. But I think clearly the idea of having a large number of properties that are each losing $500 a month isn’t going to work for most people. So, you need to have that background, you need to have done your research, you need to know that you’re on a pretty good thing and you need to feel comfortable with it. Now, some people love negative gearing, they love reducing their tax. Other people love positive gearing or positive cashflow because it gives them money every week, they’re not making a loss. It really is up to the individual to decide, to speak to their accountant, to speak to the people that are important and to make sure they are comfortable with this strategy. So when you start wondering, as I say the obvious next question is what’s the best, that’s a really hard question to answer.

Kaz: Ok fair enough. And I just wanted to sort of, give you a bit of an example here, when I first started looking to invest and we spoke to a few different investment companies, and I wanted to have a large portfolio of lots of properties in it. And so I remember talking to a representative of a company who came up to our house, came up the driveway and came in and we had a discussion about the property we were going to buy, what we could afford and all this sort of stuff. And she was basically saying that they actually, this company I was talking to, actually sell property as well which is number one for me is a little warning bell because you don’t, don’t want to mix up it’s a little bit conflict of interest getting property investing advice.

Den: Well that’s my number one. My number one thing is never take property investment advice from someone who wants to sell you a property. Now maybe, I’m being a little bit harsh there but I’ll make that rule for myself. You make your own decision. I make that rule for myself.

Kaz: No, we pretty much went the same way because I remember talking to this girl and saying that, well I want to have multiple properties, and she saying we only sell in inner city high growth areas and you could buy this house or this house and started showing me some houses, and I said that’s great but that house would be negatively geared and I would be out of pocket, 500 or more dollars a month for that house how am I going to afford lots of properties. And she said don’t worry lots of our club customers have lots of properties! But it didn’t really answer my question of how would I be able to afford multiple negatively geared properties.

Den: Well, if you want multiple properties and you want to grow your portfolio quickly, having a lot of negatively geared properties is probably going to limit that. So it’s just, again these are the considerations you need to make and I know that in future podcasts we’re going to go into how you work these things and how you work around these things. But from the beginning, it’s really hard to see how making a $500 loss per property is going to enable you to buy a dozen, fifteen, twenty properties.

Kaz: Yep and some people actually choose to combine negative gearing with other positive gearing or positive cashflows, then may have three or four positively geared or cashflow properties that are funding one negatively geared one in the hope that the negatively geared one will grow substantially.

Den: Yeah exactly. So the big thing is negative gearing it’s the sort of investment strategy someone would use if they’re looking at buying property that is expected to go up significantly in value while reducing their tax. So they’re making a profit from the property going up and at the same time they’re paying less tax in the meantime.

Kaz: And perhaps also for people who were looking at purchasing or just interested in having one or two properties that were going to grow that weren’t necessarily involved or as interested in having twenty properties.

(Music)

Listener Question

Kaz: So now we’ve got a listener question that’s been sent to us from Steph from Geelong.

Den: Hi Steph

Kaz: Hi Steph, thanks for sending us question we love them, please send more in everyone comments@everydaypropertyinvesting.com. Anyway back to Steph. Steph from Geelong says, ‘Hi Kaz and Den, thanks for the podcast. I’ve been listening on the way to work in the car. I want to start investing as soon as possible and have a small deposit available. I’ve been talking to people and some say just buy what you can afford whereas others say that you should only buy inner city properties as they grow more. Just wondering what your thoughts are.’ Thanks, Steph. Well how relevant was that to our discussion today.

Den: You’re going to ask me to answer this aren’t you?

Kaz: Yes, of course Den!

Den: Alright Steph, once again it comes down to your overall strategy. You need to decide what you want to do. Now if you have a small deposit, and I don’t know how much it is. If you’ve got a small deposit saved, there’s probably a limited chance that you’ll be able to buy an inner city property. So you’re balancing out how big is your deposit with what can you afford. And you also say you want to start investing as soon as possible. So there’s a few factors here. If you want to start investing as soon as possible, you probably going to get something that’s relatively cheap. If you want to buy an inner city property, that’s probably going to be more expensive. So you need to make that decision yourself. Remember we’re not financial advisers, we don’t know what your specific situation is. But you need to decide what the bigger driving force is. Is it about investing as soon as possible? Or is it about getting a place near the city? And that will ultimately help you decide what you would do.

Quick Tip

Kaz: Okay our Quick Tip for today, we’ve spoken about negative gearing today, so we were thinking a good tip for you may be to go and check out the ATO website, which is the Australian Tax Office if you’re in Australia that is. If you’re in another country, check out the website of the tax office of your country and have a look at the various income tax rates, and work out how much tax you actually pay, what tax brackets you fall into and understand how income tax works in your country and in your area, because that’s a really, that’s a big factor in your life and in your investing comes down to income tax rates. So a good understanding of that will do you well. The other thing is, often on those websites including the ATO website; they have a simple and an advanced calculator to help you work those things out on the website. There’s often a lot of really good resources on the website of the ATO and you can learn all about taxation there.

Den: Yeah and the one thing that we’ve been talking about with negative gearing is, if you don’t know how much tax you pay. You don’t know how much tax you’ll be saving if you negative gear, so it’s really important to do that, which brings us to this week’s action. And this week’s action is to make a point to go and learn about income tax in your tax brackets and understand exactly how much tax you pay.

(Music)

Den: Okay next episode, we’ll be going through positive gearing and positive cashflow as investment strategies. We’ll be understanding what positive gearing and positive cashflow means and looking at the pros and cons of them. As always you can email your comments to comments@everydaypropertyinvesting.com. We’ll also have our usual segments including news and tips so get over to iTunes and subscribe to our podcasts.

Kaz: And don’t forget to head on over to the website www.everydaypropertyinvesting.com and sign up for the email newsletter and we’ll give you notifications of when new podcasts are available.

Den: Alright, until then!

Closing

You’ve been listening to Everyday Property Investing, the show empowering everyday people to create wealth and achieve financial freedom. Please note that this show provides general advice based on personal experiences and is for educational purposes only. We’re not qualified accountants or lawyers or licensed to provide professional financial advice for you. We strongly advise that you employ the services of qualified professionals and seek their advice that is specific to your own personal circumstances. You can visit us at www.everydaypropertyinvesting.com. See you next time!

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