Hello My name is Ben Everingham and I’m the director here at pumped on property and today we’re going to talk about does negative gearing still work.
So before we jump into if Negative Gearing is still relevant or not, I’m going to actually explain what Negative Gearing is. So Negative Gearing has basically been an investment strategy that 90% of Australians have used for the last 50 years inside Australia. So Negative gearing is a really really simple concept and its basically, I’m an investor I go and buy property and let’s say that property is in the Sydney or Melbourne marketplace and I pay $700,000 for it. And that property is an investment so I rent it out and I get $550 per week rent for it.
So, you don’t have to be a mathematician to understand that obviously if I’ve paid $700,000, it’s renting for $550 per week there’s going to be a short fall or a negative component that has to come out of my personal pocket each week to hold the property. The premise of this investment strategy is basically that okay it’s going to cost me let’s say $10,000 per year to hold this investment property. But the $700,000 property based on the old way of thinking, is going to go up in value by let’s say, seven to ten percent per annum, and so seven percent gain on a $700,000 property is just under $50,000 per year. A ten percent gain on a $700,000 property is $70,000 per year.
The premise was simple. Basically, the property is going to cost me $10,000 per year to hold but I’m going to be making between $50,000 and $70,000 per year in capital growth over a ten year period so the benefit outweighs the negative associated with holding that property. These are just very round numbers, I’m just plucking them out of the air, obviously it’s going to cost you a bit more then ten grand per year. That’s your rent return on a seven hundred K property but, I’m just using that as an example.
Before I jump into explaining does Negative Gearing still work. I’m just going to explain how ordinary Australians have used Negative Gearing in the past to build property portfolios, build property empires, and like a lot of the baby boomers today end up in an extremely comfortable position in retirement. And the concept has been simple.
In the past, there was an investment philosophy in Australia. Or basically a myth in the Australian marketplace that property doubles every seven to ten years. And so over the longer term, when you look back at the trends, property prices have continued to double every seven to ten years in Australia. People thought if they bought one or two or three properties over the course of their lifetime and those properties doubled in value by the time they reached retirement age that they might be able to sell one of those properties off., or two of those properties off to pay off the other properties they still owned or to put a nice big chunk of cash in the bank. So that they can go and spend the rest of their life doing whatever they’d like to do. That concept has worked for a lot of people in the past. Unfortunately, I don’t want to break the bubble but, unfortunately, the concept that property is going to double every seven to ten years which so many people in the property industry still talk about, heaps of buyers agents in the industry still talk about, real estate agents still talk about, and people all over Australia still talk about this concept that property is going to double every seven to ten years. And it’s just not.
That concept worked while wages were growing in line with the cost of housing but for the first time in a long time as a percentage of the overall debt or the value of properties, wages just aren’t increasing at the same pace that properties have been rising since 2011, since the GFC. My concern for people that have a highly negatively geared property portfolio with this thought process that things are going to double every seven to ten years is that I think the growth is really going to slow down here in Australia over the short, medium, and longer terms. And my personal predictions for the market long term, and I hope I’m completely wrong, but my predictions are the marketplace is only going to do between four and five percent per annum over the next ten years within Australia. And that is including Sydney, that’s including Melbourne and Brisbane and Perth and the biggest cities and so I even think the regional areas are going to do far worse than that.
I’m a conservative guy, I would rather base my expectation for my future wealth on a worst case scenario or at least a moderate case scenario rather than expecting that I’m going to be here. And only doing half the work that I need to and ending up far short of my goals and in a position where I’m extremely comfortable at the time that I want to be comfortable.
So let’s jump into this video which is Does Negative Gearing Still Work. So the first thing, that I wanted to say is that despite everything I’ve just said capital growth is still, to me , the most important thing in anybody’s property portfolio. And for the average Australian who is going to own between zero and five properties in their lifetime, capital growth is the foundation of a great property portfolio.
For me personally as an investor and as a buyers agent that has bought over $50,000,000 worth of property in the last couple of years for our clients, the way to remove some of the barriers to capital growth now and in the future is to buy in high quality, metro markets. Like the capital cities of Sydney, Melbourne, Brisbane and the reason you target those areas and because those areas generally perform better over the longer term than regional markets is, there’s jobs, there’s infrastructure, there’s population growth, there’s a great lifestyle for those people that want to live there. There’s this concept and there’s this confidence in these market prices that property prices might be high. Incomes in these areas are still high. And there is generally people that can afford these properties both here and outside of Australia. Capital Growth is really the foundation. I still believe it’s the most important thing that everybody should be targeting. But there’s also some other things that I’ll talk about in a moment that are becoming equally important to take into consideration.
The other thing is that … why negative gearing has been such an attractive concept is because it’s 2016 when I’m shooting this video but, there is still a tax benefit associated with negative gearing in Australia. They are the depreciation benefits for the property and they’re also the tax benefits for the holding costs of holding a property.
Obviously that example before, where you’re pulling $10,000 out of your own pocket per year. That’s a pre-tax $10,000 that you’re paying but after tax you can times that $10,000 by your personal income tax bracket. And again this is not financial advice this is just the high level rule of thumb. You can obviously get a tax return or a tax benefit from holding that property which alleviates some of the pain. And might put some extra money in your pocket at tax time. So those tax benefits are part of what’s perpetuated in this approach to negative gearing. And you talk to somebody in America about negative gearing and there’s not an investor in America that would speculate without being able to guarantee a manufactured growth return or guarantee some sort of high rental return or high income return because that’s the philosophy in their country and that’s how things work over there. But inside Australia, Negative Gearing still works because of those tax benefits, at least in a lot of peoples minds.
Another thing that I wanted to talk about is that you don’t want to rely solely on Negatively Geared property as your strategy from today forward. The reason for that is that prices have gone consistently up for such a long time in Australia. Obviously we’ve had flat markets and we’ve had declining markets, and we’ve had markets that go up. But the general trend over the last 50 years in Australia and the general thought process in Australia is that property prices always go up. And you’ve got concepts or phrases in our Australian vocabulary which is, as safe as house, and , you can’t go wrong buying bricks and mortar, and, you can touch and feel property and that’s why people still love it. But the reality is, if prices don’t continue to go up like they have in the past, and your whole strategy is buying a property with the hope that it’s going to be worth more in the future than it is today. There’s going to be a lot of people that break even, some people that make some great money, and some people that unfortunately lose some money as well over the next 20 years.
Negative Gearing is definitely important as is buying properties with the potential for capital growth. But you want to make sure that that’s part of a bigger more wholistic picture which includes buying at the right time of the properties cycle globally. Buying at the right time at the rising market pace.
So to discuss that in a bit more detail, let’s say that you bought property at the end of the GFC in Sydney or Melbourne and rode that three to four years of really really strong growth that came out the back of that. That’s what I mean by riding the rising market stage. I think I love to buy properties for our clients that have some potential to manufacture some growth. That might mean buying a piece of land that you can potentially sub-divide. It might mean buying a property that you can add a granny flat to in the future. It might mean buying an ugly duckling that you can renovate, or a three bedroom house that you can turn into a four bedroom. There’s so many different ways to add value to properties but making sure you have something up your sleeve that if the market does go flat, you can add some value and keep moving forward on your investment journey. And the other thing that I thought of, the fourth thing, that is really important to me is obviously buying property with above average rent return.
So let’s say over the last hundred years in Australia, or fifty years the average annual price growth of property has been nine or ten percent per annum. Let’s say seven percent of that growth has come from capital growth and three to four percent of that growth has come from rental returns. And that’s cool and that’s worked in the past but if you’re only talking about a four percent capital growth rate from now for the next twenty years in Australia then, I personally want to be holding properties with at least the five and a half or six percent rent return, so that when I own that asset outright in the future, I’m still getting the same above average percentage return, which is better than the banks. And a safe investment strategy for people like myself. Or a strategy that I believe is a little bit more secure based off of my knowledge and skills.
It’s just about flipping the way that you create value through property investing and about not believing that property is going to grow every seven to ten years like it has in the past. And not believing that negative gearing is always going to be here in the future. Not relying on one single strategy as your approach to creating wealth through investing and just thinking about some of these other things and the effect that the long term trends in Australia are going to have.
So in terms of my personal projections for the future of Australian property, as of now, 2016, I think things are going to be relatively stable because there’s still a strong demand for property inside and outside of Australia. But I don’t think it’s going to be anything like it has been in the past. So as I said before, I personally do my numbers at four percent per annum and while they might be very very conservative and just above inflation, at the end of the day property is far more expensive than it’s ever been in the past. And a four or five percent return on a $500,000 property is still around about $20,000 plus per annum in capital growth which coupled with great cash flow and manufacturing in chunks of growth. Sometimes when you time the cycle right you might get about four or five percent growth over a short spike or a short term period, but there’s a lot of things to consider.
I hope I haven’t freaked anybody out that owns negatively geared properties because again that’s the bread and butter strategy that ninety percent of people that I’ve talked to, that have been investing for ten years or longer have followed. And a lot of those people have made amazing money from it. It’s just being cautious about what’s going to happen in the future and hedging your bets and making sure that your assumptions are realistic. And you’ve got a thought process around ways that you can add value to the properties that you buy in the future, longer term.
So that’s my thoughts around does negative gearing still work. I hope you’ve enjoyed today’s video. For anybody who’s interested in talking about this further, or for anybody that’s interesting in taking their currently negatively geared portfolio and finding a way for their next properties to buy things that have manufactured growth potential or buy things that have the potential for above average rent returns and cash flow six, seven, eight percent. Then I’d love the opportunity to personally give you a one on one strategy session with myself. Where we will really talk about where you are today where you’re looking to go in the future and begin to map out a bit of plan around your next action steps.
I really look forward to booking a time in with you and continuing this conversation.
Until next time, stay hungry.