Why Negative Gearing Sucks
What is negative gearing?
Gearing your investment so that the cost to continue it (loan repayments, council rates, maintenance etc) outweighs the income produced by the investment, leading to a reduction in taxable income.
Basically this method that you buy an investment that loses money to get a tax deduction with the hope that the character will go up in value to offset your loses. If this was a business would you buy it? The answer is NO. So why do people do it.
In Australia the government gives a tax deduction because they see this as a way individuals can help provide housing without the governments having to invest money.
So why does this suck? The true definition of an asset is something that puts money in your pocket that some else pays for. For example a character that is cash flow positive. Where the tenant is paying you more than the out goings.
Now what many investors need to realise in that in Australia it costs about 5% of the buy price to invest in a character. This includes legal costs, stamp duties, bank fees, house insurance, character inspections, mortgage insurance and other hidden costs.
For the average price of a house around $500,000 you are going to pay $25,000 in buy costs. You need a 10 or 20% place so that’s about $50,000 – $100,000. I know many investors like to buy spec houses / unit where the developer has put there own price on the investment. These are inflated prices so the developer makes his margin. The real value is when the character sells in the open market.
I have personally seen many investors pay between 10 – 15% more for the luxury of buying off a plan. Many Australia investors love to go to the auctions to buy similarities where there is additional competition driving up the price by the Real Estate Agents to get an inflated value.
If you are unlucky to be in a position where you have brought a character above the market price edges will nevertheless lend you money based on other fundamentals such as your place, income, and security. Your accountant will say congratulations because he can now charge you more for your accounting. Usually the edges valuation is based on the buy contract if it’s a transaction is a private treaty sale.
In our example of $500,000 investment where you might have paid 10% above retail. You are now $75,000 in a hole. If you tried to sell the character after 1 year. You may have lost $300 per week in negative gearing. This method you are down a further $15,000 less what you might be back for the tax man.
Now you or your partner lose their job and cannot provide to keep the character. You decide to sell by a Real Estate Agent who tells you the character is worth $550,000 to get the listing. After a few weeks your tenant moves out. You cannot get a new tenant because no one wants to move into a place that’s going to be sold. After 3 months the agent gets you down to $500,000 and it’s sold if you are lucky. The Real Estate using a thing call conditioning to get you down to the price they know it will sell at.
It may take another 3 months before the character settles. This is six months of no income. Costing you around say $21,000 in mortgage payments. You may have defaulted on your loan and destroyed your credit rating permanently. Because this investment may have been cross-collateralised with another character this character may need to be sold in addition. Hopefully it’s not your parents or grand parents home. The Real Estate Agent that lied to you to get the listing needs to be paid around 3% or in our example $15,000. One another thing, because you lost your job you have no income to offset the negative gearing against.
So in our example let’s look at the total costs
buy costs of investment $25,000
Negative Gearing loses first year $15,000. * Does not include Tax Deductions.
Holding Costs whilst selling. $21,000
Real Estate fees, bank and solicitors costs. $20,000. edges charge break fees early in the loans and legal costs say $2,000
In total you have lost around $81,000 in having the character for just one year. This is you were lucky enough to get a character at market value. If you brought off the plan you maybe down another 10% or $50,000.
The reason you could not keep the character was because of negative gearing. If the character was positive cash flow you could have kept the character. This character could have truly helped you by giving you income that you are not receiving because you don’t have a job.
Why not turn your negative geared character into a cash making machine for you. My investment strategy is that you need to buy character at a discount, add value to the character, and sell on terms to unprotected to a higher price for the character with out any real estate agents costs.
If you cannot get the house at a discount then you want favourable terms when buying. If you have to pay retail then you should only be paying $1 for the house and taking over of the owner’s loan. Which might be cheaper the one you can get from the bank.
You could then on sell this character to an investor or a new house buyer for profit. This investment strategy truly puts money in your pocket and allows you to buy lots of similarities because you’re not relying on the banking system. Why not get the tenant to do improvements to this house that adds value to your house.
So we are people going out of their way to lose money. It’s simple! This system has been setup by the edges, Real Estate Agents and legal system to make them money not you.
If you are looking for different to losing money by negative gearing then you can get our free audio gift on “How to Make Money Day One from Real Estate.