I am getting very confused on the subject,so any thoughts,especially from Steve perhaps(hopefully???)
1. A positively negative growth strategyThe current flavour of the month in residential property investment is Positively Geared Properties (PGP). Property seminar promoters in particular have taken to this type of property investment with gusto. Please beware…not only are these so-called experts misleading you the Australian public, but they are giving the entire real estate industry a bad name!
Fifteen years ago it was Negatively Geared Property (NGP) that these same groups pushed with slogans such as:
“Let the tax man and the tenant pay off your property.”
Now with a sense of delicious irony they have “discovered” PGP and are promoting this new road to financial wealth with a direct attack at their last hobbyhorse, NGP, with new slogans like:
“Why lose money every month from your property investment?”
So I felt it was about time that Hudson shared our point of view with our members.
What do we really think of PGP and why do we recommend property the way we do?
The Hudson philosophy with regard to property investment is, and always will be, that we advise our members to invest for growth. Investing for growth will not let you down over the longer term and will actually achieve the goals of positively geared property investors, as you will see in a moment.
Hudson recommends Members invest only for growth potential in residential property; with the caveat that property investors need a reasonable level of rental income to service any debt they may have on the property. For instance, while the purchase of prime Sydney Harbour residential real estate will more than likely generate a good growth return over time, the rental yield will be prohibitively low for successful property investment by the average residential property investor.
Hudson does not advise members to invest in residential property (or any other asset class for that matter) for tax deductions. If tax breaks are available then that is all well and good but they should never be the major driver of the investment decision.
So what exactly is a PGP (positively geared property)?
A PGP is effectively a property investment where the income generated by the property is greater than the interest out-laid on the loan used to acquire the property. By having a sizeable cash deposit to reduce the amount of the loan required, any property can be positively geared. The main way that the property seminar promoters achieve PGP for their clients is to ensure that the overall rental yield is well above the prevailing interest rate charged for the loan.
The Hudson view on property in general is that the more income you receive, the less growth you are likely to achieve. This idea is a fundamental rule of all investing. The overall return from any investment is made up of the income received plus the capital growth in the value of the asset. You cannot consistently have high capital growth and high income from a low risk investment.
The current boom in most capital city markets has forced up the prices of properties in even so-called “substandard” suburbs. This has forced the promoters of positively geared property out into regional areas to find stock and this increases the risk. This increased risk is in the form of tenancy and local economy risk for this type of property.
This move into regional areas has been a major cause of the strong lift in property prices in these areas. This lift has been flagged by the promoters to further highlight their case that they are achieving income and growth for investors. However, all that has really been achieved is a lower rental yield (due to the higher property prices) and increased risk of paying inflated artificial prices.
The big question to which I want an answer, and nobody has been able to provide it, is:
“Where is the underlying population demand into the future for those hot spots of residential property speculation in areas such as rural Victoria and Tasmania’s east coast?”What are the pitfalls of investing in PGP from the HUDSON point of view?
When interest rates rise (and they eventually will) above the rent received on the property, then it becomes a negatively geared property but without the benefits of capital growth.
Investors in PGP pay income tax at their marginal tax rate on the positive cash flow with little in the way of tax deductions, as depreciation etc is limited on many of the older houses that are located in regional areas. Contrast this with investors in NGP who can claim a tax deduction for the negative gearing and quite often depreciation on these generally newer properties. Likewise an investor chooses when they wish to pay CGT by deciding when they will sell the property.
What happens when the major employer in some of these regional areas (such as a mine or an abattoir or a government department) closes up shop and the tenants move away? Then investors are left with a NEGATIVELY geared property (as there is no or limited rental income) with no growth potential in a dying town.
It is true to say that investors should be seeking growth and not income from their investments in the property market. If you are seeking income then there are far better ways to get that income than investing in an illiquid, low growth, high risk, high maintenance, low tax effective residential property in a marginal regional area.The ironic thing about the argument between NGP and PGP is that they can both turn into each other. As I pointed out above, a PGP can turn into a NGP by the loss of a tenant – often permanently.
But the really great thing about negatively geared property is that it will eventually turn into a positively geared property over time – and for the right reasons. This is due to the increase over time in the rental returns on the property that are in line with the overall increase in the capital value of the property.
Contrast this with a positively geared property that has rent increases at best in line with inflation.
So a property with high growth and low initial rental yield (NGP) will obviously see higher overall rental return as the property grows over time than a high yielding property with low growth potential.
Another thing the promoters of PGP forget to mention when they criticise the overall “negative “ return of NGP is that they have not included capital growth into their calculations.
As mentioned above, overall return from property is a combination of rental income and capital growth. But the capital growth is often excluded from their calculation because it is not realised until the property is sold some time in the future. But this does not mean it is not there.
Give me growth over income anytime!!
regards bukti 1
[?]Exellent post and thought provoking!!
I to, believe that there are advantages & disadvantages to both PGP’s & NGP’s and consideration must be given to creating a balanced portfolio.
For me, I believe that several PGP’s should be sought to support the NGP – say a 4:1 or 5:1 ratio.
This way, most unforseen but inevitable circumstances, such as interest rates rises etc: should be covered. By making sure that your overall commitments do not exceed your present cashflow (allow a buffer zone for extra costs to be absorbed in the near future ie: 2-3% min increase in interest rates over next 2 years), you should be able to remain in a postion of control that allows you to bail out of a property, if need be, without to much risk of a catastrophic loss.“Where is the underlying population demand into the future for those hot spots of residential property speculation in areas such as rural Victoria and Tasmania’s east coast?”
OK…anecdotal evidence here, but I know several city dwellers who are sooo not property investors, who are selling up their city properties and translating them into mansions/land in such places -melbourne people buying in Tasmania as holiday homes with view to moving there later – Sydney city people selling and buying a mansion in the Blue Mountains for the same price as a modest city pad, Auckland people moving up to the beaches/vineyards to the north.
Huge growth of the ‘lifestyle block’ as a concept….more people able to work from home, due to technology and the net….businesses farming out or outsourcing things to independent contractors…not to mention the baby boomers thinking about where they wanna retire in a few years and buying there now while it’s cheap…
I don’t think this trend of buying rural is just investor driven. You see it when you visit the little places that used to be frumpy little forgotten places and are now humming with craft shops, cappucinos, bed and breakfast, pub and wine-bar renovations…actual people are moving to these places.
just some thoughts…..
bukti1
Thanks for the post, I would say it was interesting if I ment it!
Like all of us here we learn about and understand the risks associated with the type of investing that we choose. We know the pros and cons for BOTH positive and negative properties. Some like a mix of both others stick only with the positives!
Most of the points you raise were things we have all heard before and like anyone advocating their side only you did not manage to provide a fair unbiased opinion. I am not saying any of your information was wrong just lacking in a complete view of both sides.
I have got a negative geared unit in Sydney that has seen a good amount of growth in 6 months but still takes out more money from my bank account every month than it puts in. I have also got 2 positive cashflow properties that are putting $5000 passive income into my bank account at the end of every year after all expenses. Less income tax (say @ 30%, mine is actually less than that, but never mind!) $3500 in my pocket. My negative unit sees me shelling out $3800+ every year after all income.
We all have our own goals and reasons, so whilst your strategy is negative properties, we will all see things differently because of our own plans.
Good luck with your plans I hope they work well for you.
I choose cash[
][][]Cheers
Leigh K[]Read, learn, grow but most of all do it.
Excellent post Bukti1.
Some good comments, and I agree with it in general.I think the main issue with NGP is the servicability if you have too many of them. As o2bfree points out the best portfolio I believe consists of some of each so they balance each other out. Starting out with PGP and adding some negative ones later.
An increase in interest rates will make your NGP even more negative and increase the strain even more.
Properties with good capital gains can well and truely outstrip any short term cash gains you can get from your PGP. e.g. a $200k property with 10% capital gains will get you $20k in one year. How many PGP can do that? (less your negative cash flow of course).
The trick is to spot the areas where capital gains will happen and to maximise the balance. e.g. a $20K capital gain sounds good, but not if your cash flow is -$30k.
Andrew
http://www.rentmaster.co.nz
Software for LandlordsIt seems that a few rough examples are in order!
If one purchased a well located -ve IP for $500K
and expect it to grow by 10% pa ($50K) but it cost you $12K pa to hold then you would still be up by about $38K pa.If instead you purchase 5 +ve IP’s for $100K each and make $50/w on each or $13K pa in total you need a 5% pa return on the +ve geared IP’s to produce the same total return as the -ve IP.
If you obtain a higher than 5% pa return then you would be ahead. It seems very possible to choose rural areas at the moment which produce these kind of returns or higher but the statistics over the long term 50 year or so do not reflect good returns for +ve IP. Most rural areas produce a flat return (near 0% pa) over the long term.
So it seems that although there are reasons to go into +ve IP there can be some even better reasons to go into -ve IP. I will concede that these numbers are very rough and only indicative and that anyone can find and use statistics to justify their own point of view – so be careful.
don’t get too caught up on pos. or neg. gearing.
if you find a + geared prop. buy it.
if you pay a lot of tax and would rather pay interest than tax, and you find a – geared prop. buy it.
don’t let all the hoo haa slow you down, if you can afford it, buy it.
There was a discussion about yield vs capital gains. I think it was Margeret Lomas who said “5% C.G and 10% income are not as good as 10% C.G and 5% income.”
The support for their argument revolved around the compounding effect of the capital gain. This is an unfair and inaccurate argument, because the extra 5% income could be invested at the same rate of return and compounded. Instead, they completely ignore the returns that could be gotten from this cashflow. BOTH investments return 15% p.a. The difference is, one starts with 10% guaranteed return and the other starts at 5% guaranteed return.
I know which sounds like an investment and which sounds like a gamble.
This is an unfair and inaccurate argument, because the extra 5% income could be invested at the same rate of return and compounded.Unless you have to give half of it to the tax man of course!
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