-ve geared properties can be attractive in any situation. The difference is that without -ve gearing, you have to be sharper with the pen, and be sure the property is growing at a rate that justifies the costs – without the tax compensation. The danger is that the tax compensation has made people play fast and lose with the till.

Perhaps we can learn from some of the truly great and successful investors of the last century. The upshot of their wisdom was that they always scanned the horizon to guage and predict the weather. They then set a course that was balanced in such a way that they could take advantage of opportunities, without leaving their backside totally exposed.

+ve geared poperties would benefit in that they will continue to pay for themselves short term. But in the scenario given, the ultimate result will be recession and high interest rates. In my observation, very few +ve geared IP’s we’ve got have the potential for significant CG. The good news is that historically, they don’t move downward either – they remain fairly stable or stagnant. But interest rates will rise, and if you don’t have a reasonable equity holding (borrowed too much @ interest only), then they will no longer be +ve geared, and you will either A) be paying to hold on to an IP that will likely see little growth, or be shedding these IP’s to consolidate. The propblem is, the market for these properties is currently artificial – people are rushing to buy them because of this “IP boom” or goldrush fever. When the gloss wears off, there will be many available on the market, and few investors to buy them. Only the pick of them will be sold to the locals of the area genuinely looking for a residence. Be prepared to sit out the storm if that occurs.

Those with -ve geared properties will have to decide if they can afford the ride it out. If the bean counters are right in saying the economy is over-extended presently in committing to unrealistic prices, then there is surely going to be a price crash. The Kings will be the guys who had been in the market early, consolidated at the peak of the price wave, and are cashed up to buy all the foreclosures at bargain prices from the leanding institutions. This happened in the mid-80’s and 90’s. The visioneries sold properties that had high borrowings, and replaced them a few years later at prices that required almost no borrowings (between 10-20% less).

Is there a moral here? Sure. Cover your bets, and learn to (forecast the weather) be a visionery. If you go for -ve gearing, get something that will grow like a demon in the short term, and pick a point when the growth plateaus. At that point, sell it or gear up to hang on for the long haul. If it still has a lot of legs, mayube sell off some of the +ve geared holdings to reduce borrowings, and give you more profit in those you keep, to allow you to hang on to the IP’s with potential for capital growth. It’s a bit like being in a plane with twelve people and only 10 parachutes – you’re going to have to start picking favourites.

Here is an extract froma conversation with one of Australia’s most successful businessman (and yachtie) – a man who denies he is even clever, but will accept he has good common sense:

“A +ve geared IP stops being an IP when interest rates absorb all the profit. And don’t insult my intelligence by still referring to it as an IP just because you are not living in it. If you are not making money out it – either through cashflow or quantifiable capital gain, it is not an investment – it’s a liability. Sell it and put the cash to work, or at the very least, reduce your costs. Negative gearing is the government’s way of justifying your operating at a loss. The idea that any government can change the playing field on which you build your empire with the stoke of a pen, frightens the shit out of me, and tells me it is not a wise foundation on which to build my business. Will I take advantage of -ve gearing? Sure, I enjoy getting back as much as I can for the taxes I pay, but I will never build my entire business on it. You just know that one morning you will read the headlines and it’s going to be more than a bad day – it’s going to be a nightmare. And if you know it will one day happen, then you better keep an eye on that weather and be quick with the tiller!”

He went on to say that there is still nothing new in these “investment booms”. In the end, your success & longevity will be determined by your ability to see trends, move with the economic environment, and manage debt/costs. When costs outweigh income, you’re losing – no matter what you call it. You can own a 100 +ve geared properties. If you’ve borrowed to hold them, then there will be a point when (not if) interest rates will turn them into 100 holes in your portfolio. Is your portfolio still attractive? Ask yourself when you buy a property, if it wasn’t +ve geared would I still buy it? If the answer is no, then what do you think will have to motivate someone to take it off your hands when interest rates take the purpose out of it?

The same applies to -ve geared property. If the government takes the incentive away, why would you want to hang on to it? If you can’t find a reason easily, then ask yourself if someone else would see a reason to take it off your hands. If the answer is that the property would be desireable to anyone in any economic climate – with only price the unknown quantity (because you bought so well), then it’s a good buy.

Cheers….

David