issue with steve’s chapter on negative gearing

Hi nevbogus

‘my problem with that is, even with zero capital growth for the entire term, the investor will own the property outright after 25 years, for about $2k per year!’

This is OK for some people, but what if you want to become financially independent in a time span shorter than 25 years? And why pay $2k per year when you can by a larger number of properties that have zero running costs?

‘aa few years into the term, as the principal is reduced, the property will actually become cashflow positive!’

It might be more than ‘a few’ years, as the principal owing reduces very slowly at first, then reduces quickly past year 15. Paying off the principal is effectively a compulsory savings scheme. If you got into a situation where you couldn’t afford your property expenses (eg loss of job) you’d still have problems as the property is not self-supporting. This is exacerbated by the high reliance on tax deductions and the loss of these if you lose your job.

‘has steve just ignored this to make his way look way better (which it is anyway)’

I don’t think he has.

Negative gearing is making guaranteed losses for a gain which may or may not happen. It carries risks or opportunity costs including:

1. Loss of job means loss of funds to support property and loss of tax deductions = increased financial stress and risk of having to sell up
2. Limit on number of properties that can be bought as serviceability gets poorer with each subsequent purchase (especially if on $30k/yr salary)
3. Any absence of capital growth makes whole idea unattractive
4. Difficulty in making extra payments on loans to reduce principal
5. Negative cashflow means not being able to make extra investments
6. Not suited to low-moderate income earners or those who wish to retire in <10 years.
7. Increased sensitivity to interest rate hikes

Positive cashflow reduces these risks nicely. But positive cashflow can have risks of its own in the current environment, eg:

1. Properties that qualify may be in very small towns with declining populations
2. Properties may be higher maintenance (ie timber/asbestos instead of brick)
3. Vacancy risks could be higher
4. Small towns might not have the population to support LOCAL property managers and tradespeople.
5. More difficult financing in small towns.
6. Less chance of capital growth

My hunch is that by buying in large established cities like Ballarat, Steve’s risks are lower than many later investors who have needed to go to little towns to find the required 10% plus.

I must admit though that I am very attracted to the idea of lowering risks by buying low-maintenance properties in regional cities. Yes the yield might be slightly lower (about 9%) but in my view the lower maintenance costs and long-term tenantability outweigh the small shortfall which can come from other parts of the portfolio (eg dividends) if required.

Regards, Peter

Hi,

Actually, what I wrote in the book was that you can profit from -ve gearing, but it’s a matter of timing the market rather than time in the market.

You are right that at a point a -ve geared property will become +ve geared when you pay off enough debt so that the interest falls.

Sadly though, on a P&I loan, this will not happen for some time as the early payments are mainly interest.

It can be a forced way of saving, yet this would be a poor reason to buy property for a serious investor.

Cheers,

Steve McKnight

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Remember that success comes from doing things differently.
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