TRAPPED BY NEGATIVE GEARING

I am a relatively new property investor & am confused as to what direction I should be going.

Brief history;
2003 > Responded to press ad with Property Investment Consultants selling new H&L packages in South East growth corridor of Melb. Purchased 2 H&L packages borrowing 100% + costs each (using PPOR equity). Current value est. $350k each. Debt $360k each (int only). My weekly contribution was only $180 for both due to high depreciation claims on new property.

2005 > Based on recommendations by our 'Property Consultants/Advisors' (that property would double in 7-10 years) we purchased a 3rd H&L package. Cost $355k Loan $310k (int only)
Our weekly contribution for this ppty is approx. $120.

2006 > Today the property values have stagnated with little hope of growth in the foreseeable future. We are paying out $300 p/week ($15,600- p/annum) to hold property valued at $1.350k (INV $1.050k + PPOR $300k) with loans of $1.030k.

With increasing interest rates this position is going to deteriorate (luckily i have fixed rate loans on the first 2 pptys).

We are currently just affording to hold these properties...with no hope to acquire any more real estate due to the effect of negative gearing (no tax rebates left to claim).

I am also looking to change jobs which could result in a reduction of PAYG income possibly making this situation worse.

The only achievement we have made is to cover purchase costs on our 3 investments. Taking into account selling costs we may come out in the red.

Is it worth paying out $15K+ per annum to hold 3 properties in the current environment? I am worried if interest rates climb & property values drop we will be in a very vulnerable position.

Do we hold or do we sell?

I understand no-one can provide me with advice but I would appreciate any more experienced investors thoughts on our situation.

Thanks

JRN

hey,

i was in a similar position myself, still kind of am actually, but you should hold on to it. Im assuming that if you sold, you would make a loss, plus selling is not a fun experience unless were in a boom!
Maybe if your certain that you wouldnt make a loss on one of them, just sell one of them to ease your burden. But only if your sure you wont make a loss. that loss could set back your goals much further.
As someone said to me when i asked for similar advice, property is a long term asset. If you can hold onto it, you will realise your gains eventually, and it wil be worth it.

Maybe to ease things up a bit, you should look at some creative investing. Speak to dr. x she will inform you about lease options or wrapping. Maybe do that to one of them, or try flipping some properties to make some cash to inject into the properties to ease the repayments.
I know its tough, but your much better holding onto them if you can.
Good luck

Hi JRN,

I am not against selling property, but you have to take into account the cost of doing so and, looking foward, whether it will put you in a better position in terms of your net wealth. If you absolutely have to sell at a loss, then do so, this is a risk we all bare as investors and should be looked as a cost of doing business. There are other options as well such as selling on vendor terms, which would turn the IP's positive.

Regards
Alistair

I'd recommend you sell at least one of them using a creative strategy like vendor finance, or a second mortgage carry back.

Selling a property is NOT a sin. Even selling at a loss is sometimes worthwhile. If you were running a business and it was going broke 'cause you didn't have any cash-FLOW, you'd cut costs to increase cashflow. The same is true for individuals.

In this case, your negative equity is not very much, so you should be able to structure it so you don't lose any money AND you actually turn your weekly losses into positive cashflow.

I'm in Sydney, but I can help you with some of this if someone closer to home doesn't respond.

Send me an email (via my profile) and I'll give you a call.

Good on you for actually asking for advice. It's great to see someone getting that advice BEFORE they have problems!

Regards,

Craig.

_______________________________________
Ask me about Joint Ventures earning 15+% COCR.

I agree with Craig, I suggest you sell one property to ease your burden.
If you are worried about interest rates, why have you not got the interest locked in?

www.investmentpropertytoolbox.com.au
Complete guide to being your own property manager and all the legal document's required.

Only you can answer that one James based on your cashflows. From where I sit, it looks pretty easy. Just compare yourself to the next chap down the road who is renting for $ 300 p.w. (you wouldn't get a really flash house for that type of rent).

Good luck with your choices.

Thanks Dazzling for your comments.

My gut feeling was to hold, hold, hold...if cash flow permits.
The recent posts on doom & gloom in the property market were giving me second thoughts if this strategy was sound considering how high we are geared.

It's always easy in hindsight.....

What affect do you think increasing affordability will have on future capital growth? Will less buyers mean less capital growth?
There are also a number of doom & gloom articles on the Jenman web site in this regard.

James

hi just sat through a pitch for a similar strategy this morning ,the guy?/really big company wants me to take ALL the equity out of my house buy a brand new renter (house not unit, so he gets one tick ) in another city(x) ,all the rent plus my current payments go into my house(paying it off in record time ) while i seem to borrow the intrest payments against the investment,and i seem to be doing this while it is being built ,he exclusivly monitors my figures and rings me when i can afford another property etc
my current investment property and strategy (i had three )were ignored
i really like my equity( to me owning the house i live in is the whole point of the exercise ) and after reading how you feel now
i am walking

if i was in your shoes id grit my teeth and hang on. have a garage sale, deliver pizzas for two months and build a buffer ,sounds like right now a few grand would make all the difference to your point of view, in five years it'll be the change in your ash tray
good luck

Hi James,

I tend to agree with everyone else (how unique of me ).
We were faced with a similar problem years ago, we identified the most negatively geared of our propertiies and increased the cash flow using vendor financing techniques and multi tenancies.

Actually one of our cash flow solutions has been publised in Sep API page 34

Using creative techniques rather than just straight selling has the benefit of not having to take a possible loss on a property. Because you are financing the property the same price is higher! With multi-tenancies, there is no sales price, just cash flow!!!

The extra cash flow can then be used to fund your other properties giving you some breathing space while at the same time allowing you to enjoy capital appreciation in other properties.

I can certainly help you set up these creative techniques if you are in SA, feel free to contact me any time

Investment Property Management
www.adprop.com.au

Thanks Dr.X

Just to clarify...

Are you recommending this course of action only on the basis we cannot maintain existing cashflows or would you do it anyway to 'create' additional cashflow?

Because of the mechanics of negative gearing I have reached a point I cannot afford to buy any more property for a very long time..would this help & are there any significant risks?

I am not familiar with vendor finance or wrapps. Does this mean we would be 'selling' the property???

The key appears to hold (& hope) for future capital growth.

Can anyone give an opinion/idea on what the capital growth forecasts are for outer metropolitian suburbs of Melb over the next 5yrs? And particularly the South East (ie.Berwick-Pakenham-Cranbourne) regions.

I hope they are more than 1.2%p.a.!!!!!!!!

James

Hi James,

I don't like to recomend any course of action, everyone is different and it has to fit in with what your plan is, my suggestions is what I do here in SA.

Overall I like property portfolios to be balanced and to take care of themselves, I don't like to be putting money every week into property. I'm way too lazy to do that I like balanced portfolios regardless of whether there are cash flow problems or not, they are just safer!!!

Not all properties gain capital appreciation at the same rate. We tend to identify those that would and hold for the long term. Negative cash flow in those properties is balanced by positive cash flow somewhere else.

Positive cash flow cannot be purchased in today's market unless you buy rural properties (which I wouldn't touch personally!!!).

Cash flow can be created using vendor financing or turning 4-5 bedroom houses into mult-tenancy accomodation.

Vendor financing means that you end up selling the house to the tenant. (if they choose to buy).

Example
Purchase price of property is $180,000 and market rent is $180 per week.
Lease with option to purchase for $230,000 for 2 years (create $50 equity in property).
Rent at $400 per week with $200 per week being credited to purchase price. That would make the property positive cash flow.
You are creating cash in this property both on a weekly basis and at sale time, that cash can fund other properties building your portfolio quicker.

Hope it makes sense this time

Investment Property Management
www.adprop.com.au

Hi
I am not a hugely experienced property investor at all, but here is my take on your situation.
You said your aim (or the advisor you spoke to said, and you believed) was for the properties to double in value over about a 10 year period. Why have you thought about changing strategy??
If that is the strategy you went in with, and you thought about the strategy and you and your partner agreed it was sound, why try and bail after only 3 years? It is thinking like that that sends people to the cleaner in property investing - buying at the top of the market with a view to hold long term, then selling because in 3 years they havent acheived the results they were initially expecting in 10!!
If what you say is correct, and you are paying 300 per week for 3 investment properties AND your PPOR, I think you are on easy street! my PPOR mortgage repayment alone is higher than that!
What about the option (and you need to investigate if this is something you want to do) of getting a line of credit and funding say half of your weekly shortfall on the line of credit.
I am unsure what due diligence you did when you purchased the properties but if you are reasonably confident with your capital growth strategy, over the long term the growth you get from holding your properties will far outweigh that of the build up on the line of credit. Just an option.
Having said that you should have probably known what your cashflow situation was going to be like before you purchased the properties, and if you struggle to afford $300 per week for a PPOR + 3 rental properties, maybe you should look at your budgeting methods. Most people pay around $250 in rent anyway, so essentially i gather you are saying you hold approximately $1 million of property for $50 per week?
I think you are a pretty reasonable position, dont get so stressed about it, if you are worried about rate rises (which you should think about BEFORE you get your loan) then fix some of the variable amount now before another rise kicks in.
Just stick to your plan for the 10 years you planned to do so, and in 10 years you will laugh at an amount of $300 per week!
Hope this helps with a bit of perspective
All the best

Thanks Coopranos,

I just needed an injection of reality!

Because of being new to property investing I was having doubts about a number of issues;

- Will there be any capital growth in the next 5 - 10 years? Many "experts" predict the market will go backwards before going forward. If i had put my $15k p/a (negative gearing shortfall) into the bank or shares over the past 3 years i probably would have $50k+ that i dont have now.

- Whether my property "Advisors" are looking after my best interests or theirs. To be honest i accepted their recommendations without doing alot of due dilligence. I am reasonably happy with the end result though. I cannot see how property can double every 10yrs from now due to affordability issues. Buyer beware!

- Cash flow; I did take the precaution to fix interest on 70% of my total debt so I am not overly concerned about rate rises...yet. My main corncern is that I rely heavily on the tax rebates & therefore maintaining a minimum level of income (& paying tax) to make it work. If I want or need to change jobs I must maintain my current level of income. This is why I feel trapped by negative gearing.

- Inability to buy additional property; due to income & negative gearing limitations I cannot see how i can move forward (with investing) in the foreseeable future, although at the moment i have enough to worry about!

Overall I agree I am in a good position overall & can't complain..we all have choices to make and have to live with the consequences of these decisions.

I agree with Dr.X about positive cash flow & rural properties they are not my cup of tea.

I will continue to hold as long as I can & hopefully expand my portfolio...maybe in 10 years I will be a millionaire!!!

Thanks for your contributions & GOOD LUCK to you all.

Keep

James

James, what about getting a new job with a payrise which will help to fund the large amount of debt. Not sure what profession you are in, but moving jobs is an easy way to get a payrise quickly.

Nats12, I wish it was as easy as that!

My current job is the highest paid position I have had in my 27 year working history! With limited qualifications & very high competition within the (finance) industry I am in my prospects of getting a similar or higher paid job are difficult (but not impossible).
An alternative I would like to consider would be to become self-employed & try to build up my own business...however I can not afford to do this as I am trapped by the negative gearing!

I have also recently spoken to my Managing Real Estate agents & they estimate my investment property values to be $10k - $20k each below my current expectations.

Easy way to loose $60k overnight!!!!...... (on paper anyway) must be something to do with that negative gearing again!!!!

I will try to look at the positive side.........time will tell!

Cheers

James

There will be another boom.

Will you look back and wish you had retained the properties and slogged away at the repayments?

Will you be pleased that you had freed up the capital to invest elsewhere?

Noone can answer this but you.

Simon Macks
Residential and Commercial Finance Broker
***NODOC @ 7.15% to 70% LVR***
simon@mortgagehunter.com.au
0425 228 985

Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.

I agree with Mortgage Hunter . Economy cycle up and down every 7-10 years. Find the way to hold the IP for 10 years and make money. Sell now and loose.
I guess one option is to try to reduce principal on one of the IP down to 60% and then refinance it. This way it will pay for it self and you will have one less to worry about.

By that logic, somebody buying in Melbourne in 1989 for $184k would have made money selling in 1999 for $243k (REIV medians) would have made money? $114k in rent (ABS 3br Melb), $216k in interest costs, plus rates, maintanance, insurance, PM fees...

Hold, hold, hold. My experience , based on two defaulting tenants last year, 6mths loss of rent on one, and 10 months loss of rent on 2nd {tribunal waste of time & money} I was in a position where my back was against the wall, & a noose or a gun would have come in handy then....I just gritted my teeth , put every cent I was earning into the properties, I ended up selling one property at a loss due to the damage done to property & because of the stress, but with a creative accountant I was able to maximise taxation returns of $35k every year.
If you can recoup your payments from your pocket through legitimate taxation claims, it at least gives you control over your investment strategy. The purchaser of my property, sold the house for removal and has built 8 units on the block....{beggar.....}
It taught me a lot though, always have an exit strategy, don't over extend yourself, Fixed rates, & landlords insurance.&.... baked beans don't taste that bad for dinner!

Sorry but can't help myself. When was the last time Australia had a 7 year property cycle.

Terry

Come on ...if the market doubles up every 7-10 yrs, it can't be that hard to find out when the last "7 yr " boom happened ??????

It seems I have read this so often, it must be a fact..

Someone please put me out of my misery..

Terry