All Topics / Heads Up! / issue with steve’s chapter on negative gearing

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  • Profile photo of nevbogusnevbogus
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    @nevbogus
    Join Date: 2003
    Post Count: 3

    in the appendices steve talks about a p&i loan on a negative gearing property over a 25 year period.
    he always talks about it costing you money and the only way to get ahead being through the chance of capital growth.
    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!
    but wait, there’s more….
    a few years into the term, as the principal is reduced, the property will actually become cashflow positive!

    has steve just ignored this to make his way look way better (which it is anyway) or am i mising something?

    Profile photo of peterppeterp
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    @peterp
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    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

    Profile photo of nevbogusnevbogus
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    @nevbogus
    Join Date: 2003
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    thanks for the reply, peter
    i agree with everything you say because let’s face it, it’s not rocket science to work out getting money is better than paying money, but the way steve wrote his article made out that you really never make anything from negative gearing.

    a property with $200 a week rent and loan payments of $210 per week is still negatively geared but wont take long to be cashflow positive.

    maybe steve is really talking about the “own this for $30 per week” scams as negatively geared. these are obviously rarely worthwhile, but i don’t think he should put all negative gearing under the same umbrella

    dean

    Profile photo of Steve McKnightSteve McKnight
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    @stevemcknight
    Join Date: 2001
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    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

    **********
    Remember that success comes from doing things differently.
    **********

    Steve McKnight | PropertyInvesting.com Pty Ltd | CEO
    https://www.propertyinvesting.com

    Success comes from doing things differently

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