Five property investing myths you should stop believing
Thursday, November 8, 2018/
This article will take you through five property investing myths you should stop believing.
The best part? Everything here applies to property investing in 2018. (In other words, you don’t need to worry about reading out-of-date stuff.)
So without any further ado, let’s get started.
Myth one: Negative gearing is a great investment strategy (especially for the tax benefits)
Chalk this myth up to property spruikers and investment marketers who have a vested financial interest in getting you to overpay for property.
Don’t get me wrong, people have made money from negative gearing in Australia, but there are better investment strategies out there than relying on negative gearings tax benefits.
What’s a quick example of negative gearing?
Simon buys an investment property, and the expenses for this property are more than the rental income he earns, resulting in a $15,000 annual loss. In other words, Simon has to contribute $1,250 each month from his cashflow to hold the property. As a result, Simon can use this $15,000 annual loss to reduce his taxable income from $110,000 to $95,000 resulting in a $5,850 tax subsidy to Simon. The property still costs Simon $9,150 per year.
Negative gearing is a bad investment strategy for a number of reasons.
- It robs your cash flow. In Simon’s case, he needs to pay $1,250 of his income every month to hold the property.
- You can only make money by selling the property. But remember, each year Simon holds the property it costs him $9,150 after tax.
- It generally relies on you being heavily indebted and can limit the number of investments you can hold. It costs Simon $1,250 every month to hold the property which limits his borrowing capacity.
- Depreciation tax benefits reduce over time.
- It is reliant on a tax strategy that could be removed after the next federal election. Although it should be grandfathered, meaning no retrospective tax changes, so Simon may not be affected.
The truth is, negative gearing relies on you making a loss on an investment property while speculating the capital values will increase enough over the longer term to make a profit. While it can be good for some investors, it isn’t going to be perfect for everyone, so you should consider looking at positively geared properties or reducing your overall debt position.
Myth two: The Australian property market is going to drop 40%
A 60 Minutes report a few weeks ago suggested properties in Sydney and Melbourne were set to fall by 40%. This is very wrong.
Need convincing? In that same episode, the reporter Tom Steinfort incorrectly reported Australian property prices have only ever gone up.
Let’s start with that point. Australia’s property market moves in cycles, and Australia’s largest housing market Sydney has seen values fall 5.6% since their peak in July 2017. But this is nothing new.
In the GFC we saw Sydney dwelling values fall 7% over 12 months, and after the Sydney Olympics (downturn in 2003-2006) we saw a reduction in values of 7.1% over the same time period. It’s a similar story in Melbourne and the other capital cities. In fact, the falls we have seen over the last 12 months have been mild compared to previous downturns.
So what about that 40% fall in property prices?
The forecaster Martin North suggested the 40% drop in house prices was not his central scenario.
He outlined that for it to happen, there would need to be a “GFC 2.0 scenario” — in other words, a major depression, not just a recession — Australia’s unemployment rates would have to hit 9.5%, mortgage stress levels would need to increase above 40% and bank losses would need to increase fourfold.
What is the most likely scenario?
I agree with Michael Yardney’s comments. Plus, it’s important not to think of Australia as one single property market. Each individual state and city is in its own stage, within the property cycle.
Overall, when you are buying a property, you are doing just that: buying the individual property and not the market. So individual property research is key.
With that being said (and for the haters out there) I believe the positive factors underpinning our property market include:
- Strong population growth and net migration up 27.3% year-on-year;
- Low unemployment and good employment growth, with ABS reporting “trend employment increased by 303,100 persons (or 2.5 per cent), which was above the average annual growth rate over the past 20 years of 2.0 per cent”; and
- Inflation is under control, at the lower end of the RBA’s target band of 2-3%.
Myth three: Rent money is dead money
Yep, that old chestnut. You should buy where you live, get a massive mortgage, and spend the rest of your life paying it off right?
Ever heard of rentvesting? Rentvesting allows you to live where you want, and invest where you can afford.
With Sydney and Melbourne median house prices nudging towards $1 million, saving a deposit seems to be getting harder for most home buyers. So rather than buy on the outskirts, why not rent where you want to live and invest where you can afford?
Here’s why you should consider rentvesting.
- For the lifestyle. You can live close to your work or in the city, and live the lifestyle you want to live.
- Get into the market quicker. In Sydney, the average place will set you back $1 million. To enter the market with a deposit on such a house you’ll need at least a few hundred thousand dollars, which most people don’t have.
- You can choose where you want to invest. With rentvesting, you don’t need to buy where you want to live. You can invest in outer suburbs or different areas to give you more choice.
- Flexibility. If you own the house you’re living in and decide that you want to travel or move to a new city, you need to sell it. When renting, you can just wait until your lease runs out, instead of having mortgage worries. Instead, with rentvesting, you’ll have a property manager who will take care of it, so you have complete flexibility.
- Ability to diversify. If you’ve got a home, you want to try and pay it off as quick as you can. But if you’ve got an investment property you can make a minimum payment on your loan and focus on other things. You will be able to diversify your investments — for example in different geographical locations, different asset classes (houses, units or townhouses) or different classifications (shares or property).
Let your landlord worry about the negative gearing, and you worry about investing.
Myth four: Renovations always add value to property
I love watching The Block and I’ve done my fair share of renovations but I’m sorry to say it’s not true that renovations always add value to a property.
While it might seem fairly logical spending $40,000 on a new bathroom and kitchen should add $40,000 value to your property, this might not actually be the case.
Let’s look at some numbers crunched by Michael Matusik using Underwood in Brisbane as an example.
“Our work suggests close to two-thirds of the detached houses resold across South East Queensland over the last decade have had a renovation between sales. Furthermore, we have found that in one out of four cases, the renovation costs were close to half of the previous purchase price. And in 10% of cases, the cost of this renovation actually exceeded the cost of the previous total purchase price.”
So while these property owners may have spent more than the previous purchase price on their renovations, they may not have added the same amount to the value of their property.
Now I’ll admit, there is no broad brush approach to property renovations that will work across Australia. But, before you consider any renovation work, it’s worth taking the time to research the local area and speak with local real estate agents. Understand what appeals to local buyers — and how you can maximise the bang for your renovation buck.
Myth five: The banks aren’t approving investment loans
In August, the ABS reported investment housing commitments fell by 1.20% and the total value of dwelling financing commitments fell 2.1%. So have the banks stopped lending?
What about the reports from earlier in the year that up to 40% of loan applications were being rejected? Is the sky on investment lending falling?
Yes, the financial services royal commission has had an impact on the way the banks are assessing home loan applications. But in the last six months, we have found while the banks are requesting more information on 57% of applications (compared to 36% last year), the total number of home loans submitted to settled are in line with previous years. In other words, the banks are asking for more information and taking more time to assess, but still approving the right loan applications.
So what is the secret to getting investment loans approved?
1. Look at other banks
Different lenders have different policies. Where this impacts lenders today is with the banks’ serviceability benchmark rates meaning some banks will assess the loans you hold them at a higher interest rate than those held with another bank.
Put another way, say you have an existing loan of $500,000 with bank A, and you’re looking at applying for a new loan of $250,000. Applying with that same bank will mean they assess your existing loan at 7.25% based on P&I repayments. If that $500,000 loan was held with another bank, and you were applying with Bank A for a new loan of $250,000 they would take the repayments of the $500,000 loan at the actual amount being closer to 4% increasing your borrowing capacity.
2. Principal and interest repayments
What would have been considered insanity a few years ago is now a reality. After APRA’s speed limits put in place last year, investment interest-only loans attract a higher interest rate. Look at principal and interest options, it might actually work out better for you.
According to Macquarie Bank, “using a 0.5 percentage point [interest rate] differential, Macquarie found that a bank customer in the top tax bracket with a $500,000 loan would be $6,000 better off after five years, and $12,000 better off after 10 years switching to P&I.”
3. Lender, lender, lender
It used to be location, location, location but now its lender, lender, lender.
Another policy we are finding can trip up investors is how rental income on apartments is treated.
There are some lenders who will reduce rental income by 50% depending on the specific complex (presumably determined by the lenders total exposure to that apartment complex). Ask your mortgage broker to check ahead to make sure you don’t get caught out.
Anything I missed?
These are my five favourite property investing myths.
And now I’d like to hear from you. Are there any property investments you’ve heard of, but didn’t see on this list? Or maybe you have a question. Either way, let me know by leaving a comment below right now.
Disclaimer: this article is general information and should not be taken as investment advice. Different strategies work for different people and you should seek help from a qualified tax professional before considering any investment strategy.