UNDER WORK's policy of limiting negative gear to new housing as of January 1, 2020, had it won the election in May, would have allowed taxpayers to deduct rent losses from their other only if these losses came from newly built dwellings.
We could argue over and over again about the rationale for Labor's proposed changes, but the re-election of the coalition government, which does not speak for itself, means that Labor's proposed changes to the gears negatives – at least for the moment.
But that does not mean that the benefits of a negative gear necessarily remain at stake.
What is the negative gear?
Most people who buy an investment property must borrow the majority of the purchase price from a bank or other lender. And of course, the lender expects the investor to pay interest on the debt.
If the total mortgage repayments, as well as the costs of managing and maintaining the property, exceed the rent paid by your tenant, then you will lose money. In other words, it will cost you money to keep the property and you will have to make up the shortfall between rent and the ongoing costs of your own pocket.
The borrowing process is called "gearing" and in this case the result is a negative cash flow, the term "negative gear" is used to describe this approach.
According to ATO figures, the average investor loses nearly $ 9,000 a year on his property (see box, page 42). Making a loss of nine thousand dollars every year does not seem like an excellent investment strategy, so why do so many people do that?
The reason that 1.3 million people are willing to suffer a loss when they hold an investment property is that they can charge that loss to other income and reduce their bill. overall tax burden.
Now, it is important to recognize that the deduction of the loss will only reduce an investor's tax bill by a portion of the amount of the loss, which is equivalent to the tax rate marginal – at most 47% of the loss, including Medicare Levy. maybe a lot less. So, if your property has a negative plan, it is likely that you will still have money even after any tax refund.
An investor who takes a long-term approach may be willing to accept a cash loss today, in anticipation of a larger capital gain in the future. In the end, they hope to generate higher capital growth than they will lose with their direct costs.
However, this entails a certain degree of risk because the immediate loss of cash is a certainty, whereas future appreciation is only a possibility.
Despite the outcome of the elections, one could argue that the disappearance of a negative gear had already occurred … thanks to the APRA and the banks
It is therefore very important to carefully select the property and its location to maximize the likelihood that long-term capital growth will exceed net holding costs, but also generate a decent profit.
Lenders and Negative Gears
Lenders focus on your ability to actually repay your debt and become more and more nervous as your income is increasingly allocated to servicing debt on investment property.
A property with a negative trend generally represents a financial burden as long as you own it, and the bank will certainly not lend against the potential capital gain you say you will achieve in 20 years!
The rental income from the property helps repay the loan up to a certain point. However, lenders will only take into account a portion of the rental income of an investment property when assessing your ability to meet your obligations, generally between 70% and 80% of the gross annual rent. This is fair enough because they take into account the potential vacancies and other overhead costs associated with holding a property.
Continue adding successively to your portfolio a property with negative property. The lender will consider that each subsequent property is dedicated to debt management. This makes it increasingly difficult to obtain financial approval, and an inability to secure financing can prevent you from investing.
In the last two years, some lenders have quietly reinstated tax deductions for negative deviations in their maintenance calculators
The "Death" of Negative Gears
Despite the outcome of the elections, one could argue that the end of the negative negotiations had already occurred without any direct action from the political left. Thanks on the contrary to the actions of the regulator of the financial industry – the Australian Supervisory Authority – and to the banks.
Over the last five years, investors have seen significant changes in the credit environment in Australia, which has made it even more difficult to build a portfolio of companies. investment properties by negative conversion.
Among these changes are the stricter loan management tests imposed by regulators on banks, as well as the tightening of loan qualification criteria by the banks themselves.
These changes have a direct impact on the amount of your borrowing to invest – and on the effectiveness of the long-term negative conversion as an investment strategy.
For example, from 2014, lenders had to test your ability to take out a loan as if you had to pay at least 7% interest (most lenders actually test at 7.25% or higher ), regardless of the real interest. you may be paying
This meant that even if the bank had offered a rate of interest as low as 3.5%, it would still have evaluated your ability to pay the loan as if you were paying 7% or more (double rate).
Under pressure from regulators to reduce the growth of their investment loan portfolios and to tighten loan appraisal criteria, in 2016/17, many lenders also deleted could borrow. Any tax refund resulting from a negative adjustment would not necessarily have aided your ability to borrow.
For those who were trying to build a real estate portfolio with a negative gear, these changes meant that they would run out of borrowing capacity – and would run into a wall of financial bricks – even faster than what they could have done before.
The bottom line is that if you wanted to build a portfolio of multiple buildings, a negative gear for long-term growth would simply not allow you to. Most people were more likely to run out of borrowing capacity before accumulating enough property, due to the combined effect of the negative drain and tighter lending criteria.
Add down property values ​​recorded in most of the country in 2018, as well as uncertainties inherent in the run-up to this year's federal election, and the negative gear began to appear as one of the least effective and potentially riskier strategies you could employ in your property by investing today!
The resurrection of negative gears?
Does the election result, with the changes made to the negative cut for the moment, give new impetus to the negative reduction as an investment strategy?
As noted above, it had become much more difficult to create a real estate portfolio through a negative gear because of the introduction of stricter loan management tests. In itself, the result of the elections has not changed much in this respect.
But on the Tuesday after polling day, APRA announced its intention to relax a key loan restriction. The regulator has proposed that the 7% minimum interest rate test be dropped in favor of banks that simply add a 2.5% safety margin to the loan's real interest rate when assessing capacity. borrowing from an individual.
For example, if you were about to borrow at a 4% interest rate, your ability to manage the loan would then be tested at a rate of 6.5% (4% plus 2.5%) instead of 7% more.
Real estate investors need to be aware of the risk of change and prepare by proactively adapting their strategies
This is a significant change, which will likely facilitate access to financing for more homebuyers and investors and will allow for more money. increase the amount of funds that can be borrowed.
This change also means that the erosion effect on the overall borrowing capacity of an investor's negative debt may be slightly lower, especially in the event of a fall in interest rates. .
It should also be noted that in recent years, some lenders have quietly reinstated negative tax deductions in their service calculator, so that purchases can make all the difference to a borrower's ability to pay. investor with negative orientation.
The Future of Negative Gears
Ironically, the downward trend in interest rates means that most investment properties will become less negatively oriented as the interest deduction decreases. This will reduce any tax deduction, further weakening the effectiveness of the negative conversion as a tax minimization strategy.
In addition, the results of the last federal election do not mean that the negative gear is permanently blocked. It is always a question of topicality, and likely to be disputed again in future elections.
The coalition itself has shown itself willing to contemplate a negative gearing reform (but not now), with Scott Morrison having expressed interest in a broader tax reform during his tenure as federal treasurer .
For example, in February 2016, Morrison suggested potential policies targeting what he termed the "excesses" of negative conversion, floating ideas such as limiting the number of investment properties that may be negatively oriented, or a cap on the maximum total deduction that can be claimed.
Change is probably inevitable in the future, whether in the next term of government or in a future one. So sophisticated real estate investors need to be aware of the risk of change and prepare by proactively adapting their strategies and managing their portfolios to reduce the need for negative conversion over time, rather than reacting after the fact.
What is the alternative?
It is important to keep in mind that the goal of investing is to create a profit. If your main motivation for investing is to save tax by performing a negative gear loss, you may have misunderstood the target.
Fortunately, there are other real estate investment strategies that are well suited to current financial and market conditions and offer investors the opportunity to leverage their wealth and build it.
Strategies better adapted to the current market are: investing for positive cash flow (the opposite of negative debt); add value through renovation, subdivision or real estate development to effectively create your own capital growth; or simply be smart in selecting areas that are ready for short-term growth, rather than investing at random and hoping that the value of your property will increase faster than it does. costs to keep in the long run.
It's time to take a close look at your own portfolio balance and ask yourself how you might need to change your strategies to better adapt to the market today and in the future.
Simon Buckingham is a professional investor with over 15 years of experience. He writes frequently on the real estate market and is a director of the award-winning results-oriented mentoring program for real estate investors
