Why negative gearing still works

The regulators and banks have made life tougher for property investors. But all the uncertainty makes it a good time to consider this powerful way to create long-term wealth

Is negative gearing a strategy that still works? It’s a timely question. Let’s face it, property yields are low, capital growth is in question, the regulators want to slap limits on investor lending and the banks have responded with higher interest rates. Throw in the changes to depreciation perks and the removal of the travel allowances and it’s enough to make the 1 million or so Aussies who run a property investment at a loss – and those thinking of going down that route – to ask the big question.

I would argue yes, because ultimately negative gearing is not a strategy; put simply, it’s a tax outcome that represents a moment in time. Like a business owner who makes a loss in the start-up phase to ultimately make profits and build value over the medium to long term, so too does a property investor consider making a loss for only as long as it takes to build a big enough wealth base so that they too can move into positive-gearing territory, which will provide them with the self-funded retirement outcome they desire. Negative gearing is a means to an end, not a permanent way of life.

So, in my view, the real question here is whether residential property still remains a good investment because the taxation benefits you receive through negative gearing are temporary but, if done correctly, the impact of the capital growth and rental income from building your portfolio will be lasting.

But before we ponder that question, let’s look at exactly what headwinds property investors face.

Winter has come

The Australian Prudential Regulation Authority (APRA) this year introduced restrictions that have impacted lending for investment purposes. APRA is the prudential regulator of the Australian financial services industry, overseeing banks, credit unions and building societies to protect the financial wellbeing of the community.

It is in this protective role that it has implemented new regulations as part of an ongoing response to what it describes as an environment of high housing prices, high and rising levels of household debt, slower income growth and historically low interest rates. As a result, the banks have adopted the APRA recommendations as follows:

Deposits – increased need for larger deposit as most lenders will no longer accept a loan-to-value ratio (LVR) greater than 90% for investors.

Interest only – for most lenders, for any borrowing above an 80% LVR, interest-only facilities are no longer available, regardless of loan purpose. Furthermore, the bank’s loan book cannot have more than 30% in interest-only lending.

Investor lending – no more than 10% growth in investor lending year on year for each lender.

Interest rate – increased rates for interest-only lending to be higher than for owner-occupier lending.

New debt – tightened servicing requirements to increase assessment rates on new debts.

Existing debt – assessment rate on existing debt to be considered principal and interest even if paying interest only.

Postcode restrictions – some lenders have managed their risk by limiting lending on select postcodes.

Rental income – some lenders have further discounted rental income assessment from the standard 80% to 75%, and in some cases by as low as 60%.

Exceptions – if applications don’t meet policy then it’s simply unacceptable, with lenders unwilling to step outside strict lending policy to provide “exceptions”. This is in contrast to owner-occupier lending where they’re still happy to consider policy exceptions on a case-by-case basis.

No investor lending – some lenders are pulling out of the investment lending game altogether.

As well, the recent federal budget proposed the following changes that will affect any property investors who exchanged after 7.30pm AEST on May 9, 2017:

Depreciation – the government will limit plant and equipment depreciation deductions to outlays actually incurred by investors in residential real estate properties. Essentially, this means property investors can only claim depreciation on dishwashers, fans and other fixtures they’ve paid for themselves. Previously, investors who bought established properties could continue to claim depreciation on items they acquired as part of the purchase.

Travel claims – all travel deductions relating to inspecting, maintaining or collecting rent for a rental property will be disallowed. This applies within your own state as well as interstate.

Property investment is essentially a game of finance, just as much as it is a game of bricks and mortar, so these lending changes are significant. APRA will get what it wants as it achieves a desired slowdown in investor lending but I don’t think that is a bad thing, as neither investors nor owner-occupiers want an unstable property market.

Equally, the hit to cash flow from the reduction in depreciation and travel allowances is not ideal. However, if Melbourne and Sydney were to keep on charging ahead as they have been over the past few years, then we would have set ourselves up for some pain in the future. Measures to avoid that are warranted.

Property investment is a game of finance just as much it is a game of bricks and mortar