Macro Investor: The great property investor overhang

By Leith van Onselen.

If there is one thing that separates the Australian housing market from most others, it’s the propensity for investors to leverage into buy-to-let properties in the face of negative income returns, in the expectation that capital appreciation will repay debt and interest.

‘Negative gearing’, as it is known in Australia, is a popular form of leveraged investment in which an investor borrows money to buy an asset, but the income generated by that asset does not cover the interest on the loan. By definition, a negative gearing strategy can only make a profit if the asset rises in value by enough to cover the shortfall between the income received and the costs incurred from the asset.

Australia’s negative gearing rules are unusual in that they allow investors in both property and shares to write-off the cost of borrowing used to acquire an asset, in addition to other holding costs, against all sources of income (including labour income), not just the income generated by the asset. There are also no limitations on the income of the taxpayer, on the size of losses, or the period over which losses can be deducted.

By contrast, in the United States, rental property expenses cannot be deducted against unrelated labour income, which effectively limits negative gearing to professional investors and developers.

In late April 2012, the ATO released its Taxation Statistics for the 2009-10 financial year (FY10). This report examines this data in detail, which shows that Australia remains a nation of loss-making landlords highly exposed to a property downturn.

To read this special research report in full, take up your free 21 day trial at Macro Investor, Australia’s only independent cross-asset class newsletter.

Unconventional Economist
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  1. As recently explained to me by a ‘Professional Property Investor’ (that’s his self-appointed title):

    “Yeah, but if you’re negatively geared you’re making money because you’re paying less in tax”

    Good to see the pros get it. Now where do I sign?….

    • It’s the “if I lose money I actually make money” strategy. Genius I tells ya!

      How could people be so blind as to not see that if you lose money and reduce your tax you are actually making money.

      How could nobody have told me this before. Your friend should write a book and do a seminar tour!

      • The Patrician

        Where have you gone Henry Kaye?

        A nation turns its lonely eyes to you

        Woo Woo Woo

    • Mining BoganMEMBER

      You know what? I love these guys. I get a pencil and paper out and show them what they are actually doing. Watch the confusion sweep over them.

      Know why else I like them? Because we’re in a non-discriminatory society I can’t poke fun at women, gays, other races, religion or anything. But I can still bag negative gearers.

      Only sport I’m allowed at work.

      • The recent NZ Inquiry into Housing Affordability found that “institutions” are under-represented in “investment in rental properties”, possibly because institutions do better due diligence than the mom and dad investors who are piling into this get-rich-quick scheme.

      • Haha, classic. Made me smile like an idiot while on Adelaide’s horrible transport system! 😛

  2. Capital appreciation is not required. Rents can rise to make the investment positively geared.
    This has worked magnificently for decades, but rent for an ordinary house is now 50% of an ordinary wage (Sydney). Can it continue to work?
    Will massive inflation benefit housing buyers once again?

    • This argument is so discredited that I am bored to even respond to it.

      Seriously Claw, how much do you get paid to post such drivel here?

      • This argument is so discredited that I am bored to even respond to it.

        Almost any person who bought in the 70’s 80’s 90’s or early 00’s has done much better than renting (Sydney). This is because rents have risen and debt falls in real terms against wages. I wonder how simple facts have been discredited?
        Probably the same way I have been attacked for mentioning the shortage.

        How much do I get paid? Nothing. I spread truth and try to help young people in Sydney who require decent shelter at a fair price.

        It is better than spreading lies, abusing messengers and giving false hope.

        • I think the “better” implicitly assumes that the renter did not do anything else with their money, other than spend it or put it into a bank account, yes??

        • Sure, over the long term period you are describing, that works. But under a bubble where house prices have gone up 120% relative to incomes and rents have gone up 30%?
          You’d better be telling those young things to rent until prices crash, if you really want to keep them out of troubles such as being underwater on their equity for 10 years or more, and looking at how much cheaper they could have bought that first home of theirs had they waited.

        • I spread truth and try to help young people in Sydney who require decent shelter at a fair price.

          How exactly are you helping young people in Sydney buy decent shelter at a fair price? Do you run a charity?

    • And what happens when the RBA puts rates up to stop this ‘massive inflation’ you speak of?

      How is praying for inflation a sound investment strategy?

      • And what happens when the RBA puts rates up to stop this ‘massive inflation’ you speak of?
        If the RBA did cease inflating the money supply then the NG scheme is less likely to work as it did in the past.
        Are you sure what the future will bring?

        How is praying for inflation a sound investment strategy?
        I don’t know where prayer comes into it. However relying on inflation worked for millions of investors/homebuyers in the past. Many expect it will continue. I hope it won’t. Are you sure that the government will finally stop ripping-off the young and poor to benefit the old and rich?

        • It is difficult to increase wages and completely negate inflation. Just look at inflation over a 100 year history to see how it has behaved.

          Inflation might be low, but it isn’t zero.

          • It is difficult to increase wages and completely negate inflation

            It’s called increased productivity.

            Just look at inflation over a 100 year history to see how it has behaved.

            Inflation is entirely a policy based setting. It’s recent manifestation has been to reward rent seekers and rich at the expense of savers and poor.

            Slavery used to be a policy setting too.

            Inflation might be low, but it isn’t zero.

            It’s natural state is zero, or even negative.

            To be otherwise means polict is set to award privilege to a class of people.

          • Oh RP – that’s simply incorrect. In flation is almost never zero or negative.

          • I said its natural state, inflation is zero, or even negative.

            In terms of an asset or consumable and its real worth, by default its store of wealth in negative in an environment of increasing productivity.

            Money supply has to be recalibrated upwards to maintain a nominal monetary value, for good reason, humans aren’t bright enough to function otherwise.

            I will concede that as a useful purpose of money. When it goes the other way, such as excess inflation, or more sickening, disgiused inflation such as CPI targeting has done, it awards privilege.

          • Pete,

            I think RP might be referring to their notion of the “natural” state and tendancy of inflation, if policy were not to interfere with it – in that sense, I would tend to agree, where deflation is much more “natural” for a market than inflation; IMO, inflation tends to be systemically manufactured by policy settings, either directly or indirectly.

            My 2c

          • Yes Burbwatcher, but when have we ever had a period when policy didn’t interfere.

            In it’s natural state a body of water is idle, but in fact it almost never is.

          • Yes Burbwatcher, but when have we ever had a period when policy didn’t interfere.

            When passive resistance is so high that we don’t have effective policy.

            We are seeing in Volos, in Greece right now, the populace has started their own barter script called a TEM.

            Inflation policy of the Euro there has been rendered ineffective.

            In it’s natural state a body of water is idle, but in fact it almost never is.

            Gravity, evaporation and the tidal effect of the moon aren’t natural?

        • Hmmm, inflation good for rent you say. OK.

          OK, what about real returns on your capital investment?

          Some quick and easy numbers you should be able to understand…

          A) Year 2012, buy property for $500,000
          B) Assume no growth for three years (not unrealistic in the current environment).
          C) Assume 4% inflation per annum (because inflation is good for rental income)
          D) Year 2015, real (inflation adjusted) value of property = $442k (approx).

          • Come on Greco – the debt remains nominal, so any adjustment to the mean must be done on the debt as well.

            I know that you are smarter than that, so try to be fair in your assessment.

          • Yes Peter but you typically have more equity than debt.

            Assuming a 50% LVR, a loan of $250k would be eroded to approx $221k (inflation adjusted) over the same timeframe.

            $500k – $250k = $250k equity in 2012

            $442k – $221k = $221k equity in 2015

            Loss due to inflation = $29k

          • Greco – most investors buy on either an 80% LVR or if they are light weight investors they borrow the max, which will be 90% or 95% so the size of the debt does have weight in the calculation.

            I think that you are weighting your calculations to give you the answer that you desire, rather than the bare facts, which will give you an answer that you may not desire.

        • “If the RBA did cease inflating the money supply then the NG scheme is less likely to work as it did in the past.”

          But this would mean more interest so more negative gearing and less tax wouldn’t it? I thought deductions by negative gearing were great?

          “However relying on inflation worked for millions of investors/homebuyers in the past”

          Hardly, you take a loss on rental income due to higher interest rates or you take an inflation adjusted loss on your capital. Either way buying an asset overpriced ends in a loss.

          Like I said, relying on inflation is hardly a rational investment strategy.

          • you take a loss on rental income due to higher interest rates or you take an inflation adjusted loss on your capital. Either way buying an asset overpriced ends in a loss.

            Amazing. You people not only deny the shortage, but you deny that previous house buyers have done very well compared to renting.

            What is next? Denying that Elvis is dead?

          • There has been more than enough evidence presented to show that there is no housing shortage. I’m not going to debate a well debated point. If you don’t accept the evidence I’m not worried.

            As for the old ‘look how well people have done in the past’ who cares? Past results don’t guarantee future returns and buying an overpriced asset is ALWAYS a bad idea.

    • Ronin8317MEMBER

      Base on my experience as a former owner of an investment property, to achieve ‘positive gearing’ you’ll need to double the rental yield to 8%, then the ‘renter’ might as well buy the property.

      • russellsmith55

        I don’t hold much hope of capital appreciation, rising rents or even much inflation at all in Victoria (we’re actually looking a little deflationary). And if the mining states do stay strong their inflation will cause the RBA’s cash rate tightening-hammer to fall on us too, just compounding the problem.

        Is there any other way NG property investments can be beneficial? (that would work within Victoria that is)

        • russellsmith55

          (This isn’t me saying I want to do it, just want to hear arguments as to why people I know might not have completely f##ed up their finances for the next 5 at least).

        • russellsmith55 – short term in Victoria I’m a bear as well, but history isn’t just a few years. If you want to buy in Victoria, then the decision will have to take into account your financial position, your age, your needs and wants, the current properties being offerered etc. It is possible in any market to get a bargain – what is on offer?
          It’s entirely your call Russell, and only you can make a judgement on what is best for you. You can get info from websites like this, but not specific individual advice.

          • I agree with you, Peter.

            I would add my own caveat, however: one has to ignore opportunity cost (a discussion I have had with my father a few times!)

          • It is possible in any market to get a bargain

            In theory only. In practice, in today’s residential property market, it’s extremely, [i]extremely[/i] unlikely.

  3. There is a nasty trap for people that have used their equity in their principle residence that find themselves needing to access Centrelink.

    The principle place of residence is exempted, however if you have used borrwed agaisnt your residence and then used it to gear a property, the whole value of the investment is treated as an asset. If the loan is secured only agaisnt the investment property, only the actual equity is counted.
    People are coming unstuck when they need to refinance/restructure their debts and the valuations have come down.

    • boyracerMEMBER

      Jack – I had not heard that before. Not that I disbelieve you but do you have any links to support it?

      If not I will go trawling through the centrelink website on the weekend and see what I can find as that is quite interesting if correct.

          • Thats right Peter, centerlink doesnt assess the principal residence, however if you have borrowed 200k against your principal residence and used it to buy a 400k property, the amount of asset being assessed is 400k. Centrelink looks at the source of the security. If the loan was secured against the IP, the amount assessed would be 200k.

          • Peter, I have also come accross people that have borrowed agaisnt their principle residences, gifted or loaned the amount to the children so that they could get into the property market and then Centrelink assesses the couple for either deprived assets or the amount gifted as a loan and deemed to be an asset and income

          • Jack – well of course centrelink assess the PPOR at full value if the debt against it is for an investment, and then they will assess the investment, whether it be a property, shares, or a racehorse.
            Surely none of that would come as a revelation…

          • Peter, you would be suprised at how many people would just think that the IP less the debt is the assessable asset, not realising that Centrelink look at the source. I have also come accross brokers and lenders that dont realise this as well. Its all about investors making informed decisions.

          • Fair enough Jack – I do question why someone on centrelink benefits would have an IP. Surely retirees expecting an aged pension wouldn’t hold IP’s or is that what you are referring to?

          • A lot of boomers have utilised the equity in their principle residences during their 50’s as an alternative to super due to their belief in property.The concept of getting a tax deduction etc.
            Its at the point when they retire or forced to retire that this becomes an issue. Someone that has bought in the wrong area and is sitting on losses might be reticent to sell and crystalise the loss, meanwhile the whole value of the IP is counted as an asset due to the way in which the loans were originally structured. Anyway its another interesting snippet re the demographics and the investment property overhang and I suppose belief systems.

          • Just another point re the assets test the age pension cuts out when they exceed 998k excluding the home so its probably not that uncommon for someone to have an IP at retirement.

          • Jack – but surely those boomers have sold their IP’s and repaid the equity loan that they took out to fund the IP purchase.

            That is the part of your argument that doesn’t make any sense to me. Either that or the IP’s are positively geared and they are self funded. In which case they won’t be claiming a pension – so good on them for being self funded – they had no super when they started working, so they did what they had to.

  4. Negative gearing is a tax rort and negatively geared property ‘investors’ are the scourge of society. Why should I pay tax to prop up their failed investments? The sooner the govt gets rid of this malignant tax loophole the better for everyone!

  5. you re probably too gloomy about NG:
    as rents rise (quite a bit lately)
    as principal get repaid
    as interests are on their way to ZIRP, value increase and principal repayments increase.
    as states/federal gov invest in the surrounding infrastructure, value increase
    as the country get more crowded, value increase

    like it or not, property NG still look like a quite good investment compared to the gamed/crap shares investment or zero-yield gold

    • “Property NG will lose you money, but not quite as fast as buying crap shares or just setting fire to a wad of fifties. So it’s awesome”.

      There, fixed that for you.

      Now, why not compare NG to an investment that actually makes you money?

      • i m all hear : which investment beside TD will make me money without the risk of becoming worthless like shares/debentures or risk of dropping 80% like gold ??

        currently I am on TD/Saving accounts and pretty much 2kg of gold (that I am not going to keep), but I am looking at property as it seem to be the best investment so far available .I know macrobusiness bloggers do not agree, but so far their track records in term of share investment seem quite pathetic so far, most unskilled property investors had a much better run than them the last 10 years and even if it not as good it used to be it is likely to be much better than most other investments.

        • You’re aware that bonds increase as interest rates drop, right? Shares aren’t the only alternative to property.

          As far as the last 10 years has gone, ever heard the expression – “Past performance is no guarantee of future results”?

          My experience tells me that investments that have outperformed in the past tend to underperform in the future.

        • dam,

          With respect to your comments re: share investment and MB…don’t assume they are “buy and hold”-type, index-type investors.

          I think you will find that they are, for the most part, short-medium term traders wrt shares, so the volatility of the last 10 years or so has probably served them quite well…

          Thought I should clear up that implied misconception…

          • “don’t assume they are “buy and hold”-type, index-type investors.”

            Well if Dam is assuming that, then the comment about becoming worthless is nonsense. Anyone else think the ASX200 is ever going to zero in our lifetimes?

          • Just the share permabears – watch out they do exist!

            Kind of like the property bugs and dropbears…

            All types out there, must be careful, and carry a fox at all times…

            although from memory, I think the Cyprus stock market is off 97% from its highs… hmm

          • But TP, the fox might eat my chooks and what would I do for eggs, meat and fertilizer then?

          • Just ask the trolls to have a chat in your backyard, no meat of course, but a lot of hot air and then plenty of fertilizer sprayed over the ground….

            The fox won’t bother them, since they basically keep to themselves in one nest….they like it there, nice and warm in their own detritus.

        • Yeah I missed that dam – are you saying the commenters here or the bloggers here have “pathetic” track records in share investment?

          • sorry have been a bit unfair but I havent see to many good calls this year and your macroinvestor portfolios, if behave as foretasted, will make my TDs (0% risk) look good.

            I am just a bit frustrated sometime by hammer like behavior on this blog, their are not many good investment available nowadays, all are quite pathetic, property as well, not as good as it used to be but it is not a reason to discard it totally in favor of share trading or other exotic instruments.

            Property market is gamed as is the share market but at it is gamed in favor of investors.

        • which investment beside TD will make me money without the risk of becoming worthless like shares/debentures or risk of dropping 80% like gold ??

          My precious metal investments have doubled in value in 4 years, so I’m not with you on he 80% gold drop.

          If you think houses are a riskless investment, after what’s happened to them in almost every country, you must be blind.

          • with your nametag you should know that a reverse to mean is always possible and it is not only for property.

            I am not quite enthusiastic to see so many forecasting a price to the moon for something as useless as gold.I am going to sell mine someday.

    • “as rents rise (quite a bit lately)”

      You keep saying that, but any number of MB posts show that rents haven’t risen much recently.

      In the 12 months to March 2012, rental growth has failed to beat inflation in the major southern capitals. Segments of the Brisbane (units), Perth (houses), and Darwin (houses) have done better

      “as states/federal gov invest in the surrounding infrastructure, value increase”

      Not sure what state you’re in, but most of what I’m reading is about governments reducing their infrastructure spending.

      “as the country get more crowded, value increase”

      Try having a play with Google’s Public Data tool. You’ll find plenty of countries that had high population growth rates during their housing bubbles. Didn’t stop the bubbles bursting.

      • beside Melbourne, look quite an significant increase, and +50% the last 5 years according the census.

        with interests rates to their way to zero, that compare quite favorable with the ASX200 isnt it ?

        • “with interests rates to their way to zero, that compare quite favorable with the ASX200 isnt it ?”

          Not sure – my balanced portfolio has done quite well given the increase in the value of my bonds. Why is it a choice only between the ASX200 and property?

          I wonder what share investors were saying to other investors at the peak of the Australian share market…

        • russellsmith55

          Has enough evidence accrued yet that one could make a sweeping generalisation about property ‘true believers’ – that they probably don’t know much about any asset class except property? (except a cursory understanding of gold and shares, assuming they even do understand property).

          Could that sweeping generalisation go further to include an ignorance of what a diversified portfolio is, particularly one weighted by forecast class/product returns?

          Seems time and time again I only see a vague but firmly held belief of large unspecified future property returns with a ‘buy and hold as much as possible’ strategy.

          If there was any truth to this sweeping generalisation, then discussion with them might be analogous to discussing the evidence supporting evolution with a Creationist.

          • In the words of Chris Joye –

            “A final wrinkle with residential real estate is that the risk of investing in an individual home is far greater than most people realise. In fact, Rismark estimates that the volatility of a single family home is akin to the volatility of the stock market.

            Accordingly, the best possible residential property investment would be a product that allows you to invest in a portfolio of thousands of individual homes to give you the diversification you need to reduce risk.

            A nationally diversified residential property index has very low volatility of about 5 to 6 per cent per annum (compared to the 15 to 20 per cent per annum of the ASX All Ordinaries Accumulation Index).

            Leveraging up against this would be safe: gearing against an individual home is a far more hazardous exercise.”

          • russellsmith55

            If even Chris Joye thinks they’re missing the volatility/diversification relationship and undertaking a hazardous investment, then I’m sold; we shouldn’t overestimate our debater.

            But lol his final spruik for everyone to ‘leverage up safely’ against his shiny new index was a nice touch.

          • BB – I’ve given up trying to understand how all these “coming real soon now” tradeable property indexes are supposed to work.

            I’d love to see one finally be produced though.

          • I’ve just realised that the whole article is about “… capital preservation and generating long-term [returns above inflation]” and it only mentions bonds in the context of the value of a company.

            Absolutely no discussion of them as an investment option which is a bit strange, given that he also talks about the problem of dropping interest rates.

            Of course I tend to dismiss advice on capital preservation that includes the phrase “Leveraging up against this would be safe…”

          • Russell I think that you underestimate property owners. I know a lot who not only own property, but they have a diverse investment portfolio that includes property.

            EDIT: removed smugness

          • you much be right, property investors are bunch of idiots.

            diversified portfolio is frankly overrated with the current correlation between vehicles.It use to be true, now it s just BS.

          • Dam, I honestly don’t think all property investors are idiots and I have no problem admitting that they have done very well over the last 20 years.

            The ones I do think are idiots are the ones who don’t realise that a large part of those gains was due to an unprecedented build-up of private debt.

            Five years ago I thought massive levels of private debt was dangerous but it could certainly at least be argued that it was a “capitalisation of lower interest rates in to prices” (ignoring the fact that it hadn’t happened when interest rates were just as low prior to the 70s).

            We now have plenty of examples to show what can happen when these bubbles burst.

            Every other country thought they were different. Perhaps we are, but chances are we’re not.

  6. Unconventional Economist, I have an issue with this line

    “By definition, a negative gearing strategy can only make a profit if the asset rises in value by enough to cover the shortfall between the income received and the costs incurred from the asset.”

    That’s not strictly true. On a personal level, if I saw an apartment that would yield say $50 a week less than the mortgage payments, then I would consider that an investment regardless of capital gains.

    The reason that would work for me, is I would be assuming the yield would inflate at give or take 3% annually while the repayments would remain fixed. Within a few years, it’s entirely likely that the $50 shortfall would become neutral.

    Let’s say it takes 5 years. It’s cost me $13000 to own this property. Sounds like a lot, but odds are, I’ve made a larger dent in the balance outstanding than that. Hell, I will have spent more on coffee in that time.

    It’s a very cheap way to buy a property, no?

    That’s entirely without capital gains, which effectively means I’ve lost 3% a year. It’s still not a particularly costly mistake. You can make a pretty good bet that Central Banks will favour inflation over the longer term.

    • George Locust

      If the rental income increases at a faster pace than inflation you may be correct but i think the long term numbers show that rents merely keep the same increase as inflation i.e real yeild growth is nil, especially after inflation growth in holding costs like maintenance and rates.

      Also, it is the “opportunity cost” (what else u could do with the money) that is more relevant than the mortgage payments.

      • Maybe I should clarify.

        The rents rise in nominal terms while the repayments do not change in nominal terms.

        In real terms, the rent does not change, while the repayments fall.

        So, in this case, even facing real rent stagnation, you’re still paying a very small net price for property.

        • McPaddyMEMBER

          Myne, I think you’re forgetting about the stamp duty and the opportunities to invest the deposit that you will have forgone. These are also costs that need to be added to the debit side of the equation. There is also maintenance and rates etc. When you factor that all in, the sums don’t look so hot, even assuming you have moderate, sustainable capital growth. Rather than back of envelope approximations, you really need to add everything up from go to whoa (or woe perhaps) over the lifetime of the mortgage, using specific and real figures to get the real answer.

  7. George Locust

    And yet if i start a business enterprise I cannot offset operating losses against labour derived income.

    So it’s clear.

    Speculative investment – good.

    Productive investment (that might one day create sustainable jobs, exports, productivity innovations, company tax revenue etc.) – bad.

    Where is the logic??

  8. What is it about the economy that degrades people to zealots.

    On an individual basis it worked in the 90’s, it doesn’t work now.

    On a societal level it is a horrible policy resulting in crap, overvalued properties.

    • It confirms their individual exceptionalism. It worked because of an application of that exceptionalism.

      To concede that it was rather a perfect storm of events, including redistribution via government policy, then there is a moral basis for counter policy to hand it back the other way.

      There are too many european holidays in retirement to consider for that to happen.

  9. George Locust

    Another form of generational theft, in other words.

    The people who lived through the 30’s n 40’s rightly earned the accolade of “hero generation”.

    The generation(s) that followed deserve no such praise.

  10. This relates back to Claw’s earlier question.

    The reason hyperinflation was OK in the 70’s and is NOT ok today is simple:

    In the 70’s and early 80’s, hyperinflation benefitted the Baby Boomers, so it was OK. Today it would NOT benefit the BB’s, so it is NOT ok.

    The Baby Boomers are very numerous, and can out-vote everybody else.