Stephen: In this blog, I'm going to look at the 4 broad categories of positively geared properties
and some of the traps that the unwary players can fall into.
Firstly, purchasing a property with a large enough deposit so that your interest bill
and your property expenses are covered by your rent that gives you a positive cash flow.
Virtually any property can be positively geared. Now, if you already have a home mortgage which
is non-tax deductible, you'd be crazy to use that cash to pay off a tax deductible debt.
Now, it would only make sense putting in a large enough deposit into a property if you
already have your mortgage paid off. The other way of getting a positively geared
property is trying to find one that is returning, or other words renting for 2 to 3 percent
above the standard mortgage variable rate. For example, if the mortgage rate's around
6, you're looking between 8 to 9 percent yield. Now, properties like this tend to be exceptional.
That is, not exceptionally good, just that they are exceptional and that they're not mainstream.
Now a couple examples come to mind: the first one is in the USA, and the
second is remote or regional areas here in Australia, and the third broad category is
what we call hotel rooms. Now, there are heavy risks in each one of those 3 classes and today
I just want to go through some of those so you can have some understanding of what they're all about.
Firstly, in the US we only have to look in the state of Detroit which just declared bankruptcy.
It was once the 7th largest city in the US
and as a result of that bankruptcy, home values have fallen so much, they are virtually worthless.
There are no Australian, or US banks for that matter, that will use those properties collateral
for the loan. Now, what does that tell you?
The next category is what we call remote regional. Now, these could be considered a mining town.
These towns, in recent years,
have shown some quite enormous growth in both values and rent. However,
their sustainability is really determined as to what the international commodity market is doing.
They seem to be overly dependent on just 1 singular market. Now when demand is up,
there's a shortage of housing. Why that happens is that all the workers come into a town,
they find they can't get enough accommodation, that pushes up the rentals and also values.
Now, also the reverse is true. When the commodity market falls, the workers leave the town leaving
a lot of empty houses, and consequently values and rentals are plunged. In the short term,
they can be great investments. In the long term, they don't really have that sustainability
for a long term growth. The next area is hotel rooms. Now, selling
an investor a hotel room or a serviced department as they're more commonly called, it's a very,
very clever way for the hoteliers to shift the burden of funding a hotel room from themselves
to individual investors. Now, these apartments can't be used for owner-occupiers and given
that an owner-occupier make up 70% of the market, that's a large part of the market
that's missing, and very few astute investors are interested in purchasing these properties
simply for that reason. Now, this is why the banks won't use these properties as collateral
for your loans and will require an investor to put up another property such as their home
or another investment property. Now, while the promised returns may sound particularly high,
and they are, it's the constant replacement and refurbishment that's required to keep
the hotels or the serviced departments looking fresh, it's that cost that kills the return
to the investors. Unfortunately, investors find themselves in the property not only locked
into a long term management agreement, a 30 year one I saw the other day, but they also
have a non-existent resale market. Now, in my next blog, I'm going to be covering
some of the benefits of negative gearing and you can see for yourself as to how you can
benefit from being negatively geared, but in a very positive way.