Why Do People Choose Negative Gearing? 

Real Estate Investing Secrets

In 1985 the Australian Government, in an effort to encourage the masses to invest in real estate and to attract more funds into government coffers introduced taxation benefits for property investors. This move provided an opportunity for investors to avoid tax by funding a place for someone else to live. 

Accountants all over the country advised people with high tax bills to ‘negatively gear’ into property (and other investments) to reduce the amount of tax they had to pay. This changed the focus from the returns achieved by the investment to the tax benefits which could be enjoyed. In a mad scramble to invest for the tax benefits, people invested in overpriced properties with rent guarantees and gross returns as low as 3% while they were paying interest at 9% and more. They were told these were good investments because of the potential for future capital gains. 

It seemed no one had the courage to ask the most obvious question of all – “why should I spend one dollar in order to save 50 cents in tax?” 

Needless to say, some people made money as property prices escalated while most who dreamed of becoming property millionaires found they were losing money and often sold out at a loss to stem their haemorrhaging negative cash flow. 

The promise of big capital gains combined with the perceived security of ‘bricks and mortar’ made for a very lucrative hunting ground for developers and property marketeers who offered (sales) ‘advice’ and assistance for those wishing to negatively gear into real estate. Seminars were (and still are) held daily around the country promising wealth and early retirement for those who invested heavily into the properties promoted by the one-stop-shop marketeers who allegedly had done all the research into the best areas and who could provide finance and rent guarantees ‘to take the worry out of managing your investment properties’. The marketeers paid healthy commissions to accountants, financial advisers and clubs to recommend negatively geared investments to their unsuspecting clients and members. 

Usually these properties were (and still are) marketed in interstate locations so that the investors had no idea about the true value of the properties they were buying. Skilled and high pressure sales people (many with poor financial track records) met naive investors at the airport and took them to the property developments without providing any true comparative information so that the investor could make an informed choice. Contracts were signed the same day to ‘secure the property’ and the investors flew home the proud owners of one or more investment properties which they were assured would soon appreciate in value and provide for a secure income in retirement. 

The marketing operations were slick and professional (and still are) and so unsophisticated investors trusted what they were told. Most did not think to do some research in the area to check out comparable values and rentals. 

Years later when many of these negatively geared investors wanted to sell and reap their capital gains, they rang a real estate agent in the area asking for a market opinion of their property which they were sure had increased along the same lines as properties where they lived. To their horror the real estate agents often informed them that the current market value for their property was LESS than what they had originally paid for it. The reality is that many of these properties were sold for at least $20,000 to $30,000 above their true market value at the time. 

Let me give you some examples of properties I bought in July 2002 in Queensland which had previously been bought by ‘negative gearing investors’. 

Logan St, Eagleby QLD – 2 bedroom townhouse with lock up garage 
This property was originally bought by an investor in June 1992 for $88,000 and when I purchased it in July 2002 it was rented out for $90 per week which is the original rent that was charged at the time of purchase. The investor accepted my offer of $58,000 which I had worked out based on a market rental return of $115 per week. The property was in excellent condition and an owner occupier would have paid around $72,000 for this property at the time I bought it. By the time this property settled, I was able to rent it for $125 per week. 

After I had placed a deposit on this property, I asked the agent to approach the other owners in the complex to see if they were interested in selling to me as well. I was able to pick up the property next door for the same outlay. 

A similar situation occurred in Pendlebury Court Edens Landing. 

Here investors paid $90,000 in 1992 for 2 bedroom townhouses with lock up garages which I bought for $62,333 in July 2002. I bought three townhouses in the same complex and rented these out for $135 per week. 

In Syria St Beenleigh I bought a two bedroom townhouse with a lock up garage for $62,000 which originally sold for $98,000 in 1995. 

The book Due Diligence Made Simple contains a chapter explaining the operations of the property marketeers and also some helpful questions you need to ask when selecting a property manager. 

Could anyone have done these deals or was there something special about them? 

Absolutely anyone could have done the same! They were listed with local real estate agents and I just asked them to submit my offers. Mind you, I made quite a few offers and not all of them were accepted. In fact, quite a few students of the Super Secrets® to Wealth do-it-yourself real estate investment Home Study Course have found similar deals in various parts of the world and I know you can too. 

Have the prices of these properties actually dropped? 

Not really. Even though the offering prices of some properties were less than what an unsuspecting buyer may have paid several years ago, they were probably closer to what the current market values were at the time the offers were made. Values have increased since then and rents have increased as well. These properties were highly overpriced in the first place and unless there was massive growth, these buyers were always destined to lose money. Believe it or not, people right around Australia still continue to pay too much for their investments today because they don’t research the market and they don’t understand what they are doing. 

Are these properties likely to go up in value in the future? 

If you buy well, I believe they will go up in value in the future. I have experienced this with these types of properties in Sydney in the past and some of my students (that I know of) have seen exceptional growth on the Gold Coast, in Canberra, Perth, regional NSW and Victoria. The important thing to understand is that you make your money when you buy, - not when you sell. In other words, you need to find good deals which you can snap up below market value. This is exactly the same principle that Warren Buffett applies in the sharemarket. He looks for undervalued companies with growth potential and buys them. I look for undervalued properties with growth potential in areas that I believe are likely to experience a growth of rents and property values. 

You’ll learn more about my strategies and techniques in the Super Secrets® to Wealth do-it-yourself real estate investment Home Study Course. 

How is this possible? 

There are two main types of buyers in the residential property market. One is the owner occupier and the other is the investor. 

The owner occupier often pays the retail price for a property because they are emotionally involved with their purchase. They fall in love with the property and don’t want to miss out on it. Once they have decided to go ahead with their purchase, they want to move quickly in case someone else snaps it up from under them. In fact, if someone else offers more money, the owner occupier usually increases their bid too. If they are buying at auction, owner occupiers will often pay substantially above the market price for a property they desperately want to own. Owner occupiers are generally interested in only one particular house because that’s the one they’ve got their heart set on. Investors on the other hand are not going to live in their investment properties and therefore it doesn’t really matter to them which properties they end up with as long as they are profitable. 

A level headed and calculated investor cannot compete with the owner occupier buyer. The investor needs to buy wholesale in order to make money on the deal. The investor buys according to his or her figures and not their emotions. In fact, an experienced investor will make offers before he actually inspects the property. These offers will be made purely on the financial returns and growth potential of the property. That way there’s no emotional involvement. This investor knows he won’t get every deal he puts an offer on (if he does, he’s paying too much). He doesn’t care either. The investor knows there are plenty of good deals out there, - it’s a matter of finding them. They pop up all the time. The astute investor lives by the motto: the opportunity of a lifetime comes past at least once a day. 

If his offer is not accepted, the astute investor simply walks away from the deal and says to the agent: “if your vendor changes his mind, please give me a call.” 

Do I increase my offer if the vendor does not accept it? 

Once I’ve made an offer on a property, I hardly ever increase my offer. I stick to my price for a number of reasons: 

1. I want to communicate to both the real estate agent and the vendor that my offer is already generous and that if they want to do business with me, they’d better move quickly before I lose interest and move on. 

2. I pre-frame our discussion by explaining to the real estate agent that I will be buying a number of properties if they meet my formula and if they pass my physical inspection. As such, I am communicating that the numbers are more important to me than the particular property. 

3. If I’ve done my calculations correctly and determined the offer price which will give me my required return, then if I increase my offer, I am cutting into my profits and this does not make sense for me as an investor. My strategy is buy low, sell high - NOT buy high, sell higher, therefore, once I’ve made my offer, I stick to it. 

4. From experience I know that from time to time, agents will come back to me after a few months asking if I am still interested in buying a property at my original offer price because they could not find another buyer. It’s just a game of nerves. For my part I have decided that I am happy to buy at my price and that I’m also just as happy to walk away if I can’t do a deal. To me it’s just a numbers game. 

You’ll learn more about my strategies of buying positive cash flow real estate in the Super Secrets® to Wealth do-it-yourself real estate investment Home Study Course. 

Are you one of the people that got burnt by the marketeers? 

A Brisbane law firm, Carter Capner is leading the way in seeking compensation for victims of failed property schemes. In early 2002 they won a landmark case on behalf of a Sunshine Coast couple who were awarded $130,000 damages for losses they suffered as a result of buying overpriced real estate from a marketeering company. You can find them on the web at: www.cartercapner.com.au/property.html or ring Judy Teitzel on 07 3210 3444 or 1 800 077 310 

The way forward 

Investors are becoming more discerning in their property investment choices and are questioning the wisdom of paying $40 - $50 a week from their own pockets for the pleasure of owning an investment property. Nevertheless, the marketeers are re-inventing themselves as marketing positive cash flow properties. 

The truth of the matter however is that they are still peddling negative geared properties that have been repackaged to present the tax benefits as the positive cash flow. 

Here’s how it is typically presented: 

Ken and Julie’s family home is valued at $300,000 on which they have a mortgage of $120,000. This means they have $180,000 equity in their home, a part of which they can use as security for an investment property. 

They buy a new house as their investment property for $175,000 which rents for $185 per week. They borrow the full amount for the investment property plus legal fees and stamp duty, namely $185,000. This means they don’t need to put any of their own money into the deal. They can use the investment property plus their equity in their family home as security for the investment property loan. 

Here’s how their financial picture looks: 

Rental Income Tax Deductible Expenses 
$9,250 * Loan interest at 6.5% $12,025 
Property management at 8% $ 740 
Council & Water rates $ 1,000 
Repairs $ 1,000 
Total cash outgoings $14,765 

Depreciation on building $ 2,300 
Depreciation on Fittings $ 5,300 
Total Non Cash outgoings $ 7,600 

Total Expenses $22,365 

* I have only taken 50 weeks income to allow for a 2 week vacancy factor 

At first glance it would appear that Julie and Ken have made a loss of ($22,365 - $9,250) $13,115 and this is certainly the case on paper. 

However, depreciation is an on paper cost and not one that Julie and Ken have to pay out of their pocket. They are entitled to claim these costs because they have invested in the property. 

They therefore make a tax loss on the property of $13,115 and receive a tax refund of $6,230 

Their cash position therefore is: 

Rental income $9,250 
Tax refund $6,230 
Total cash receipts $15,480 
Less cash payments $14,765 
Total cash flow $ 715 after tax in the hand or $13.75 per week 

This is how the marketeers are now dressing up negative gearing as positive gearing. This is not true positive cash flow! 

The problem is that furniture and fittings can be depreciated at varying rates from 1 to 20 years and many are fully depreciated by the end of three years. This means that the tax benefit (and resulting cash flow) will decline over the period that you own the property. The positive cash flow calculation may be correct in the first year but thereafter it may turn cash negative. 

The second problem is that the property needs to be cash flow positive before the tax benefits are taken into consideration. That is true positive cash flow real estate! The tax benefit is an added bonus. 

Even blind Freddie can see that the loan interest alone is greater than the rental income! How can this property possibly be cash flow positive? 

Here’s an actual example from one of my properties that are mentioned above: 

My total acquisition cost of this property including legals and stamp duty was $65,000 and the tenant was paying $135 a week in rent. 

Rental Income (50 weeks) Operating Expenses 

$6,750 Loan interest at 6.5% $4,225 
Property management at 8% $ 540 
Council & water rates $ 800 
Body Corporate Fees $ 760 
Repairs allowance $ 400 
Total cash outgoings $6,725 

In this example, my income is $25 greater than my cash expenses from day one. This is without any tax benefits and with 100% financing! This investment makes sense from an investment fundamentals point of view. Now a $25 surplus may not be enough to get too excited about, however now we can look at how to structure things from a tax point of view and INCREASE our cash flow from the property. As the market rents for these properties increase over time, they become more and more cash flow positive whereas in the case of negatively geared properties, the increased rents just help to reduce the amount of money the investor needs to contribute from their own pocket. 

To this end, I will have a quantity survey done for each of the properties in order to claim the maximum depreciation allowances possible. Since these have not been done at the time of writing this report, I cannot give you actual figures. 

My rule is this: As a first step, make sure that the investment makes sense from an investment fundamentals point of view i.e. it should break even or be cash flow positive from day one. 
Then structure it in such a way to maximise your tax benefits. 

You’ll learn more about my strategies of buying break even and positive cash flow real estate in the Super Secrets® to Wealth do-it-yourself real estate investment Home Study Course. 

To order Super Secrets® to Wealth, click here 

This wealth report was written by Hans Jakobi for Wealth Dynamics International Pty Ltd. © 2002 Hans Jakobi. All rights reserved worldwide 

Hans Jakobi is an educator, author and investor. He is the author of six best-selling books including, How To Be Rich & Happy On Your Income which is available at: www.supersecrets.com 
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It is recommended that you seek professional advice from an independent, licensed, qualified investment adviser, accountant or solicitor prior to implementing any investment programme or financial plan. 

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Real Estate Investing Secrets