Real costs of owning a negatively geared rental property?

Our properties seem to be cash flow neutral on paper, but they are P&I loans so we are out of pocket around $20K per annum. When calculating tax, the Principal amount is not tax deductible.

 

Interesting, those are very high yields, so maybe was undervalued at the time, would be near impossible to find those yields now..

 

Yes when yields were 5% in sydney 10 years ago, there wasnt any money in it because yields should be 10% and......

(Waking up)

 

If a property costs a net 1-2% a year, and inflation is approx 1-2% per year, that means a property needs to appreciate 2-4% per year just to break even. That doesn't factor in the purchase costs of approx 5%.

Not a fan of negatively geared property unless there's scope to add value.

Quick example is a standard sydney $600k budget buy that has a net cost of -1.5% p.a. and a one off cost of -5%. Assume the p.a. cost is consistent over 10 years, that is, it doesn't compound and the difference between rental income and costs is consistent. Total cost after 10 years is a net -20%. So far you need $720k to break even in nominal terms. Factor in inflation @ approx 2% p.a. and your 720k after compounding is approximately $880k in 2029 dollars, that's breakeven pricing.

Please note this doesn't factor in leverage. You fork out $120k + $30k = $150k for this purchase, to then watch your low liquidity purchase lose approx $9k p.a. (-6%p.a. cash on cash return) over 10 years ($90k total).

 

Did you consider that most people leverage into property though... so 100k or thereabouts allows you to control the 600k asset. You get the growth on the whole 600k even though you only put in the 100k.

 

When I borrowed money and the interest rates were around 11% for IP, yes very difficult, but now that interest rates are so low and if you can achieve 5.5%, I find that most properties are fairly neutrally geared in many areas- especially Brisbane. Your example is a small price to pay to hold such a valuable asset, IMO.

 

You're right, I forgot the leverage part, I added a bit about a -6 % p.a. cash on cash return over the 10 year period to finally capture the profits. In the example before you essentially end up spending approx $240k in 2019 dollars. Some quite expectations and price targets below:

Assume returns are real returns after accounting for leverage and adjusting for inflation, at approx 2% p.a.

• If you aim for 2% p.a, you need to sell the property at approx $943 000 in 2029 dollars
• If you aim for 4% p.a., you need to sell the property at approx $1 023 500 in 2029 dollars [edited from $1 235 000 to $1 023 500]

Keep in mind I did my math on $240k paid, but of course its really $150k (2019) + $9k (2019 but paid in 2020) + ... + $9k (2019 but paid in 2029), this complicates the math a bit more, but the approximation is still fairly indicative.

 

From my experience, some of your points are valid, I believe that you do need an upside for every property and you can't afford to hold onto a dud property. I hold for the very long term, I have properties that I have held for 30 years, I believe that you need to buy extremely well, hold for the long term (2-3 cycles) and in a desirable area with historical capital growth. I have only ever sold 2 properties, first PPOR ( 60% capital growth in 2 years, bought in more desirable suburb) and another a dud unit (kept 3 years). The multiple properties that I have kept have done much better than your assumed returns, and they are fully owned or positively geared as I have held them for the long term (it also helps that money is cheap), and you can become your own bank in time. But that is just my experience. Leverage and time.

 

Did the rentals compound annually at 8 to 9pc too Simon?

 

Assuming $10k in maintenance and repairs is ridiculous. I’ve got 6 properties and most I’ve ever spent on maintenance in one year was $3500. Let’s keep it realistic

 

Depends on the property / tenants. A major renovation might only happen in year 5, but cost you a substantial amount, shouldn't this be accounted for? Also you can count depreciation as an actual cost too, but thats a hypothetical, as you dont actually spend your cashflow on it, so I don't bother.

Anyway, maintenance repairs is just one part of the equation..

..I'd say its fairly standard for a Sydney property to cost about 1.5% net per year after factoring in all costs, in fact thats probably quite optimistic. This is nominal of course, you have to assume 100% of the price is borrowed money for the math to be consistent and comparable.

It might not be, but when analysing, money usually has a cost equal to the market's interest rate. "Cost of liquidity", e.g. taking money out of an offset or drawing equity effectively uses the interest rate as cost of money.

Not knocking negative gearing, just don't like it for a simple buy and hold, unless its a real no brainer

 

I have had the same thoughts too.
The growth in property prices well exceed salary and rental growth.
there must be a catchup sometime soon

 

Not a fan of negative geared property unless it is positive cash flow. If you borrow the money and it costs you 10K a year for to hold for 10 years and you have paid 100k. The property only owes you 200k. The whole point of borrowing is to let inflation pay of the loan it reduces the loan amount in current dollars, of the 2019 500k, so using your figures you only need 380k 2029 dollars to pay off the loan plus 120k of 2029 dollars to repay the deposit and about 100k to cover the holding costs. 600k 2029 dollars to break even. If you paid cash than you would need 720k to get your original 2019 capital back, but if you net 20kpa in rent you would only need 520k to break even, but you have had high opportunity cost. If there is even only modest CG of 20% the ROI of the borrowed 100k will be 600k+ 20% = 720k = 720%. And on paying cash 720k + 200k rent = 50 % ROI, If you bought 6 properties with a 100k deposit. and only had 20% CG you would have 6x720k + 4.3 million instead of 920k. thanks to inflation. Having debt free property is expensive, after tax interest may cost 3%, after after inflation 1%, after depreciation 0%,

 

The price to salary growth idea has two flaws
One, it ignores upgraders who have a much bigger deposit than fhbs.

Two, it ignores gentrification driven by population growth. A 3/1 fibro 20 years ago bought by person on average wages is now a 5/3 for a lawyer on 2, 3 times average wages. At the extreme end, what is the yield in the most expensive suburbs? Nobody cares.

Not saying this must continue. Too many variables. But it is possible because a lot of cities in the world have higher multiples than syd mel.

 

I think if you’re counting on a major renovation after 5 years you’ve bought the wrong property. I’ve got property in Sydney. Let’s assume every few years the following needs replacing:

- hot water system $1500
- air con $2000
- blinds $1500
- carpet $2500
- interior paint $5000


Even if all these happened in one year it would only be $12500 and these aren’t things that happen regularly. $10k per year is ridiculous. I reckon across my 6 properties I average $2k per year per property. A bad year a hot water system and air con goes might be $3500. A good year might be a few tap washers so only $500. Lets get realistic.

If it’s costing you $10k per year you’ve bought a lemon.

 

I just wonder who will be able to get loans, if the average property is 2mil and average wage is 100k, thats a 20-1 ratio, and the banks would still only be lending ~600-700k on that salary? I know there will always be overseas buyers, or upgraders etc who can use equity, but what % are they? I think it must still have an impact.

 

To be fair, he didn't call out rates, utilities and land tax which closes much of the gap.

 

Agent fees at 5.5% of rent, vacancy of approx 1 week per year (2% of rent), cost of interest, which when you have a 3.5% yield and a 4.5% loan, is already 1% by itself, etc.

If it’s a strata purchase, then you have to add a significant quarterly cost as well. If it’s a new build (less maintenance) these strata costs are worse.

Stock standard old place in western Sydney at $600k and earning $450 per week (generous) is a gross rent of $23.4k before you factor in other costs. The cost of money on $600k is $27000, that’s already $4k on just funding costs without even including the funding costs of stamp duty and other purchase costs ...

If you’re investing in a nicer area, such as lower north shore or inner west, that $4k quickly accelerates to $10k+, and that’s before the other costs

 

In agreement as well tbh.