Negative gearing has been a favoured strategy among property people for decades in Australia, because of its popular tax-reductions. But what happens when your cash flow faces a squeeze like so many during COVID-19? See why I think negative-gearing is the wrong strategy and how you can become Cash Flow Positive, as I chat below with Australian Property Investor.
Developer’s campaign to make negative gearing obsolete.
By Dan Wilkie | Australian Property Investor | 23 May 2020
Queensland-based developer has created a solution for residential investors battling to service debts because of a sudden drop in income due to COVID-19: convert your single rental property into several.
While negative gearing has been a popular tax-reduction strategy for decades, many investors are facing significant challenges to service their debts in the current crisis.
With a large percentage of renters seeking rent reductions or deferment, investors are being forced to rethink the makeup of their property portfolios, with the tax benefits of negative gearing no longer outweighing the financial burden associated with operating a rental property at a loss.
Small is the New Big founder Ian Ugarte said his company, which is part-developer, part investment educator, had recently experienced a 37 per cent increase in enquiries around positively geared property strategies.
“The biggest realisation is that negative gearing relies on the fact that you need a job to keep it going and those people that have either lost their job or had a decrease in hours are starting to realise that the tax back on the first of July is not making up for the fact that on a weekly basis they can’t afford to live,” Mr Ugarte told Australian Property Investor Magazine.
“Even if they have not lost their job, they realise how quickly things can change overnight, so that’s causing fear and panic in the marketplace.”
Mr Ugarte said while many property owners were considering selling in depressed markets across the country, offloading investments at this time should be a last resort.
Other options included switching to interest-only loan repayments, refinancing loans, reviewing insurance needs and seeking premium relief, or negotiating with agents to reduce letting fees in the short term.
However, Mr Ugarte maintained that the best option available would be to convert properties from negatively geared to positive.
Mr Ugarte said most four-bedroom, two bathroom homes could be easily converted into micro apartments, which when leased were likely to create positive cashflow for the property.
Typical costs for conversions ranged between $20,000 and $45,000, and while Mr Ugarte acknowledged it may be difficult for all property owners to access those funds, particularly if they are in financial distress, the benefits of the strategy were clear.
“We can do these really quickly,” he said.
“There was a house with a granny flat and we created five micro-apartments in 48 hours.
“The rent would normally be about $500 to $550 per week at best, and we are pulling in $1,220 a week and we filled it in eight days.
“So we’re talking a serious turnaround in cashflow and quick turnaround in time.”
Mr Ugarte developed the conversion strategy around a decade ago, with his previous career developing four-bedroom homes providing little job satisfaction.
“I was doing really well, had lots of money in the bank account and was what I always would have considered to be successful, but I was the unhappiest i’ve ever been and I’d planned my own suicide,” he said.
“That’s when I started to do the research and looked at census data and what communities really want and why was it that these four bedroom houses weren’t doing anything for me other than making me money?
“Then we started to realise that the largest houses in the world are built here in Australia, we have got 2.5 people per household and there are 12 million empty bedrooms every night.”
Those market fundamentals, according to Mr Ugarte, indicate a mismatch between the built form and the amount of space that’s actually needed to live comfortably and cost-effectively.
He said the majority of people seeking rental accommodation were single people, couples with no children, or what he calls ‘double households’.
“It could be a couple that are married, defacto, or boyfriend and girlfriend, or it could be a parent with a single child,” Mr Ugarte said.
“It could be also friends that live together or it could be two siblings that live together.
“Between 60 to 80 per cent of the marketplace are single and double households, and 60 to 80 per cent of the rental properties available are 3, 4 and 5 bedroom houses, so there is an absolute mismatch in the marketplace.
“People that are renting four-bedroom houses are paying too much, because there are not enough one-bedroom or two bedroom properties.
“So what we do is we reduce their rent by one third to one half of the four-bedroom house, and put those double households into one house.”
Mr Ugarte said Small is the New Big’s capabilities included retrofitting large established homes, or building adaptable homes from scratch.
Central to the new-build strategy is a theory that a property can adapt over time, depending on the occupant’s needs.
“I’m a big believer in adaptable housing because demand changes over time,” Mr Ugarte said.
“You only have to look at granny flats in Sydney, there are areas in Sydney where if you built a granny flat today, you would be absolutely crazy because it’s an overexaggerated marketplace and there is too much supply.
“Any of the properties that we build are adaptable so that they can be micro apartments today, while tomorrow they could be used by some grandparents with a family that wants to live multi-generationally.
“It could be used by siblings that live together and their partners, it could be used by a whole bunch of friends that live together, it could be used by a family with teenagers that want their own space.
“You’ve got this great availability to be able to use these properties into the future however you want to, depending on the marketplace and the adaptability is a big part of that.”
Mr Ugarte said while he was confident that property markets across Australia would rebound from the current coronavirus-induced uncertainty, his mission was to help make negative gearing an obsolete strategy and create a marketplace where investors are able to generate positive returns.
“Even if it’s a small return, they’re relying less on the government to make up the shortfall by way of tax deduction and they’re not so vulnerable to market forces when another unexpected fall in cashflow hits them,” he said.
“Tax deductions suddenly don’t look as enticing when people are faced with losing their homes.”