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Why use property for wealth creation?

Property Investment Advice

The property market has experienced recurring cycles with periods of flat growth, slow growth and accelerated growth, with the long term result of an upward trend.

Due to the power of compounding, the time it takes for a property to double in value can be calculated using the Rule of 72.

This rule states that “72 divided by the compounding growth rate equals the number of years it will take to double in value”.

This means that when a property increases at a rate of 10% it will double in value every 7.2 years. It will quadruple in value in 14.4 and in 21.6 it will have increased in value 8 fold.

As an example: If an investment property is purchased for $250,000 and held for 21.6 years with a 10% growth rate it will increase in value to $2,000,000 (increase of $1,750,000). This averages out to a growth of $81,018 per annum.


Why does gearing into property purchases have such a great effect?


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Most people don’t have a spare $250,000 to invest. This is where gearing comes into play. Gearing is where you utilise a portion of your own money, along with a greater proportion of borrowed funds, to allow for the purchase of an asset of a much higher value than you could otherwise afford to invest in.

If you purchased the above $250,000 property using a 10% deposit plus 5% of the property value for purchasing and legal expenses, then you would be investing $37,500 and borrowing the remaining 90% ($225,000).

Therefore if this property had an average growth of 10% in 21.6 years your property would have grown in value to $2,000,000. Your investment of $37,500 will have increased in value to $1,775,000 giving you an average profit of $82,175 per annum.

Had you just invested your $37,500 into an asset which had also grown at 10% per annum then after 21.6 years your investment would have grown to $300,000, a gain of $262,500 or an average of $12,152 per annum. Hence gearing would have gained you an additional $1,512,500.


Cash is not really necessary when you have equity in your own home.
Having sufficient assets against which to borrow is all that is required and in this way, you can borrow the full amount plus all the additional costs.

This example has not taken into account the effect of inflation, holding costs or the rental income and is used for demonstration purposes only.

Negative Gearing


Negative Gearing of investments refers to a situation where the interest and the other costs incurred to acquire that investment are more than the income received from that same investment.

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This cash loss is offset against other sources of income, reducing the amount of income tax payable.

In other words, with a negative geared investment property you make a cash loss, but the effects of this cash loss are reduced by the tax system.

Put simply, Negative Gearing is when:

  • You borrow to purchase an investment.
  • The interest on borrowings when combined with other incurred costs are more than the returns from the investment thus making you a cash loss.
  • This cash loss is offset against income from other sources, thus reducing your taxable income, and as a result the amount of tax you have to pay.

 

Contact Us for free advice on using negative gearing as part of your property investment strategy.

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