| 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?
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. This cash
loss is offset against other sources of income, reducing the amount of
income tax payable. In other words, with a negatively geared investment
you make a cash loss, but the effects of this cash loss are reduced by
the tax system. Put simply, Negative Gearing is when:
a) You borrow to purchase an investment.
b) The interest on borrowings when combined with other
incurred costs are more than the returns from the investment thus making
you a cash loss.
c) 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 |
