Help on My Math on Negative Geared Investment Property

focus123 on 27/05/2024 - 18:13
Last edited 05/06/2024 - 05:03

Dear Ozbargainers,
I'm trying to do some math on negative geared investment property and I am not sure if I am getting the numbers correct.

I really appreciate it if you can pinpoint any wrong calculations or assumptions in below scenario.

Investment Property - A Unit worth 500,000.
Mortgage 400000.
Down payment 100000
Transfer and stamp duty - 26000
Conveyance fee - 1000
Total out-of-pocket Initial investment 127000.

Rental income @400 per week x 50 = 20000

Monthly P&I repayment @6.30% = 2475

Outgoings(council, strata, maintenance, water and sewer, agent fees) excluding interest is 7500 per year.
Interest is - 25,000 1st year.

cashflow loss of 12,500 per year (rental income - expenses).

Depreciation 7,500 per year.

The reduction in taxable income is 20,000 (12500 + 7500).

Assuming 120000 per year taxable income, the annual take-home pay is 88,000
After purchasing the investment property,
Assuming 100,000 per year taxable income, the annual take-home pay is 75,000.

Annual loss of after-tax income 13,000

10 years after tax loss 130,000.

After 10 years, the property value is 930,000 (@ 6.5% long-term appreciation).
The sale cost is 2% = 20000.

Remaining mortgage balance after 10 years = 345,000
Total depreciation claimed = 75000
Capital gain = 930000 - (500000 - 75000) - (27000+20000) = 458000

Net proceeds (before CGT) i= 930000 - 345000 -20,000 = 565000

CGT = 20300 @ 37% + 78300 = 98,600.

Total balance in the bank = 565000 - 98600 - 20000 = 446400

Initial investment + ongoing negative cashflow = 127000 + 130000 = 257000.

Total profit from property investment is $189,400 (446400 - 257000) after 10 years of owning.

Is this math correct?

Update 1

Thank you for all your valuable feedback. I updated the math as below.
* Reduced the appreciation rate to 4% as many suggested 6.5% for a unit is very optimistic. This brings down the sale price after 10 years to $740,000 (from 930,000).
* Included the principal payment part as a non-tax deductible cashflow loss, Which reduced the annual after-tax take-home income to 17,700 (previously I used 13,000 for this)
* Because of the above change, the 10-year cumulative after-tax loss becomes 177,000.
* Capital gain reduced to $268,000. Included the wife also in the CGT calculation to get a more accurate picture. Combined CGT reduced to $51,400.
* Updated total balance in the bank to $323,600 (Sale price - Sale cost - Mortgage balance - CGT).
* Updated the total investment to 304,000 (initial investment + ongoing cashflow loss)

Investment Property - A Unit worth 500,000.
Mortgage 400000.
Down payment 100000
Transfer and stamp duty - 26000
Conveyance fee - 1000
Total out-of-pocket Initial investment 127000.

Rental income @400 per week x 50 = 20000

Monthly P&I repayment @6.30% = 2475

Outgoings(council, strata, maintenance, water and sewer, agent fees) excluding interest is 7500 per year.
Interest is - 25,000 1st year (tax-deductible).
Principle - 4700 (non tax-deductible)

cashflow loss of 17,200 per year (rental income - expenses).

Depreciation 7,500 per year.

The reduction in taxable income is 20,000 (12500 + 7500).

Assuming 120000 per year taxable income, the annual take-home pay is 88,000
After purchasing the investment property,
Assuming 100,000 per year taxable income, the annual take-home pay is 75,000.
Reduce the non-tax deductible principle payment of 4700.
Net take-home pay is 70,300

Annual loss of after-tax income 17,700

10 years after tax loss 177,000.

After 10 years, the property value is 740,000 (@ 4% long-term unit appreciation).
The sale cost is 2% = 20000.

Remaining mortgage balance after 10 years = 345,000
Total depreciation claimed = 75000
Capital gain = 740000 - (500000 - 75000) - (27000+20000) = 268000

Net proceeds (before CGT)i= 740000 - 345000 -20,000(sale cost) = 375000

CGT liability (for 2 people) = 134000
CGT liability for 1 person = 67000
CGT 1 person = 20300 @ 37% + 5400 @ 45% = 25,700.
CGT 2 persons = 51,400

Total balance in the bank = 375000 - 51400 = $323,600

Initial investment + ongoing negative cashflow = 127000 + 177000 = $304,000.

Total profit/loss from 10-year property investment is $19,600 (323,600 - 304,000) after 10 years of ownership.

Update 2

Thank you all for comments. The key takeaways for me are;
* Avoid negative gearing if the cash flow loss is noticeably higher.
* Avoid negative gearing on apartments/flats as appreciation and rental returns are low.

Financial

Comments

  • mrvaluepack on 28/05/2024 - 04:52

    Huge 6.5% capital appreciation assumption!!

    I would always assume the worst and only budget a more realistic 3% growth per annum instead.

    And like others have said, where is your maintenance forecast? I would put aside $5k or 1% of house price per annum for maintenance costs.

    Looks like you also forgot to mention annual insurance costs.

  • philmccracken on 28/05/2024 - 07:27
    +7

    Maths. Looks like everyone else has covered the rest.

  • larndis on 28/05/2024 - 07:38
    +1

    I like this calculator, you can play around with the assumptions and see the impact of rate changes, etc.

    https://www.homeloanexperts.com.au/mortgage-calculators/nega…

  • kaleidoscope on 28/05/2024 - 08:00
    -3

    Thats not the best strategy for an IP afaik…

    1) you don't put that much of money as downpayment for an IP even to offset LMI as it is tax deductible
    2) paying P&I. you dont do it either, pay interest only where possible such as part of the loan itself.
    3) there could be additional expenses for ongoing such as safety checks and tenant requests, repairs etc..
    4) 10 year wait. No you just sell around 3-5 year mark where the CGT passes the threshold and when the market is hot.

    Think of it as spending about 50-60k savings and walking away with a 200 in a matter of 3-5 years. That is about it.

    • star-ggg on 28/05/2024 - 08:17

      What do you do with the cash after selling?

      • kaleidoscope on 28/05/2024 - 09:04

        pay off home loan / buy next ip …

  • jonkvh on 28/05/2024 - 08:13
    +10

    I'll help with the spelling first… it's Maths.

    • ThithLord on 28/05/2024 - 09:41
      +5

      The Americanisation of the internet is complete. They got OzBargain - f**k

      • FezMonkey on 29/05/2024 - 10:03
        +5

        "down payment" is also American. It's "deposit" here

    • RTX9090Ti on 29/05/2024 - 13:24
      +2

      or Meth depending which suburb the IP is.

  • BigBirdy on 28/05/2024 - 08:15
    +4

    Forget the maths, it's the vibe that matters

  • Lastchancetosee on 28/05/2024 - 08:17
    +6

    Isn't this what accountants are for?

    • focus123 on 28/05/2024 - 08:18
      +3

      OzBargainers provides free financial advice.

    • ThithLord on 28/05/2024 - 09:42
      +4

      They wouldn't be a landlord without cutting corners every chance they got, huh.

      (this isn't directed at the Good landlords of OzB :))

      • pizzip on 29/05/2024 - 12:03
        +2

        Yet renters are apparently the entitled ones…

  • netjock on 28/05/2024 - 09:11
    +1

    Whatever in your offset PPOR split a loan out for that amount and then stick it into the sharemarket. That loan is tax deductible rather than paying for a unit. Best thing about shares is you can sell $100k and let the rest ride rather than having to sell the whole lot (like a property)

    The worst part is you get caught because the owner is selling due to defects and you end up holding the bag. I assume if you got depreciation it is relatively new. Most stuff built in the last 15 years has either a lot of remedial work or hiding something if there isn't.

    I have one in a relatively problem free building. The high pressure regulators in the water system burst and flooded a few of the floors. Who would have thought. No cladding issues (in VIC) and comprehensive check of the history (developer still in business which is nice and built before the latest boom in cardboard apartment building).

    • d-hunterz on 29/05/2024 - 09:37

      That loan is tax deductible(on PPOR) rather than paying for a unit?

      • netjock on 29/05/2024 - 10:49

        It is called debt recycling. Google it.

        If you had $500k loan in one lump and $100k in offset. Split the loan into $400k and $100k. Pay the $100k within $1 then redraw into a share account then buy shares with it. The interest on $100k is tax deductible. Same for if you pay off the $500k to $499,999 then redraw it all into share account and buy shares with it.

  • morebunnings on 28/05/2024 - 09:37
    +3

    You need to account for rental increases.

    You will be renting it out for more than $400 after a couple years. Much more after 10 years.

  • jhlook on 28/05/2024 - 09:45
    +1

    Not sure if I missed it but what about a building and pest inspection? And I didn’t notice any insurance

  • MrThing on 28/05/2024 - 10:17
    +1

    Tldr?

  • redfox1200 on 28/05/2024 - 10:25

    principal payment is not a loss

  • aboogee on 28/05/2024 - 10:36

    this is one step short of a basic valuation model - regardless of the outcome, good job to OP for trying to work this out.
    only point i would (and can make) is i bought my unit in 2011. went up by 60% in 5yrs but in the following 7yrs it hardly moved.
    i am not suggesting an average, i am suggesting that it may be lower than the 4% on a look forward basis, but i might be wrong.

  • LFO on 28/05/2024 - 10:47
    +7

    Transfer and stamp duty - 26000

    /off_topic starts

    $26,000 to the government for doing absolutely nothing constructive, nothing productive (other than shuffling papers).

    Isn't that appalling?

    /off_topic ends

    • wimphrel on 29/05/2024 - 13:54

      % fees on transfers help to reduce the likelihood of laundering/fraud practices with property.
      Well… the government makes sure to gets a cut of it if the fraud works :P

      • movieman on 30/05/2024 - 15:25
        +1

        I'm also surprised that Stamp Duty is so high - what a rort.

  • R4 on 28/05/2024 - 10:53
    +1

    Maths

  • jeeg on 28/05/2024 - 11:22
    +1

    From update2 to the post, the total profit after 10 years is 20k, after minus all the expenses, tax etc. So u are 20k richer after 10 years. Am i reading this correctly?

    • focus123 on 28/05/2024 - 12:27
      +1

      Yes, when the rate of appreciation dropped to 4% it reduce the profit by a big margin.

      • jeeg on 28/05/2024 - 13:53
        +1

        So that would just be $2k per year profit on average. I m rather surprised but thanks for the educational experience. I m learning something.

      • xrayed giraffe on 28/05/2024 - 15:47

        So 2%/year profit…
        Buy shares/ ETFs instead

    • filmer on 28/05/2024 - 20:48

      Looks like they aren't accounting for increased rent etc. If rent increases 2% per year that will result in about another 18k before tax. If interest rate drops 1%+ soon its could be another 40k+.

  • zorodluffy on 28/05/2024 - 11:43
    +2

    Hey if you have equity in your PPOR, you can get a investment loan against that equity to use as a 20% down payment for your investment property. Rather then using that equity as a down payment.

    Therefore you can deduct 6.3% * $400,000 as you did plus an extra 6.x% * $100,000 (investment loan).

    6.x% because the investment loan interest is a bit higher the mortgage, but i have co-workers that said it was only 0.2% higher then the mortgage for them.

    This means you can deduct an extra $6.3k per year in interest, that you otherwise couldnt have.

  • Munki on 28/05/2024 - 11:45
    +3

    Quick maffs.

    • cashless on 28/05/2024 - 23:00
      +1

      At least you put the “s” at the end.

    • RTX9090Ti on 29/05/2024 - 13:26

      MAFS

  • duchy on 28/05/2024 - 12:29
    -2

    Investment Property - A Unit…

    I stopped reading after that.

    Just … don't bother. It won't work financially.

    • Castcore on 28/05/2024 - 17:11

      I looked at my parents unit value after 9 years…that sh!t is so grim.

      Has had a lot of utility though, I'm not sure if that makes it worth it though.

  • firestint on 28/05/2024 - 15:26
    +2

    Didn't reach into details. But a few call outs;

    • Rent will normally increase and not stay at $400 for 10 years
    • Are you sure depreciation will stay at $7.5k p/year? The amount normally reduces quite substantially after 5 years, especially with yours being a unit.
    • When selling, you need to account for a bunch of costs e.g. marketing costs, conveyancing, PEXA. But, on the flipside, stamp duty and other purchase costs can also be included so your cost base is higher than purchase price.
    • Most importantly, depending on where your unit is located, but even at 4% growth p.a., that's a really optimistic forecast for apartment units.

    Investing in units is usually only to improve your cash flow, get a landed property if you're trying to invest long term.

    • nomadspartan on 28/05/2024 - 17:36

      What's landed property?

      • SBOB on 28/05/2024 - 17:56
        +4

        Property where you're also buying the land underneath it (eg not a unit)

  • plentifoo on 28/05/2024 - 19:04
    +1

    Title says negative gearing, but post is focused on calculating profit on sale of property after 10 years. Suggest you focus on your net cashflow on an annual basis instead. Calculating profit on an asset sale in 10 years without factoring time value of money, fluctuations in rent, IR and every other market condition just seems like pissing in the wind.

    Also your Update still contains reduction in taxable income of 20,000 even though you adjust cashflow loss to 17,200, meaning you’re actually negative gearing by 24,700 incl deprecation. To declutter and simplify things for usefulness, negative gearing calcs by and large will end at this point.

    Sorry I didn’t bother to look at your numbers past that point.

  • spammingb on 28/05/2024 - 19:25
    +2

    This is why negative gearing is not all what it's cracked up to be.

    I aim for neutrally or positively geared properties so I'm not bleeding at a loss every year I'm holding the property and am getting capital gains for effectively free

    • fullmetal on 28/05/2024 - 19:32
      +2

      The NG policy is not for average earners, it is for those with extremely high income (although it is widely supported by ignorant average earners). OP is only looking at 100k - 120k income which by government standard is average income. I suspect that number will change quite drastically for those in 37 and 45 bracket.

      • filmer on 28/05/2024 - 20:50

        I'd argue its intended to be used with new properties only where there is a large amount of depreciation such that the property is negatively geared but still positive cashflow.

        It does seem to have morphed into losing less money on the way to making all gains via capital though.

      • spammingb on 30/05/2024 - 00:54

        But why would you buy a NG property when you can buy neutrally or positively geared and have the same capital growth?

    • trapper on 29/05/2024 - 11:27

      I aim for neutrally or positively geared properties so I'm not bleeding at a loss every year

      Yeah imho you want to be cashflow neutral at minimum - still negatively geared due to depreciation etc, but no actual cash leaving your pocket each month.

  • pebee47 on 28/05/2024 - 20:46

    Have you factored in thr rise in rent each year? My property in Kalgoorlie has been rising around $50/wk these past several years. Admitedly Kal is a mining town, so rents vs property value are igher than most cities.

  • Assiduous on 28/05/2024 - 21:19
    +5

    You left out the cost of being becoming a morally bankrupt rent seeker.

  • Jaspa7 on 28/05/2024 - 21:45

    Huh? surely you can't claim depreciation and assume the house will appreciate at the same time? what am I missing??

    • focus123 on 29/05/2024 - 05:53

      The amount claimed under depreciation gets added to CGT liability at the time of sale.
      https://www.ato.gov.au/individuals-and-families/investments-…

      • Hangryuman on 29/05/2024 - 07:47

        'The amount claimed under depreciation gets added to CGT liability at the time of sale'

        or the total depreciation claimed over the years you held the investment property before you sell it, then reduces the 'cost base' which increases the net growth figure (net sale price minus your cost base), which is then used to calculate the CGT liability

        CGT then typically being around 25% of the net growth in my example nearby

    • Hangryuman on 29/05/2024 - 07:43

      buildings depreciate (lose value over time) -
      land appreciates (grows in value over time)

      depreciation can be claimed on plant and equipment - see the list in https://www.ato.gov.au/forms-and-instructions/rental-propert…

      appreciation is what landowners hope happens to land, e.g. inner Sydney terrace house land component valued 30 years ago at say $100K might be now valued at $1500K - that looks like 9.4%pa cumulative growth.

      your home may be exempt from capital gains tax (CGT) -
      your investment property tends to incur CGT on the price you sell it for

      a quick estimate might be 25% tax on the increase in value, e.g. $1.4M x 25% tax = $350K CGT - that can be a hard act to swallow …

      • netjock on 29/05/2024 - 10:51

        The best part is the CGT is so big it pushes you into the 47% tax bracket and because you are high income earner you lose concessional contributions to super (Division 293 tax on concessional contributions by high-income earners), literally bent over barrel then.

        Problem with property is you can't realise the capital gains gradually and manage your CGT liability.

  • cashless on 28/05/2024 - 22:59
    +1

    My Math

    So that’s the story in the USA.
    What about here in AU?

    • Hangryuman on 29/05/2024 - 07:49

      huh ? it looked like AU calculations to me

      US could be a whole different ball of wax - with different taxes, different deductions - and 50 states that can have different rules

  • goms on 28/05/2024 - 23:04

    Looks fine. The only thing you havent factored in is the increase in rent which will increase cashflow over time.

  • Thorn69 on 29/05/2024 - 08:57

    seems to me your making a huge loss until 5 years after the house is payed……………just skimming through it im accounting for rate rises that will happen but on average like 2k a year? you might make assuming no damages as well

    you probably would have been better off with a bank that gives 5% interest that's 5000 passively………

  • yokel on 29/05/2024 - 11:04

    Units don’t always go up in value. Even after 10 years. Depends on demand in the area. Builds of a certain vintage can put off buyers. Before 2000 internal sizes were larger and typically built better with less dependency on water proofing.

  • trapper on 29/05/2024 - 11:22

    Rental income @400 per week.

    Seems too low.

    Monthly P&I repayment

    Why pay P on an investment property?

  • wimphrel on 29/05/2024 - 14:03
    +1

    Staying negatively geared on an apartment is not a great investment compared to alternatives IMO -> capital gains is low, and cashflow was meagre.

    I've just sold my apartment (1st investment property) because it was underperforming & the interactions with property manager became too annoying for the benefit. I paid off principal as fast as I could to reduce interest & it helped me get loans for other properties interstate (houses) that have had better returns so far.

    You look like you're doing a good job working out the overall benefit to you in cash terms.
    People often jump to comparing perentages, but the problem is that a 6% return on $100K with no loan, is not necessarily better than a 3% return on a $500K house with $X loan amount.
    With the recent interest rate hikes, preference has definitely shifted back towards more liquid types of investment.

    I've done excel sheets with a month by month P&I calculation per row -> lets you model with increasing rents & changing interest rates during the 10 year path.

    • orangecarpet-22 on 29/05/2024 - 14:48
      +4

      People often jump to comparing perentages, but the problem is that a 6% return on $100K with no loan, is not necessarily better than a 3% return on a $500K house with $X loan amount.

      OP has a PPOR so they can get leverage on their ETF buys using redraw, and if it's an income producing ETF (most of the indexes) they can also deduct the interest costs, and the securing asset (PPOR) isn't marked to market, the same as a property.

      I'm also glad to see my first IP sell recently. I bought it for 698 and sold it for 859. Australians will clap and cheer and pat you on the back (propadee mate) but it's a crap return over 9 years. Also, they're not counting the outgoings, and the opportunity cost. My down payment was $170k. $170k in SP500 in 2015 until now, total return is $500k, NASDAQ $671k or someone like MSFT $1.85m. Look at that return without leverage, without agents, tenants, repairs, maintenance, stamp duty, conveyancers, marketing fees, staging fees, auctioneer fees, building, delays, two settlements, banking fees, mortgage discharge fees, land tax, councils, strata, strata meetings, class actions, building defects, and all my time and energy, then my reduced capacity to borrow money.

      Than you add in all the cash flow and losses along the years and you think, what a disaster.

      But propadee mate, you sold it for more than you paid for it! You made money!

      • Tleyx on 29/05/2024 - 16:53
        +1

        Poperty does so well because people are bad at maths and cant work out true returns

      • Needausername on 29/05/2024 - 20:53
        +1

        Property investment is all about laveraging. I am not sure which bank would lend you $671K to buy share, secure against a property? Not giving too much of my personal details, here are 2 of my personal properties stats (longest and shortest holding). Both are purchased using 104% bank loans, no personal input.

        Longest holding (19 years)
        * Cost - 385000
        * Val - 1300000
        * Exp - $27150 / yr
        * Inc - $28225 / yr

        If sold now
        * CGT = 228750 (est)
        * Bank loan = 385000 (assuming I am not forced to pay into principal)
        * (1300000 - 228750 - 385000) / 19 = 36118 / yr

        Shortest holding (11 years)
        * Cost - 800000
        * Val - 1800000
        * Exp - $40545 / yr
        * Inc - $27650 / yr
        * Out of pocket (assuming 30% tax bracket) - 9026.50

        If sold now
        * CGT = 250000 (est)
        * Bank loan = 800000 (assuming I am not forced to pay into principal)
        * (1800000 - 250000 - 800000) / 11 = 68180 - 9026.50 => 59155 / yr

        • wimphrel on 29/05/2024 - 21:42
          +1

          Property investment is all about laveraging [sic]

          +1 Yes this… I got not-so-great (I wouldn't say bad as it still outperformed a savings account) returns on the apartment overall, but it helped me get loans for houses in more sane states. The houses have done well & kept up with the markets, and I've made more than if I just invested the deposits into ETFs. The risk of low returns has been spread across different properties in different regions (i.e. I got higher returns from the houses).
          Thus like any business, I've decided to sell the apartment due to low returns (recent interest rate rises made it relatively worse) and moving the cash to better returns: ETFs, other offset accounts, or perhaps a new property somewhere else.

          As @Needausername correctly points out: banks aren't willing to lend me $1M to buy shares, so there is some sense is borrowing as much as you can safely afford to for investing early on, even if returns aren't as high (but obviously you need a long term strategy - sitting negatively geared on 1 apartment on interest only is unlikely to work; If it's a stepping stone for more, then its different). Shares will always be there, but banks may stop offering me large loans as I get older.

          Hindsight is just "what-ifs". I wouldn't have as eagerly borrowed $100K to buy Microsoft during Balmer days nor Apple during coloured CRT iMac days -> I even joked about buying $1K bitcoin when it hit $1 and not looking at it for 10 years…. would've had $80M+ now, but honestly it wouldn't have made any sense to "invest" in it back then when it was a gimmick as opposed to the market it is now (not to mention any sane exit strategy would have you selling all of it when you hit the tens of $Ks)

          My apartment was also my first property -> something I was going to move into. Just things in my life didn't go as expected, and I never ended up living in it. Good fallback place to have if I lost my job tho.

        • orangecarpet-22 on 31/05/2024 - 12:11

          You leverage the property you already own (PPOR) by redrawing and that way you can deduct the interest cost. You could also just use your offset cash but you won't be able to deduct the interest cost of the loan.

          BTW, 671k is the total value of $170k from 2015 invested in NASDAQ. It outperformed property without leverage.

      • ninnypoop on 31/05/2024 - 11:25

        Thanks for this. Me and my partner have been tossing up whether we get an investment property. I think in Australia we get strung along by the Australian dream narrative. When in reality, the old stock market seems to make more sense. Especially when you factor in having to deal with agents, banks, and tenants!

  • chintu123 on 30/05/2024 - 00:23

    Hi, when you are calculating your cgt: Capital gain = 930000 - (500000 - 75000) - (27000+20000) = 458000

    where is the 27000 coming from? I can't seem to figure that one out.

    • focus123 on 30/05/2024 - 11:29

      Its the initial cost of purchase (stamp duty etc). I think it is not included in the capital gain.

      • chintu123 on 30/05/2024 - 12:09

        Yah I am not sure if that can be used there.

  • vid_ghost on 30/05/2024 - 16:39
    +1

    Wow.. 10 years of hassle just to make $20k :) you would make more leaving $100k sitting in a savings account for 10 years

    • orangecarpet-22 on 31/05/2024 - 12:09

      It's an incredible amount of work and risk for $20k after 10 years. Like $15k once you adjust for target inflation. Absolutely woeful.

      But sold price higher than buy price! You made money — Regards, Australian public.

  • ninnypoop on 30/05/2024 - 19:50
    +1

    So you make $19,600 over 10 years? $1960 a year?
    Doesn't seem worth it to me

  • v8bargain on 30/05/2024 - 21:50

    So much efforts for 10yrs for <$20k profits. This is got to be a joke, right?

    Hence I've been telling friends and family share market is the way to investment.

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