Why lenders are negative about positively geared property

GUEST OBSERVATION

We all want a property portfolio that costs us nothing to hold. It’s the dream to be able to purchase more and more properties because every property pays for itself. So why do people opt for negatively geared property if the best option is a positively geared property portfolio?

The general argument is that negatively geared properties are that way because they are in areas offering higher capital growth but lower yields. For example, metropolitan areas where the value of the property is high in comparison to the rental income it receives. And the common notion is positively geared properties, are typically in regional or fringe areas of cities or may involve a dual occupancy, like a granny flat and as a result achieve higher rental yields in comparison to the overall value of the property.

However like all things there are exceptions to the rules and some properties with reasonable capital growth can still offer reasonable rental returns. For example, according to the Commonwealth Banks recent report on the state of the property market in Australia over the last 12 months:

Kelvin Grove in Brisbane reported 4% capital growth and averages 4.7% rental yields.

Strathfield in Sydney reported 13% capital growth and averages 4.5% rental yields

St Kilda Melbourne reported 4.7% capital growth and averages 4.3% rental yields

And with RP Data’s latest economic report showing average nationwide unit rental yields while down are still achieving on average 4.7%, most investors would be looking at the current three year fixed interest rates under 5% and thinking we have hit the sweet point where you can achieve the dream and just keep adding properties almost ad infinitum.

So why is lending still a problem and why can’t investors just keep adding properties?

The first thing to keep in mind is the normal costs associated with owning an investment property, like real estate agency fees, council rates, strata fees. Then there are the ones that people often overlook like the unexpected hot water system replacement.

Let’s assume though that you achieve a rental return of 6% and the costs are no more than 1% so that you have net rental of 5%.

Won’t the lenders give you unlimited loans?

This is when the lenders start to apply their own stress testing to your borrowing and it can make a huge difference. For example while some lenders will allow you to consider the actual interest rate of your loans where the loans are fixed for more than three years others will apply the normal variable testing interest rate.

And what a difference, on a typical $500,000 loan the difference could be. Interest only payments with a fixed rate of 4.99% of $2,079 per month or calculated loan repayments of $3,530 per month where the lender loads the interest rate by 2% and applies principle and interest payments over 25 years.

That is a difference in rental payments of $1,451 per month in order to get the loan to match the rental income or put it another way, a net rental yield of 8.47%.

Now there are creative ways of increasing your rental yield like renovations, allowing the tenants to keep a pet or adding an extension or granny flat that will allow the property to generate an additional income stream.

So why do lenders look differently at your current loan repayments? We know it all comes back to the four credit rules or  four C’s of credit. That is each lender is weighting the importance of your ability to afford the loan repayments slightly differently depending on their expectation of where interest rates, unemployment and the general economy might be going.

So there is no right or wrong answer to the question about whether negative or positive is right or wrong because for every investor is comes down to personal circumstance, your individual goals and your ability to service your loans.

If you would like guidance on which lenders might be right for you or a free property report on the possible capital growth of your properties why not give us a call.

Albertus Waldron is a partner at Chan & Naylor. For a free portfolio review or guidance on which lenders might be right for you, you can contact Chan & Naylor.