February 20, 2023 by Dymphna

The trap is set for the negatively geared

This won’t derail the market, but some people are going to feel the pain

We can expect to hear a lot more about negative equity over the coming months.

This is the unfortunate situation where you owe more on the property that the property is worth.

In a sense, you’re trapped. It costs you money from your own pocket to sell the property because the money you get from the sale won’t pay out your mortgage.

It sucks.

So far, it’s not a big deal. The Australian Financial Review estimates that about 120,000 homeowners across the country are now facing negative equity. But that number rises the more prices continue to fall.

Around 120,000 homeowners nationwide who bought with low-deposit loans at the tail end of the pandemic boom are likely to have already fallen into negative equity after nine successive interest rate rises triggered record-breaking price drops.

A total of 289,125 homeowners who bought between November 2021 and April 2022, when house prices were booming, were also edging closer to going underwater as prices fell 8.9 per cent since their peaks.

These calculations are based on CoreLogic’s records showing that a total of 1.188 million homes changed hands between March 30, 2020, and April 30, 2022, and Standard & Poor’s estimate that more than 40 per cent of new mortgages taken during the pandemic peak were low deposit loans.

Experts say a large chunk of these properties would be worth less than their mortgage within months, particularly if interest rates rise to 4.1 per cent as predicted by some economists.

So far, there is little evidence that households are under mortgage pressure, although mortgage arrears are starting to creep up at a faster clip according to Standard & Poor’s Performance Index.

That’s right. This isn’t a big deal for the market overall. The numbers are relatively small compared to the total housing stock, and we’re seeing very little evidence of forced selling yet.

So I’m not fazed.

And for most people, if you can still afford the payments, what do you care if you’ve got negative equity on paper? Give it a few years and the market cycle will turn and you’ll be right.

But what I think it does do is point to the dangers of negative gearing.

Sometimes, based on your particularly financial circumstances, and depending on how you structure it, negative gearing can make sense.

But for a long time, accountants were telling people to go out and buy property, and just ignore whether it was cashflow positive or not. If it was making money, you won. And if it was losing money (negatively geared), you just claimed it on tax, and you still won.

But that’s not how it works.

Because if you’re negatively geared at this stage of the cycle, you can get in to trouble.

As mortgage rates go up, your property just starts costing you more and more money.

And if you can’t afford that, then you probably have to sell.

But if you’re stuck with negative equity, you can’t sell unless you can come up with the money to cover the difference.

(At a time when money is already tight!)

That’s a pickle.

Seriously, I’ve worked with so many students who just walked blindly into negative gearing (often holding the hands of their accountants – accountants who knew very little about property investing) and then just found themselves in a real pickle when the market turned.

It’s a tough lesson to learn.

But in the end, it’s probably healthy that the market has given us all this reminder.