Mark & Alice talking about the Sydney property market

"The property market tide is in ebb. The introduction of new taxes for NSW investors has added additional pressure to an already slowing Sydney property market." - Mark

Those who negative gear show no fear

By Tim Blue

May 29, 2004

INVESTORS wanting more exposure to the property and financial markets apparently don't give a fig for warnings of high valuations and imminent price collapses. Latest Reserve Bank numbers show borrowings in margin lending are at a record level of about $12.3 billion - up 3 per cent in the March quarter alone.

While a more risky way to build wealth, margin lending allows investors to use shareholdings, in direct shares or managed funds, as security for an investment loan. The point to remember is that losses can be magnified as much as gains.

How much that can be borrowed depends on an assessment of the security stock, ranging from 70 per cent to 40 per cent for more volatile stocks and managed funds.

The minimum loan varies between lenders, although a $20,000 to $40,000 minimum is the rough norm. There are some lower limits, however.

To borrow $40,000, an investor would need at least $17,143 of stock as security, if geared at 70 per cent.

Margin loans can also provide tax advantages. Borrowers may be able to pre-pay interest and so bring forward the tax deduction for interest payments for the following financial year, provided the period is less than 13 months.

Tax deductibility of interest matters drive a fair share of negative gearing investment, though it should not be the main yardstick. Fundamentally important is the growth potential of the asset being bought.

St George head of margin lending Andrew Black says: "Whether an investor gets a tax deduction should be looked on as icing on the cake - it should not drive the deal.

"The whole point of gearing is to invest in an asset class which you think has the potential to grow over time in addition to a dividend income stream."

Borrowing to invest usually takes one of three forms:

Borrowing against the equity on your home.
A margin loan where your investment assets form the security to the loan.
Savings instalment gearing, where you can leverage your regular investments into a managed fund with regular drawdowns on an investment loan.

Interest rate movements are critically important in determining the break-even point in geared investments and so too is the state of investment markets. Many choose to have relatively low levels of borrowing (or gearing) compared with the owned or equity proportion.

At St George, the average gearing ratio of customers' loans is 41 per cent compared with a market average of more than 50 per cent.

Andre Black says this more conservative gearing means it makes less than two margin calls a day, or 1.3 per cent of the industry total, despite holding a 9 per cent market share.

"Overall, gearing levels are little changed in the past six months at St George," he says.

"Some people do borrow to 70 per cent gearing. However, it is in a planned portfolio to accumulate wealth with clearly defined strategies in place to manage risk."

Gearing can still be part of a wealth-creation strategy, but with interest rates at historic lows, it will pay to be careful. One alternative might be to gear into unit trusts, which invest directly in shares, and offer professional management of funds as well as reducing the risk through diversification of assets across market sectors.

In property:

Consider the wisdom of waiting six months before investing. Prices are expected to flatten under the weight of higher interest rates, and consumer misgivings about future rises.
Be wary of apartment investing outside the big cities, as oversupply looms again. Sydney and Melbourne may weather the storm better, but still be affected, as tenants go missing.
Watch for oversupply in the lower CBD of Sydney.

In gearing:

Make sure you have adequate liquidity to meet margin calls on margin loans.
Beware of fees that may apply to the early termination of a loan.
Take out income protection insurance to cover the risk of being disabled and unable to work.
Consider additional life insurance if the lender requires the entire loan.
Invest in assets that have the potential for long-term capital growth.

Reference: The Australian