Real Estate Investor Magazine South Africa August 2013 | Page 26

FINANCE

BY JASON LEE

Simple Steps To:

Negative gearing and negative equity

T

he truth about the buy-buy-buy-andnever-sell philosophy is that it could
make you catastrophically poor before
it ever makes you wealthy.
Most property investors start off by investing in
a buy-to-let property, such as a flat or a townhouse.
Given that interest rates in South Africa are high
in comparison to most First-World countries, it
is very difficult to find deals in which the tenant
covers the bond repayments from the start of the
investment. This is particularly true if the investor
gears the property highly through a 90 to 100 per
cent bank loan.
This means that the investor is in a negative cash
flow position, which becomes even more dire
once rates and or levies and maintenance costs are
deducted from the monthly income. The investor
may be short on the deal by one to two thousand
rands per month. Then he or she decides to buy
investment property number two. Once again,
the rent is usually not sufficient to cover the bond
repayments and property expenses, so that the
investor finds himself one or two thousand rand
short on the second property, too. The investor
may repeat this a third time, and then a fourth
time, and so on. The net effect of this investment
approach is that the investor may be able to brag
about owning five or ten properties, but in reality
he or she is living mere seconds away from disaster
on a day-to-day basis, because he or she is asset
rich, but cash flow poor.
This investment approach is what is known
as the negative gearing approach to property
investing. Negative gearing is the term used
to described deals in which your income does
not cover your bond repayments each month.
Investors who follow this approach do so because
they believe that the eventual capital appreciation
of the property will far outweigh the cash-flow
shortfalls and constraints in the interim. They
also argue that tax write-offs mean that the
government is assisting them in the ownership
of the property.

24

August 2013 SA Real Estate Investor

A belief that capita l
apprec iat ion w i l l out weigh
cash f low shortfalls may be well
founded, as histor y shows that
property prices always exhibit an upward trend
over the long term. The problem is that there is
a school of piranhas out there that is viciously
attacking your cash f low every month and,
as in any other business that has a cash flow
problem, it usually doesn’t take long before the
piranhas win.
Besides cash flow issues, there are a myriad of
other problems that can present themselves in
the property ownership business. True disaster
strikes when they all hit you at the same time.
These problems can range from non-paying
or absconding tenants to interest rate rises,
to property owners losing their jobs or their
business getting into f inancial diff iculty.
Suddenly the shortfalls become unmanageable
and unsustainable. If hard times strike in
the middle of a depressed property market,
investors who bought properties based on a
negative gearing approach have a massive new
problem to contend with – something called
negative equity.
Simply put, negative equity occurs when the
value of a property that is used to secure a loan
in the form of a bond over the property is less
than the outstanding balance on the bond. Once
this situation arises, the bank owns you, because
they can prevent you through an interdict from
selling the property for an amount that is less
than what they are owed. They can also foreclose
on the property, recover what they can on public
auction, and hold you liable for the shortfall on
this property, although you no longer own it or
receive income from it.
This is the ugly face of negative gearing,
which has crippled thousands of property
investors when times get tough. So, holding
on to property for the medium to long term is a
sound strategy if you are looking for solid capital

growth, but you will only enjoy capital growth
if you are able to weather the short- to mediumterm consequences of property ownership.
Unfortunately, this is where many property
investors get it horribly wrong.
However, gearing can be your best friend and
help you on the road to unprecedented wealth if
you are able to manage it properly. I would like to
reiterate that I would not be in a position today to
write books on property investing if it were not
for the banks and the money they lend investors
for buying property. I have been at the coalface of
doing property deals in the best and the worst of
markets. I have tasted the joys of positive gearing
and the absolute despair of negative gearing,.

This excerpt has been taken from
Jason Lee’s new novel, Ten Simple
Steps To Property Wealth.

RESOURCES
10 Simple Steps To Property Wealth
Zebra Press
www.reimag.co.za