Over recent years negative gearing has been labelled as an excellent investment strategy, in the media and amongst would be property investors. But what exactly is negative gearing? And is it right for you?
Borrowing to buy
Put simply, gearing means borrowing money to buy an asset. When it comes to property, it means taking out a loan to buy that property. There are three types of gearing:
- Negative gearing: where the interest you pay on the loan is more than the income you’ll get from that property. (That is, you’re making a loss.)
- Positive gearing: is when what you pay on the loan is less than what you earn from the property.
- Neutral gearing: is when the interest on the loan and income on the property is equal.
Advantages: Making a loss
Yes, you read that right. Sometimes making a loss on your investment is actually a good thing. Let me explain.
When you negative gear an investment property, you create a taxable loss. This means that you can offset that loss against your wage, which can provide you with tax savings.
For example, if your investment property rents for $500 a week, but you’re overall expenses for that property (such as loan repayments, council rates, strata fees, water etc.) totals $650 a week, there will be a $150 a week shortfall. This shortfall, which is covered by your own money, helps to reduce our taxable income.
Advantages: Capital growth
Owning a negatively geared property can be very profitable, if there is capital growth on that property. For example, if you lose $3,000.00 a year on your investment property, over 10 years you would’ve lost $30,000.00. If during that 10-year period the property increases in value by $300,000.00, your profit is actually $270,000.00.
With the way the Sydney real estate market performs, you can see why property is such an attractive investment.
Advantages: Tax savings
When your property is tenanted, or available to rent, the interest on a loan can be claimed as a tax deduction – this can greatly reduce the cost of the loan.
Negative gearing also helps you with your taxable income. For example, let’s assume you’re in the 30% tax bracket and you’re losing $1. With negative gearing you’ll get 30 cents back. Yes you’ve still lost 70 cents, but at least you get 30 cents back. (This is a really simplified example, and you should speak to your accountant or investment advisor for more detailed advice.)
Another tax savings comes from depreciation. This is where the property itself (both the building and fittings within the building) goes down in value. Even though you’re not actually paying for it (for example, the depreciation of the carpet or kitchen) you can still claim it as a loss.
Advantages: Property ownership (eventually)
Once you finish paying for the loan, you’ll own the property outright. That’s a pretty big positive of negative gearing.
You can sell the property, use it to fund another property purchase (or renovation), or keep it and use the rental income to supplement your own income.
Negative gearing risks
As with most investment strategies, there are risks associated, especially when you’re borrowing money to fund that investment.
The fact is, when you’re negatively gearing an investment property, you’re still recording a loss. Before you take the plunge into the negative gearing pool you should ask yourself:
- What if I can’t repay my loan?
- What if I can’t get a tenant?
- What if interest rates rise rapidly?
- What if there’s a downturn in property values?
Speaking to an expert, such as your accountant, investment broker and real estate agent is also a good step to take, before you consider a negative gearing strategy.
Every savvy investor, with full knowledge of the risks, should seek to manage that risk and minimise it as much as they can. When it comes to negatively gearing your property, some ways you can reduce your risks include:
- Getting your budget in order: there will be times when your property will cost you money, such as when it needs repairs. Make sure you can cover all contingencies.
- Purchasing insurance: this will protect you in the event of unforeseen circumstances. A financial planner can help you to understand the different insurances available and help to choose the one right for you.
- Choosing the right investment property: buy a property that is close to amenities and that will appeal to a range of tenants, that way you can help to reduce the risk of the property sitting vacant.
Get good advice
Getting good advice, which is relevant to your individual circumstances is a must. It will help you get the most from your investment strategy, while also protecting you from any potential pitfalls.
Negatively gearing, while offering many advantages, is not a decision that should be made lightly. We recommend doing your research, your sums and speaking to experts. A mortgage broker, investment planner, your accountant and a reliable real estate agent can all help you to identify any risks and formulate a plan to get the most from your investment time and money.
Over to you
Do you currently have a negatively geared investment property? What motivated you to include negative gearing in your investment strategy? Any pitfalls you’d like to share?
Disclaimer: The information here is provided on a general basis. You’re encouraged to consult with an expert who can consider your individual situation.
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