Negative Gearing: Explained
When property investors enter the market, they increase the supply of rental housing. As a result, they can deduct any losses incurred on their investment property against any other income, like their salary, on their annual tax return.
With negative gearing, investors are not dependent on rental income for profit, ensuring that rents remain competitive. Alongside the tax reduction strategy and long-term capital growth, negative gearing continues to attract investors.
Negative gearing is a great way for many investors to limit their losses until they sell the property.
Essentially, negative gearing works if an investor's money from a property's capital growth is larger than the loss they make from the rent.
What about positive gearing?
Unlike negative gearing, positive gearing is when the income from an asset is more than the costs. In other words, investors have a passive income.
In most cases, the most viable long-term investment strategies should be positively geared, which can create opportunities around debt recycling.
Sometimes investors adopt this strategy to build their wealth while increasing debt in the short term. For property, you increase the number of investments that produce passive income and rely on the market's historical potential for capital growth over time.
What are the benefits of negative gearing
You should expect the property value to increase over the long term
With current headlines screaming property boom to bust, it's essential to put the correction in context. Yes, the market is experiencing a correction following record highs over the last two years.
But historically, property in Australia has appreciated over the long term.
Capital growth is when an asset increases in value over the long term. For example, in 1973, you could purchase a home in Brisbane for $17,500 ($ 169,131 adjusted for inflation).
That same home in 2020 was worth $535,000.1
If you purchase a property for $650,000 and then sell it five years later for $800,000, this $150,000 increase in value is known as capital growth.
Provides a regular income
Many investors receive a regular income from the rent paid by tenants that helps cover some of their ongoing costs.
Other investors will use this income to help build up equity to purchase additional properties. Or start to pay down the loan amount (principal), so the mortgage is paid off faster.
Decrease your tax liability
Currently, Australian property investors benefit from reduced tax liability. As mentioned earlier, this is due to investors purchasing property and helping support and maintain competitive rent.
Any changes to negative gearing laws could impact how attractive investors see property as an asset class.
Things to be aware of with negative gearing
Costs can be high compared to other assets
Property costs differ vastly from investing in stocks and bonds, such as ongoing property maintenance costs, interest and stamp duty.
Most Australians find that purchasing a property is the most expensive asset they buy in their lifetime. Not only is saving for a deposit
challenging, but the cost of the property over the loan term can also run into the hundreds of thousands.
Your tenants will move
While we are in a tight rental market today (January 2023), you should anticipate your tenants will move. And when your investment property is vacant, you incur all the ongoing costs.
When purchasing and maintaining your property, you consider its position to appeal in the market to attract the right tenants who will be reliable and pay rent on time.
Be aware of hidden costs
Unlike other investments, the property can attract costs, including body corporates, council rates, water rates, ongoing maintenance and repairs, and insurance. All these costs need to be paid upfront by you.
So while you can use these costs to offset your overall annual tax liability, cash flow issues can occur if your expenses aren't
appropriately managed in the short term.
You're a landlord
Some investors find becoming a landlord discouraging, especially if they decide not to hire a property manager. However, the right
property management team can support you in finding the right tenant and managing the relationship with them, saving you time (and
intervening in any issues that arise).
Case study: Investing in Harvey Bay, Queensland
Megan and Matt purchased their first investment property, a unit in Harvey Bay[1] . Annually it costs them $18,000 in home loan interest fees and other charges. However, at the same time, they charge $270 per week in rent ($14,000 per year).
So, while making a loss of $4,000 per year, they can claim that against their tax liability from other income earned, such as wages. This enables Megan and Matt to reduce their overall tax liability.
Over the long term, their property has increased in value. For example, when purchased in 2018 for $189,000, it's now worth approximately $259,000.
So if Megan and Matt sold their property today, they'd make a gross profit of around $70,000.
But if they held onto the property for another few years, the value would likely increase further.
By owning the property over the long term while minimising costs, you can reasonably expect capital gains to continue.
Here's how you can make negative gearing work
Importantly, you will need a reliable cash flow to cover pre-tax costs and generate enough rental income to repay your loan.
You should consider if you will be in a position to hold on to the property over the long term so that the value increases. That way, when you sell, you will achieve a profit (the sale price is larger than the overall costs).
Negative gearing allows a considerable portion of the population to purchase an investment property by offering tax concessions to deduct any loss against taxable income. Therefore, more investors can enter the market than if they need to rely on positive gearing.
If you are seeking strategic advice on seeing if negative gearing can work for you, contact our expert property advice team or mortgage strategy team today.
[1] Source: ABS for house prices past 2003, RBA inflation calculator, and HOUSING PRICES IN AUSTRALIA: 1970 TO 2003 by Peter Abelson and Demi Chung