Negative Gearing vs Positive Gearing

Negative gearing property is probably the most popular investment strategy in Australia. But is it really a good idea?

The burning question today is around whether negative gearing property is really a clever way to grow your assets, or whether the benefits are worth the risk.

Let’s zoom in and have a closer look at the pros and cons of investing in negatively geared property.

Negative Gearing Explained

‘Gearing’ is when an investor borrows money to purchase a property.

Negative gearing is the term that’s used to describe the situation when the income generated from an investment property (often a rental investment) is less than the cost of the loan repayments and associated property expenses.  The result is that the investor makes a yearly net loss.

Negative gearing can be claimed off your tax – the losses you make on your investment can be offset against your overall yearly income to reduce the amount of tax payable.

Positive Gearing Explained

The reverse scenario is called positive gearing – income generated from the investment property is more than the cost of the loan repayments and associated property expenses. The result is that the investor makes a steady passive income on the property, in addition to their regular yearly income.

When the conditions are right, negative gearing can be a really good investment. Let’s take a closer look at the pros and cons of negative gearing and how they might affect investors like you.

Pros:

• Income Offset: any loss that is incurred during the year from the investment can be offset against your annual income. This reduces the amount of tax you have to pay.
• Long-term Gain: property is a tangible asset, and while the market fluctuates with time, prices generally increase, as do rental rates. So, while short-term losses may be incurred, the investor should be able to capitalize on the investment either by sale or rental in the future.
• High Depreciation: a certain amount of depreciation applies to the building and fixtures each year, due to general wear and tear. You can get a tax refund for that depreciation, which reduces your overall tax bill.
• Purchase in Safe Areas: by opting to negatively gear, you will have access to a greater range of properties which allows you to choose a secure investment in a safe area.

Cons:

• Negative Cash Flow: a loss is a loss, and by definition, the yearly losses incurred by the investor will result in a negative cash flow. Even if it can be used as a tax deduction at the EOFY, the cash for the bills has to come from somewhere each month.
• Capital Loss: there is a certain amount of risk associated with investment, and if the climate isn’t right (e.g., the market is fluctuating or slumping), you might be the loser in the end. You are completely reliant on capital gains to make the investment worthwhile.
• Ability to Service Properties: having a negative cash flow might be a dampener on how many investment properties you are able to have – with money coming out of your pocket each month to service each property, affordability becomes an issue.

In summary, negative gearing works well if the climate is right.  And there are some strong positives in favour of the investor right now:

1. Record Low Interest Rates

In Australia, interest rates are at record lows.  And despite some lenders already starting to raise the rates on long-term housing loans, the RBA has repeatedly stated that national interest rates are unlikely to change until 2024 at the earliest.

2. Property Market Strong

Despite a series of lockdowns across our country throughout 2021, the housing market remains resilient and buoyant across all sectors.  Buyer demand continues to be stronger than supply, which is driving prices steadily up.

Admittedly, a little of the heat is predicted to go out of the market as we enter the new year, but it’s important to keep this in context – the property market has been moving at its fastest pace since the end of 1989!

Is Negative Gearing a Good Idea?

Ultimately, this is a decision that you have to make.  There’s not exactly any rights or wrongs when it comes to investment, but an informed decision will help you make the best choice for your future.

It’s crucial that you understand the pros and cons of any investment before you sign on the dotted line. Read the fine print. Understand all the jargon. Ask questions.

Don’t be afraid to seek professional advice. Consult your accountant or financial advisor. Speak to a trusted real estate agent such as Love & Co about current market conditions and predictions for the future.

The information in this article is for information purposes only and should not be taken as financial, legal or personal advice. 

While care has been taken to ensure that information contained in this article is true and correct at the time of publishing, any changes after the time of publication may impact on the accuracy of this information.

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