Negative Gearing of Investment Property

If you are looking to invest in Australian property market, you should have an insight into negative gearing. Gearing simply means borrowing money to invest, especially in investment property. The investment property can either be negatively or positively geared. The difference between both concepts is the income outcome.

In this article, we will discuss the meaning of negative gearing, its benefits, and risks. We will also help you understand how to reduce the risks involved.

What is Negative Gearing?

Negative gearing is when an investor receives lesser rental returns compared to the expenses involved in maintaining the investment. These expenses include interest repayment, council charges, water rate, insurance, and certain upkeep costs.

An investor can match this loss against their taxable income. This reduces the amount they pay as tax, making it an attractive strategy.

What is Positive Gearing?

Positive gearing is when the rental returns are higher than the interest repayment and other expenses related to the property. In this case, you are making more money that can pay back the loan within the stipulated period. You will also have extra funds to repair or maintain the property as well as make other expenses related to the investment property.

A Case Study of Negative Gearing

Joe takes a loan of $900,000 at a 2.34% interest rate to purchase a property costing $1 million. At the end of one year, he is expected to pay an interest of $21,060.

Joe charges a weekly rent of $350. Therefore, at the end of one year, he should have earned $18,200 as rental income.

The figures show that Joe is paying an interest of $21,060 but earning only $18,200 in rent. He is making a loss of $2,860 each year. Because Joe’s property is geared negatively, the Australian government will reduce his taxable income by $2,860. As a result, the amount he will pay as tax will be reduced.

Benefits of Negative Gearing

The major benefit of this strategy is that you can offset net rental losses per financial year against your other incomes such as wages or salary. 

Are you eager to know how much other investors are bidding for properties?

You can order a free property report on our website and get a better understanding of the most recent sales in that area.

How to Make Profit from Negative Gearing

Negative gearing becomes profitable when you sell the property after its value has appreciated. The rule of thumb for selling is that you must sell at a time when property values are appreciating; not stable or depreciating. If the values are stable or depreciating, you may not sell at a price that is high enough to cover the losses you incurred when your asset was not generating sufficient income.

Furthermore, you need a cash flow that is reliable such that it can cover your borrowing costs before tax deduction. This will assist you in repaying your loan on time. Also, you should be able to hold the asset for a long period for its worth to rise above the losses incurred on the investment.

Is Negative Gearing Risky? 

There is no investment without risks, and negative gearing is not an exception. Below are some risks involved in the venture.

1. Insufficient Cash Flow

The highest risk investors face in negative gearing is when they borrow money to buy the property. They may not even have enough funds to pay the principal and the interest. Yet, their investment keeps incurring losses. This can lead to a bad credit score.

Don’t wait until things become too bad. Check your future monthly repayments using our online repayment calculator placed on NG Loans website or book a free consultation to get pre-approval done. You can also consider some other options such as refinancing your existing debt that might help to reduce monthly commitments.

2. Changes in Tax Policy 

If the government decides to change the tax law to an unfavorable one, you may discover that you’ve shot yourself in the foot. Your only option here would be to increase your rent since you won’t gain anything in the near future. But what if your tenancy agreement states that you can’t increase the rent until after 2 years?

3. Property Depreciation

Property can depreciate due to a number of reasons which include nearby foreclosures, the value of the location, and improper renovations. If the value of your asset refuses to rise, you won’t be able to sell at a price that will cover your losses.

4. Unoccupied Property

In this case, no tenant occupies the property for a while. This means that you will lose rental payments until you find a tenant.

How to Minimize Negative Gearing Risks

The following tips will help you reduce negative gearing risks:

1. Choose Location Wisely

You can’t buy properties in just any location and expect tenants to occupy them immediately. Proximity to major amenities attracts people of all ages. This ensures that the property does not remain vacant for long.

2. Count the Cost

Investment in property requires more than the money to acquire the property. You still need to maintain and repair structures and appliances which will cost a lot of money. So, before you decide to engage in negative gearing, ensure you have sufficient funds to manage all your expenses.

3. Insure Your Investment

Protecting yourself as well as your investment should be the top priority in case any unforeseen circumstance arises. Although we all hope for the best, you need to prepare yourself for the worst. You can reach out to a mortgage broker to find out the insurance types that are suitable for property investors. 

Negative vs Positive Gearing: Which Should You Choose?

Just like every other investment, the strategy you choose should reflect the amount of risk you can comfortably handle. If you are considering negative gearing, you need to be financially stable. This will cover the period when you are not making a profit from your asset. We recommend booking a session with a broker or financial advisor to work out the strategy that works best for you.

Book a free consultation today and our mortgage brokers will be happy to navigate you in the right direction.