There is an on-going debate about the virtues and value of negative gearing in Australia. Let’s take a closer look at how both negative and positive gearing work, and what may be the right choice for you as an investor
Negative gearing is, in effect, a cash flow outcome, as a federal tax policy allows investors to claim their investment losses against their taxable income.
Positive gearing really just means that the rent you receive is more than the cost of all the property expenses each month. So you’re making an “income” from it.
When a property is positively geared, it means you don’t need to top up your mortgage each month – and so it could be argued that it is faster to accumulate more properties this way – as it can be easier to save money to generate a new deposit for your next property purchase. Most positively geared properties are however, in less ‘desirable’ areas – with a lower property cost entry point – areas with a lower socio-economic population – such as fringe, or regional areas – where often the capital growth will be lower. It’s better for your cash-flow, but usually not as strong in terms of capital growth. So in this case, as a serious investor, it’s important to save and invest your positive cash-flow to make up for the usually lower growth in property value.
Investors buying in more ‘desirable’ – higher entry point, areas – would expect that their rental yield will be lower, so the rent received for these properties won’t cover the mortgage and other expenses – but that the capital growth over time would be higher and thus exceed any outlay that they had during the time they held the property. So they need to ‘top-up’ their mortgage repayments each month, to save on tax at the end of each tax year.
For example, an investor might receive $10,000 a year in rental returns but pay $25,000 a year in interest on their loan. If they are earning $100,000 a year, then the negative gearing tax policy allows them to reduce their taxable income in this scenario to $85,000 a year, which can mean a big tax refund. Negative gearing works differently and means a different cash flow outcome for everyone – depending on your tax bracket and the age of the property.
The negative gearing policy also allows many deductions to do with the costs of owning, servicing, maintaining and even improving an investment property
When it comes to negative gearing – those in favour of it say it encourages wealth creation by incentivising investors towards independent wealth creation. This in turn would reduce those investor’s dependency on the old aged pension that is funded by the government. Critics say it gives an unfair advantage to investors over first home owner buyers, and artificially inflates property prices.
It is a controversial policy – and it is suggested that this tax break for investors costs the Government, and therefore Australian tax payers – is around $4 billion a year
If you have enough income to comfortably cover the cash shortfall in mortgage payments each month – and crucially, if you are confident that the capital growth of the property will significantly exceed your losses, then a property with negative cash flow can be worth it. It is said that depreciation is the best of the claimable elements.
Be very careful though – that with new changes in the latest budget in regards to depreciation, this depreciation schedule will not, for most investors, have anywhere near as significant an impact on your cash flow as it used to, certainly within the first couple of years. Those that are not the first owner of a particular property, or are foreign investors, have been significantly affected by these new laws. See our recent article on the impact of the latest budget on investors.
So you need the right investment advice and property team, including the right specialised accountant, to have a very close understanding of your particular risk profile and circumstances. Strategic planning here is most important – especially around ownership structure.
Negative cash flow comes with inherent risk – such as if you suddenly lose your job and can’t afford these extra repayments each month
Also consider that over time you would expect a property to become more positively geared – as rent returns rise, and cover more of the mortgage repayments. However with too many and too heavily negatively geared properties – you reduce your available cash flow – and so as a property investor It can take longer for you to save deposits or access loans, and therefore to accumulate more properties to get you to a point of financial independence.
One strategy for investors can be to have a mix of negatively and positively geared investments – to balance this ratio along with your regular earnings
The long and the short of it is that there are a number of variables – including your and your partner’s income, security in your work, your existing equity position, your capacity to borrow and service your loans, the market at the time, the likelihood of capital growth versus higher rental returns and your particular investment goals and strategy.
Everyone has a unique set of circumstances that need to be properly investigated by professionals who understand and deal professionally in these details
Call us for a chat today, and get some up to date insights into the market and into what may be the best way to structure your investments.