What is negative gearing?
Negative gearing is a term that comes up a lot when talking about property investment. But what does it actually mean, and how does it work? And, more importantly, is it something that can work for you?
Negative gearing refers to when a property costs the owner (i.e. the investor) more money than it makes. A property that costs more than it yields is a ‘negatively geared’ property.
It’s important to note here that ‘negatively geared’ isn’t a legal term or a designation that you have to declare or anything like that. It’s just an industry term that refers to a property that is deliberately making a loss. If you’re accidentally making a loss, that’s not negative gearing so much as unfortunate planning.
Let’s look at some of the ways that a property can make a loss.
Let’s say you bought a property, and you took out a loan to do so. Let’s say you have a $400,000 loan at 6%. This would attract interest of $24,000 per year. If the property wasn’t earning you that much back (and in that situation it would require $461 a week in rent just to pay the interest), then the property is said to be negatively geared.
Of course, there are other costs incurred with owning a property that extend beyond servicing the interest on a loan. For example, if there are maintenance costs for the property, it’s possible that it will wind up costing you more than you’re making from it, the same as once you add rates and other utility fees into the mix.
Why negatively gear a property?
You might be wondering why you would want to make a loss. The long and short of it is that losses on investment properties are tax deductible. As a property, even an investment property, is generally considered a personal asset, those losses are deductible against your personal income, which includes your salary and wages. This means that a negatively geared property can save you some money on tax while it’s generating a loss for you. Ultimately though, the property will be profitable when it’s eventually sold (at which point those gains will be considered capital gains and taxed accordingly).
Of course there are some things to keep in mind with negative gearing. The idea isn’t to sink all of your money into huge loss leading projects. Rather, the idea is to buy a property and manage the losses that it makes while ensuring that it gains enough value over time to make an overall capital gain, which will cover those losses. This involves some speculation as to how much property value will go up in a given area over a certain period of time. There’s also the issue of how relevant it is as a strategy for you, which will depend on your personal situation and preference, but also your tax bracket. Obviously negative gearing offsetting income in a higher tax bracket is going to be more financially rewarding than offsetting income in lower brackets.
While negative gearing has obvious advantages, if your current investment strategy is to make a profit from your properties, it may not be for you. While this has been a relatively short summary of negative gearing, it’s an involved, technical enterprise to manage, and it pays to make sure your strategy will work before you sink good money into it. It’s also worth thinking about the future: you may be able to manage a deficit on your investment now, but will you be able to in two years’ time? What happens if you lose your job or things change? Financial planning and investment strategising can be difficult, so talk to professionals who can help you, as well as doing your own research. If it’s right for your situation though, negative gearing can be a creative way to build your portfolio while ensuring strong financial growth in the future.