Negative Gearing & Investing - What's it all about?
There has been much news of late about negative gearing, with varying opinions and heated discussions of it in relation to Australian politics. What is it and why does it seem so terrifying? How does it affect investors? In this month's piece, General Manager Lindy Lear, demystifies the nuances behind negative gearing.
What is gearing and opm?
Gearing is when you borrow money to invest with the goal of achieving a capital gain. Only a few people buy property with their own money. Most investors use the principle of borrowing ‘other people’s money’ (OPM). Generally, this will come in the form of the bank's money and using a 10% - 20% deposit. This allows investors to build an asset base using the principle of leverage that can create wealth and a passive income for the future.
So what is negative gearing?
Negative Gearing occurs when the costs of owning the property are higher than the rent. Such costs include the interest on loan, rates, insurance, maintenance, strata fees and property management fees. These costs can be quite stressful for investors when they find that the property may be costing them $100 - $200 a week or more to hold.
At tax time, a negative gearing benefit can be claimed against your taxable income. This benefit allows you to claim this as a tax deduction on the loss - so that the costs are minimised by the tax refund received.
Why invest if the property is running at a loss?
Some investors have a taxation strategy and buy negatively geared properties just to get the tax benefits. With this strategy, capital growth potential may be overlooked.
Others have a wealth creation strategy to build an appreciating asset base over time that will deliver capital growth and a passive income, and the tax refunds are not the reason to invest - just an added benefit along the way.
How can you have Positive cashflow and negative gearing?
It may surprise many investors that a negatively geared property does not always have to cost you money. Buying property that has capital growth potential and a positive cashflow after tax benefits is a great strategy that I have used. With two incomes, one from the tenant and one from the taxman, a positive cashflow outcome is very achievable. Once the penny drops on this concept, it opens up a whole new way of thinking about negative gearing!
How to make negative gearing work for you?
Negative gearing can work for you to maximise your tax refund, minimise your holding costs and increase your positive cashflow outcomes. If each property you buy pays for itself with the rent and the tax benefits, your worries over negative gearing and holding costs can disappear. For myself, I have always invested in new properties. See why, in the next section.
Benefits of buying new
Not only do new properties attract good quality tenants willing to pay premium rents to live in that high demand area, but they're generally maintenance free properties in the early years. One of the other main benefits is higher tax refunds which boost my income and give me a positive cashflow outcome. The secret to achieving this I wrote about in a recent article entitled 'Have you got the X factor?'
So rather than thinking positive or negative gearing - think ‘positive cashflow and capital growth’ properties. As an investor you want to get to your goals sooner rather than later. Making the most of the negative gearing benefits can have a number of positives for Australian investors, not the least of which is creating a second income stream from the tax refund and having positive cashflow properties. Negative gearing is a great benefit for investors, but not the reason to invest.