If you’ve ever considered property investment, chances are you’ve heard the term ‘negative gearing’. But do you really know what it means and how it could affect your investment strategy?
What is gearing?
Gearing means borrowing money to buy an asset. In terms of property, gearing means you’ve taken out a mortgage to buy an investment property.
Neutral gearing means that the rental income you receive for the investment property is the same as the amount you pay in interest charges. You’re not making a profit or a loss.
Positive gearing means that the rent you receive is higher than the interest charges you pay, so you’re making a profit.
Negative gearing simply means that the rent your tenants pay you is less than the amount you pay on interest charges for your investment mortgage. Overall, you’re making a loss.
How does negative gearing work?
Let’s say you purchase an investment property for $450,000 and you borrow $400,000 from the bank at an interest rate of 5.5%. You would end up paying $22,000 in interest per year.
Now let’s assume you receive $400 per week in rental income. That’s a total of $20,800.
At first glance, it can appear as though you’re only making a loss of $1,200 per year. However, you also need to factor in all the other costs associated with owning an investment property.
For the purpose of this example, let’s assume you’re paying council rates, water rates, landlord’s insurance premiums, and property management fees at a total of $5,800 per year.
Overall, in this example you’d be paying the shortfall of $7,000 per year to own that particular rental property.
Can negative gearing be positive?
Obviously, no one enters into an investment decision with the sole intention of making a loss. However, there are other benefits to owning a negatively geared property.
The cost of purchasing a residential property in Australia means that most investors start out with a negatively geared property. Over time, the rental income should increase, which can help reduce the shortfall between rent received and interest paid.
There is also the benefit of capital growth. If the capital growth of the property is greater than the loss you make in rental shortfall, negative gearing can be profitable overall.
In the previous example, we looked at a property with a potential loss of $7,000 per year. However, if you assume the property you bought was in an up-and-coming location and saw 5% capital growth over the year, your investment could potentially be worth $472,500.
While you might have been negatively geared to the tune of $7,000 in that year, your property could potentially have grown by $22,500 in value over the same period of time.
There may also be some tax benefits available for investors who take advantage of negative gearing. If the tax office determines you’re making a loss on your investment property, they may allow you to deduct the shortfall of costs you’ve contributed from your own pocket from your taxable income. As a result, you could end up paying less tax.
Always take the time to speak with a good accountant so you can maximise any potential tax benefits associated with owning a negatively geared property.
If you aren’t sure where to begin with your investment property portfolio, call the specialists at Nieuvision on 1300 832 554. We’ll help you create a property investing strategy that can help you achieve your financial goals. Or to book a seat at Nieuvision’s next FREE property investment info session click here.
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