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Find out all about negative gearing and the impact this strategy has on investors, buyers, sellers and the wider market.

Heavily debated, negative gearing is certainly a buzz topic in Australia at the moment.

As it's important in the property investment landscape, it is vital to develop a good understanding of negative gearing.

Firstly, gearing is when you borrow money to invest and it's most often talked about in relation to investment properties. Other investment assets like your share portfolio or managed funds can also be negatively geared.

The income earned from your investment is usually positively or negatively geared. A property is positively geared when the rental return (the amount of rent you receive from your tenants) is higher than your interest repayments and outgoings.

A property is negatively geared when the rental return is less than your interest repayments and outgoings. 

Advantages

The most obvious benefit of negative gearing is that it allows an investor to reduce their taxable income. When you offset the loss being made on your investment, you do so against earned income from other sources. While doing this, you will effectively be reducing your income, so you can potentially have less tax to pay at the end of the financial year.

It usually only becomes a profitable action however when the property is eventually sold, allowing the investor to reap the capital gains benefits. Therefore, using negative gearing as an investment strategy relies on the value of property to be rising, not maintaining or going down.

If negative gearing works for you though, then eventually the capital that is made once the property is sold will outweigh the borrowing levels and costs of wealth creation.

Disadvantages

As with any investment, there comes a select amount of risk. When you negatively gear your property, you are reliant on housing market values to continuously rise so that you can benefit when the property is sold via the capital gains. If prices were to stagnate, there is a possibility that the gains that can be made would not cancel out the losses that come with negatively gearing a property.

It is also a long-term strategy. While that's not necessarily an issue now, if there was a sudden change in your circumstances and selling became a must, then you may not recover any losses that have been incurred through negative gearing.

It is also a strategy that can be rather time-consuming due to the need to budget for any potential shortfalls in your future.

Is it right for you?

Negative gearing is an investment strategy that requires an investor to choose properties that have good potential for capital growth. It can also be a solid means to build equity for when you retire.

Whether it is right for you is dependent on a few different factors. To begin with, having a comprehensive understanding of how negative gearing works is vital. It's important to know key factors like the deductions you can make. 

Negative gearing may be better suited to investors who will be able to financially bear the cost if the value of their investment was to drop.

Your financial situation can also be difficult if your property is untenanted for extended periods of time. This is why property investors who use this strategy will often have reliable income and the necessary cash flow to be able to manage if circumstances become challenging.

Another challenge that investors can face with negative gearing is the rise of interest rates. This occurring means the loan used to purchase the property will have greater interest repayments and could affect any budgeting done if not properly prepared for.

In the wider market...

An interesting talking point relating to this issue is the effect that negative gearing has on the wider property market and the impact negative gearing can have on groups other than investors, like first-time buyers and renters.

With a greater level of property investment comes higher amounts of available rental properties. With a higher level of supply for the rental market, assuming demand stays the same, prices could potentially go down for renters. In that sense it can be considered a good thing for renters.

For those looking to purchase a home, the current level of home ownership is 66.7%, which is the lowest it has been since the mid-1950s. With negative gearing in place and investing in property a seemingly inviting prospect, there is some possibility investors are willing to gamble and spend more with the returns they will receive in the future in mind. This pattern may see issues down the track for potential home buyers struggling to get into the market. 

At Little Real Estate we pride ourselves on our vast knowledge and experience relating to the real estate industry. If you’re looking to learn more about the property market or are interested in having your investment managed, contact us today.

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