You may have come across this term a number of times in the past. You know it’s a buzz word that people use when talking about buying property but what does it actually mean and how can it apply to you?
Negative gearing is a fairly simple concept to understand, so don’t be too frightened. It occurs when the money you earn from renting out a property to tenants doesn’t fully cover the costs associated with
maintaining that property. You then have to delve into your own pocket to make up the difference each week or month.
Most properties in Australia are negatively geared so the chances of you purchasing an investment property that is negative geared is quite high. The obvious question to ask now is, if you’re making a loss each month then what is the appeal in buying an investment property? Even though it might seem you’re losing money, in actual fact you’re making money. Let us explain, even though a negatively geared property makes a loss on paper, it can actually produce a positive cash flow after tax. The following example explains it a little bit better:
You own a property that brings in rental income of $500 per week or $26,000 per year. You have a mortgage on this investment property and you pay $30,000 in interest each year. This leaves you with a substantial shortfall of roughly $4,000 per anum or $333 each month you need to come up with. Yet, as an investor you can claim a number of expenses back in your tax return such as:
- Borrowing and interest expenses
- Depreciation
- Legal fees
- Land tax
- Rate from the council such as water charges
- Property management fees
- Cleaning
- Repairs and maintenance
- Gardening and lawn mowing
- Insurance
Now that we know what negative gearing is what are the advantages and disadvantages?
Advantages of Negative Gearing
Tax Saving
The main advantage of negative gearing is the tax saving you get when you submit your annual tax return. Because your property is generating a loss you can offset this loss against your income and thus reduce your tax bill resulting in a saving. This is perfect for high income earners who might find themselves in high tax brackets.
Easy To Find
Most
properties are negatively geared so they’re easy to find. If you’re looking for an investment property within 10kms of the city there’s no shortage.
Capital Gains
Properties that are negative geared grow in value at a faster rate than positively geared ones. This is mainly due to location. If you buy in the right place you can benefit from high capital grown and then reinvest this into your next property.
Disadvantages of Negative Gearing
There are some disadvantages associated with negative gearing. Here we detail a few of pitfalls.
Higher Risk
As negatively geared properties are ultimately costing you money to hold, if certain things like interest rates or your job security changes you might find it difficult to repay the loan. Furthermore, if things go bad you may be forced to sell it which takes a bit of time. If you’re rushing to sell it, you may have to settle for a lower price you could end up losing money.
Risk of Vacancy
You might find it difficult to rent out a property and if no one is renting the place out your monthly repayments could be a lot higher as you try to cover this even bigger shortfall. The longer a property doesn’t have a tenant in it the more it will cost you. Remember to purchase in the right areas, close to public transport and the CBD to make it easier to rent out.
Before buying an investment property, speak to a mortgage broker or financial adviser. They will be able to discuss the benefits and risks associated with investment properties. For expert investment property advice and tips on where to buy to avoid some of the risks mentioned above, speak to the dedicated team at
iBuyNew today.
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