Negative gearing is an investment strategy where you purchase a property that loses money in monthly cash flow in order to make back more when you sell the property at a later date.
Negative gearing has it pros and cons, but whether negative gearing is good or bad really relies on who the investor is and what their investment goals are.
When Negative Gearing Is Always Bad
People who invest in negatively geared (also know as negative cash flow) properties generally want to achieve at least one of the follow milestones.
1. Rent increases over time to the point where the property is now positive cash flow
2. The property increases in value and is sold or borrowed against to access the profit
Negative gearing is almost always bad when neither of the above milestones are hit.
If neither of these milestones are hit is means you are constantly paying money into the investment with no way of seeing a return on your investment.
When Negative Gearing Is Sometimes Bad
Negative gearing is not ‘a bad strategy’ per say, but it is not an investment strategy that works for everyone
Negative gearing is sometimes bad if:
- You can’t afford the monthly repayments – If cash is tight you may not be able to cover the shortfall ever single month while you wait for the property to go up in value.
- You don’t pay much tax anyway – One of the benefits of losing money through investment property is that you can claim it as a tax deduction as get some of it back. If you don’t pay much tax then you can’t take advantage of this as you don’t have much tax to save.
- You want to build a big portfolio – For most people a big portfolio has one major issue…serviceability. How many properties can you afford if they each cost you $1,000 per month? The answer for most people is not many.
- You want more time, not just more money – Passive income through positive cash flow gives you the freedom to work less because your properties pay for themselves (and some). Negatively geared properties tie you to your job until you achieve the big pay day of selling your property.
When Negative Gearing Is Good
Negative gearing is good in a few circumstances:
When The Property Increases in Value Above Your Overall Expenses
If you buy a property for $500,000 and hold it for 5 years and pay $10,000 in expenses because it is negatively geared the property has effectively cost you $550,000.
If that property is now worth $1,000,000 then you have earned $450,000 over that 5 year period.
If the property was only worth $550,000 after that 5 years you would have only broken even and thus you wouldn’t make any profit.
Negative gearing is good when you get solid capital growth above an beyond the amount of money you put into the property.
When Rents Go Up and Now It’s Positively Geared
Let’s say for 5 years you spend $50,000 in negative geared expenses on the property but then rents go up and the property now makes you $10,000/year in passive income.
Well in another 5 years you will have broken even and then after that your property generates passive income for you.
When Your Strategy Involves Saving Tax
High income earners pay a large amount of their wage in tax (almost 50%).
Let’s say you pay 50% tax and over 5 years you pay $50,000 in negative gearing expenses towards your property. Well you will actually get back $25,000 in a tax refund so your true expenses are only $25,000.
Let’s say the property goes up to $550,000 in those 5 years. Even though your expenses and the rise in value are both $50,000 because of the tax refund you have effectively gained $25,000 in value.
However, if you were to sell the property and you were still earning a higher income you would still have to pay capital gains tax at that 50% threshold. But if you had retired and were paying less tax you would likely come out ahead.
So Is Negative Gearing Good or Bad?
The answer is neither. Negative gearing is good for some investors and bad for other investors.
It depends on the investor, their strategy and the overall results the property generates.
If you want to understand your own financial goals better we have a training module dedicated to that inside Positive CashFlow Academy. We will walk you step by step through understand what financial goals you should set and what investment strategies best suit what you want to achieve.
Want more info? Read this article: Negative Gearing vs Positive Gearing