The Pros and Cons of Negative Gearing (Ep55)
Negative gearing is likely to be the most popular investment strategy in Australia.
Negative gearing is when you purchase a property that costs you money on an ongoing basis. The rental income does not quite cover expenses like your mortgage, insurance, management and so forth. This means that you have to pay money out of your own pocket towards this property every single week or month or year.
What are the pros and the cons of negative gearing and why do so many investors opt to negatively gear their properties when investing in Australia?
The Pros of Negative Gearing
Let’s start by looking at five of the pros or benefits of negative gearing.
Pro#1: Capital growth
Benefit number one is high capital growth.
The majority of properties in Australia are going to be negatively geared. By opting for negative gearing you will be giving yourself more properties to choose from.
This means that you could secure property in high capital growth areas if you are a great investor who knows the market well.
Positive cash flow properties can also achieve capital growth but they’re much harder to find. Therefore you’re going to be limited in which properties you can invest in. But you will be able to invest in negatively geared properties all over Australia.
Gaining those capital growths will allow you to make more money in capital growth than you are spending through the losses of your property.
Pro#2: High depreciation
Benefit number two is high depreciation.
You can look through the large scope of different properties for those that have high depreciation.
You can depreciate the building and all the new internal fixtures and carpets and so forth. This high level of depreciation would give you a tax break and you can claim that against your income. Effectively you can get a tax refund from that depreciation.
I do suggest getting a quantity surveyor to do a professional assessment of your property. You should also check with your accountant what you can and can’t claim.
I do have another video and article on depreciation that you can check out.
Pro#3: Potential tax savings
Benefit number three is the tax savings from negative gearing.
Every dollar that you lose in an investment property can effectively be claimed against the money that you are earning from your job.
It is best to see a professional when claiming anything to do with tax. This article is for educational purposes only.
But the money that you lose through depreciation or through a loss in cash flow may be able to be claimed back as a loss. So there can be great tax benefits to investing in negatively geared properties.
Pro#4: Opportunity for development
Benefit number four is the opportunity for development.
Investing only in positive cash flow properties will limit the areas and places that you can purchase from. However it’s more likely that you can develop or convert one property into multiple properties or land into a development asset with negative gearing properties.
Creating more properties will give you a better rate of return through negative gearing in some circumstances than you would have by simply purchasing a positively geared property.
Pro#5: Safe and secure areas
Benefit number five is the ability to purchase in safe and secure areas.
This might be a capital city or a beachside suburb or somewhere that you know is a popular and safe city. And because you’re negatively gearing you have more choice and can choose to purchase in these safer neighbourhoods that are likely to offer secure investments.
The Cons of Negative Gearing
Negative gearing is not great all the time. Many people lose a lot of money through negative gearing when their property has not gone up in value. So let’s look at some of the cons to negative gearing that you need to consider before you invest.
Con#1: Cash flow
Con number one is cash flow.
Negatively geared properties are going to suck your cash flow. Negative gearing probably isn’t the best investment strategy if you don’t have a lot of money to spare or if you want to create an influx of passive income.
You need to pay money out of your own pocket every single month in order to keep a negatively geared property running. If you don’t do this you won’t be able to pay your debts or your bills and you will eventually lose the property.
Con#2: Capital gains
Con number two is capital gains.
I stated earlier that capital gains was a benefit of negatively geared property. But it can also be a risk.
This is because you become so reliant on market fluctuations and on capital gains that you risk not making any money if the market is stable or going down.
The great thing about positive cash flow property is that you can make guaranteed money each month even when the market is stable or when property prices go down.
So one of the cons of negatively geared property is that you are completely reliant on capital gains.
Con number three is serviceability.
You are limited in how many properties you can buy and still afford to live because you’re dishing money out of your pocket every single month in order to pay for this property.
Maybe you can afford to purchase quite a few properties if you earn $1 million a year. But what if you’re earning $100,000 or even $40,000 per year? Being able to afford even $100 per month per property is going to severely limit how many properties you can afford to buy.
This lack of serviceability may prevent you from developing a large investment portfolio. You may limit the returns that you’re going to get across your portfolio because you’re limited to just one investment property.
There you have the pros and cons of negative gearing in Australia. I hope that this has helped you consider whether or not negative gearing is going to be the right investment strategy for you. There are benefits to negative gearing but there are also risks.