What Does Negative Gearing Mean? (Ep249)
Negative gearing is probably THE most common investment strategy in Australia. But what does negative gearing mean?
Negative gearing means you are investing in property where the expenses are greater than the income which creates an ongoing deficit you need to pay using income from your job.
Negative gearing is a very common investment strategy Australia. In fact I would say that it’s the most common investment strategy in Australia. There are a lot of people making a lot of money using negatively geared properties.
What Does Negative Gearing Mean?
Negative gearing means that the income you generate from a property is not as big as the expenses. In other words your expenses are great than the income. This means that every week, every month or every year you have more expenses than you have income coming in and so there’s a deficit that you need to pay yourself in order to maintain that property.
This money is generally paid out of your regular income which probably comes from a job, it may come from self-employment or other investments but you need to pay this money into the property in order to keep it going, so you don’t default on your lines or on your taxes, etc.
So why would you invest in property that loses you money?
It sounds crazy. But the goal of negatively geared properties is that you can purchase the property and lose money by holding the property but eventually make that money back because the property goes up in value. The hope is that the property will go up in value beyond what you’ve paid for it and therefore you will make a profit.
The goal is that it will go up significantly and you’ll make significant amounts of money. For example in Sydney at the moment the market is going crazy and I know people who have made $100,000 or $200,000 in the last 6 to 12 months because there’s been a boom in that area. That’s an example of people purchasing negatively geared property that cost them money but making significantly more then what it cost them.
Benefits of Negative Gearing
More Options to Achieve Growth
The major benefit is obviously that you can look for high growth property and achieve that high growth. If you are looking at positively geared property then it really narrows the scope of the potential properties that you can look for.
However by investing in negatively geared properties, most of the properties in Australia are going to be negatively geared. This opens up almost every single property in the country that you can invest in so you can hone in and choose the growth properties.
Another benefit of negative gearing is that hopefully over time rents will go up in value and then turn that negatively geared property into a positively geared property.
Access to Equity
One more benefit of negative gearing is that as the property grows in value you have equity which you can then borrow against to invest again. That way you can grow your portfolio faster if your properties are going up in value.
The last benefit that I know of with negative gearing is that there are some tax benefits to negative gearing where you can actually offset the loss on your property against the income that you’re earning from your job. This will then hopefully save some tax along the way.
I always recommend going to see an accountant and getting professional taxation advice when you are going to do anything like this. This episode can’t be considered as financial advice.
End Goal of Negative Gearing
Generally for people the end goal is to build up a lot of equity and a lot of wealth through growing the value of your property. I talked in yesterday’s episode about how investors build wealth through investment property and one of the main ways they do that is through capital growth.
So the end goal for most negatively geared people is to get that capital growth and then live off of that capital growth in some way.
It may be to sell the property and access the growth. It may be to borrow against the property and access the equity that way. Or it may be to sell the property and sell a couple of the properties in your portfolio. Then you could use that growth to pay off the debt on other properties and convert it into cash flow because those properties wouldn’t have a mortgage but would be generating rent. That way you can generate a passive income.
I just want to encourage you to think about the end goal before you go ahead and invest because there is something that I like to call the “equity trap” where people get richer and richer in terms of equity and they have hundreds of thousands or millions of dollars in equity but it’s not actually moving them towards the lifestyle that they want because they’re investing in negatively geared properties that cost them money.
This means that they can’t actually get any money out of those properties through positive cash flow that they can use for their lifestyles.
And the thing about equity is that as your equity grows you take that equity which extends your mortgage so you have more repayments. They often use that equity to invest in other negatively geared properties which may or may not grow in value.
The fact of the matter is that you are negative gearing and you are purchasing more and more negatively geared properties which puts you more and more in a situation where you can’t actually quit your job and live the life that you desire.
So be careful of the equity trap where you can be extremely rich in terms of equity but extremely poor in terms of cash flow.
My guess is that ultimately you want to invest for your lifestyle and you actually want to find some of those positive cash flow properties that can spinoff some passive income that can counteract the negatively geared properties that you have. Or it may be an investment strategy that you want to explore.
Go to www.onproperty.com.au/free to get access to my free report on where to find positive cash flow properties.
Until next time stay positive!