What is negative gearing? And how to make it work when investing in Sydney
Negative gearing is a practice where an investor borrows money to acquire an income-producing investment property. The expectation is the gross income generated by the investment is at least in the short term to be less that the cost of owning and managing the investment. This includes depreciation and interest charged on the loan.
Negative gearing only applies to investment properties rented out to tenants – as in those properties that are earning an income. According to the ATO about 1.9 million people declare annual rental income and from these approx. 1.2 million run at a loss or are negatively geared.
These losses are at the crux of the negative gearing discussion because they are deducted against your assessable income. The losses can include things such as:-
- Interest rates
- Bank fees
- Property Management
- Repairs and Maintenance
- Council and Water rates
The question is should you buy a positively geared or a negatively geared property?
Positively geared property is when a property’s expenses are exceeded by rent coming in and you actually make a profit each week.
But, beware of property spruikers selling positively geared property. As much as this can be an attractive hook there is often a reason why this is the case. Take for instance the mining town of Karratha that services a nearby iron ore mine town with median house prices in local suburbs such as Nickol dropping from $900,000 in 2012 to $544,500 in 2014. Townhouses in these areas were fetching $1600 per week in rent and were very attractive for investors as they were positively geared. Now many investors have lost their money in these deals due to capital loss and mines closing down. Now their investments are not worth what they paid.
Negatively gearing for better investment options is a strategy.
Buying into the Sydney property market as an investor is expensive. If you earn a great wage and are looking for an investment it may suit you to negatively gear your next purchase. However, with this comes potential risks:-
- The property purchased is not worth what you paid
- Interest rates have gone up
- The rent has gone down
- A sudden special levy in a strata property comes up
- Or a maintenance issue arises in a house
Despite the risks, the ability to purchase property opens up areas that can really provide excellent capital growth in the long run. In Sydney for instance in the last 18 months according to RPData Core logic prices have risen by 30% so the capital gain so far is an obvious plus.
To consider whether negative gearing for your investment is an option make sure that the property has:-
- Good potential for capital gain
- Is not bought off the plan
- Has potential to add value
- Has a decent return that you can service if things go wrong
- Is attractive to the rental market
Tip: When you use the negative gearing tax break ensure that your investment property is both serviceable and has great capital gain potential. If you are unsure which way to go we are happy to discuss with you.