The trouble with negative gearing

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Ryan Crawford asks the difficult question: does negative gearing really create wealth?

 

The ATO released data recently from the 2010/11 tax year which showed that two thirds of Australian property investors claimed a total of $13.2 billion in losses on property during the period. 

It has renewed debate over the government’s negative gearing policy which essentially rewards investors for losing money (while draining tax funds) by allowing them to claim a deduction on their interest payments and other costs associated with owning a loss-making property. 

It is unlikely the government will abolish the tax benefits associated with negative gearing after the last attempt in 1985 which saw it quarantined for a period. The act allegedly caused rents to surge (although there is evidence to the contrary) resulting in a swift reversal of the decision. Nonetheless, it has highlighted the need for property investors to ensure their wealth creation strategies are in fact creating wealth. 

Some investors are drawn to negative gearing solely by the tax advantages, giving little consideration to the capital growth potential of the property.  Regardless of the tax benefits, while an investor holds negative property, they are losing money, putting them at financial risk. 

Other investors are prepared to absorb the losses, relying on speculative capital growth to achieve a return, which will only be realized at the point of sale. By comparison, positively geared property delivers a cash return to the investor immediately, providing a passive second income stream and the opportunity to fund their lifestyle and further investments. 

It the meantime, negative property investors must dig into their own pockets to supplement the shortfall in rent thereby reducing their monthly cash flow and reducing their capacity to funnel earnings into other investments. And while interest rates are currently at their lowest level in half a century, any future rate rises can impact on an investor’s ability to make payments. 

A common belief held by negative gearing enthusiasts is that positively geared property does not deliver good capital growth; the resources towns of the Pilbara and central Queensland have proved otherwise.  Investors in these regions have been able to build sizeable portfolios in very short timeframes by taking advantage of the equity generated and extra income available to them to acquire more positive property.  For some, their portfolios provide enough passive income to fund their lifestyle, allowing them to shift their focus way from work and onto family, travel and other pursuits. 

A negatively geared portfolio does not offer this option. If a negative property rises in value during the holding period, any equity generated can be used as a line of credit, but it cannot be drawn as an income stream to fund living expenses. 

Furthermore, negative gearing benefits higher income earners (which are on higher tax rates,) the greatest. Yet, oddly, the majority of negatively geared property investors are in the middle income tax bracket. 

Investors considering negative gearing should proceed with caution.  Assess your financial goals and investigate the strategies that are available to you. 

Ryan Crawford is the founder of Crawford Property Group, a specialist in positively geared property investment.

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