The pros and cons of property investment negative gearing

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Negative gearing is the foundation of millions of investors’ wealth creation strategies, but some claim it’s pushing up property prices and pushing out first home buyers. Is it for you? Your Investment Property looks at the pros and cons of negative gearing.

Negative gearing is one of the most powerful tools in the property investor’s armoury: and there’s no arguing with its popularity. Tax figures reveal about 1.7 million property owners use negative gearing – which could explain why the government ignored recommendations put forward in the  Henry Tax Review calling for the removal of this system.

 From the perspective of many first home buyers, however, negative gearing is evil. According to some experts, it has created an unholy fixation on property as a means of wealth creation and propelled housing prices sky high. Who’s right?

The good

Negative gearing is when the costs of the investment exceed the investment income of the asset. When an investor uses negative gearing to buy property, he is expecting that the costs of borrowing, combined with the costs of owning the property (maintenance, property management, strata fees, et cetera) will not be completely offset by the rental income.

Here’s a quick run-down on some of the pros associated with this property investment strategy:

  1. If everything  all goes according to plan, the returns from the property’s capital growth will eventually outweigh the borrowing levels and costs, thereby creating some serious wealth for the investor
  2. And (here’s the biggie) negative gearing allows investors to deduct the negative amount from their tax, therefore the impact of excess cost is offset by the taxman
  3. When the investment is sold for a profit, the taxman collects on this gain, thereby making everyone a winner
  4. Proponents argue negative gearing makes property investment more attractive for investors who in turn provide housing for tenants at relatively low cost – something the government could not possibly do on its own.

If you’re an investor with a keen eye for rental gems then it can be a great way to generate wealth. Negatively geared investments will eventually become positively geared as rents rise by a greater proportion that the interest on the loan. Meanwhile, the capital value on the investment will also increase. So upon sale and repayment of the loan, investors that use negative gearing can come out significantly ahead.

The bad

The cons include:

  1. Investors need to budget for ongoing shortfalls
  2. Some indicate the attractiveness of negatively-geared investment property has led to an overconcentration on this wealth creation strategy
  3. And experts argue that investors who use tax breaks to own properties are willing to pay more for purchases, pushing up prices for first home buyers

It’s true that housing affordability has significantly worsened over the last decade. And despite forecasts of a relatively flat market going forward, many struggle to get off the rental roundabout. The latest study by Genworth revealed the average age of first home buyers has risen to 31 – up from 25 in the 70s. However, whether negative gearing is to blame for this is unclear. Other countries which don’t have to ability to negatively gear properties are facing similar issues of affordability.

A more pressing concern for negatively geared investors is that the sums don’t necessarily add up in a flat or falling market. By all accounts the property market is looking pretty flat, and the National Housing Supply Council recently warned investors that the market could remain subdued for the next 10 years. If the profits don’t outweigh the shortfall, then negative gearing is just a quick way of losing money.

That’s not to say that all properties will fall in price: there will always be pockets of growth even in a falling market, due to local factors. Therefore, if you’re looking at buying a negatively-geared property, it’s more important than ever to do your due diligence on any potential purchase to ensure that you’ll make the most out of this strategy.

What are your thoughts on using negative gearing in the current market? Have your say by commenting below this story, or joining the debate on our property investment forum.

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