Negative gearing refers to buying an investment property that generates loss instead of income. That is, the total sum of expenses from maintenance, repairs, loan principal and interest repayments exceeds the rental income the property generates.
Despite a potentially large recurring loss and being forced to pay some expenses out of pocket, some property investors prefer to invest in negatively geared properties.
There are two main reasons why some investors prefer a negatively geared property investment.
- Losses may be deducted from their tax payable once they file their tax return.
- They are confident about their property’s potential to increase in value over time and they wish to reap the potential profits once they sell the property.
However, this property investing strategy isn’t for everyone. Investors must first understand the pros and cons of negative gearing to determine whether it can meet their objectives.
Below are some of the common advantages and disadvantages of negative gearing.
Advantages
High demand from low rental fees
Some investors lower their rental rates to ensure negative income and keep their property negatively geared. In doing so, they can also benefit from maintaining long-term tenancy and, should the tenant leave, having more potential tenants to choose from.
Tax deductions
As previously mentioned, the losses incurred from the sum of all expenses relating to the negatively geared investment property may be applied as a tax deduction in their tax return. This allows negatively geared investors to lower the amount of tax they must pay annually.
Long-term capital growth
By choosing an investment property that is situated in a real estate market that has the potential to increase in value, they may also benefit from the property’s potential value appreciation. This capital appreciation may allow them to regain their losses and profit from the property once it is sold.
Disadvantages
Capital loss
No one can say for certain how real estate markets will move as the years pass even if certain markets seems stable and unshakeable. Since investors typically hold their investment property for the long term, it’s possible for them to be affected by interest rate hikes, market fluctuations and property bubbles and crashes.
If these events occur, the capital appreciation negative gearers are counting on may not come to pass, which means they may not be able to regain their intended and unintended losses even when the property is sold.
Negative cash flow
A loss is still a loss regardless of the tax deductions that negative gearers “enjoy” and how real estate markets move because they would be using their own income to pay for property expenses.
Unless they are able to sell the property at a profitable price after years of income loss, they may have a difficult time recovering from their losses, especially if the market spirals downwards.
Passive investors and those who don’t have excess income may be better off with income-producing investments to reap the benefits of the time value of money.
Limited portfolio
Since negative gearers have their money “locked up” to pay for the expenses incurred by their negatively geared properties, they may not have enough resources to grow their investment property portfolio.
Likewise, they may also be unable to expand their portfolio by purchasing other income-producing assets.
For investors who wish to buy a negatively geared property, it is highly recommended that they conduct due diligence and seek the advice of a licensed professional.
This information has been sourced from Nest Egg and Smart Property Investment.
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