Find out how you can use negative gearing as an effective investment strategy.
Wednesday June 26, 2013: There are many misconceptions around the concept of negative gearing and while it comes with a degree of risk, negative gearing can be a useful way for investors to lower their taxable income.
Marcela Garza-Barba talks to Lindy Lear, general manager of the Rocket Property Group, about making the best out of your negative gearing strategy and your property investment portfolio. Read ahead and find out the power that a negative gearing strategy can have if you know how to use it correctly.
Read ahead and find out the power that a negative gearing strategy can have if you know how to use it correctly.
- Successful Property Investor.
- General Manager of Rocket Property Group.
- Winner of Reader’s Choice Award 2009 for Property Investment Advisor of the Year.
- Certified Property Investment Advisor with Property Investors Association of Australia.
Is negative gearing the best strategy to build wealth?
There are many ways to build wealth through property investing. Using a negative gearing strategy when purchasing property is one way to acquire a large portfolio where you can maximise the tax benefits. To build wealth you need a large asset base to provide a good passive income. So if negative gearing allows you to reach your goals to build your portfolio more quickly, then it may be the best strategy for you.
How does negative gearing work?
Negative gearing is peculiar to Australia where the government allows investors to claim expenses from their property investment off their income before they pay tax. Hence, you pay less tax or the taxman gives you a refund. It is just like having a business, where you are also allowed to take all business expenses off your gross income before paying tax.
If the income from the property is more than all the expenses, the property is said to be positively geared. This happens when the rent is high compared to the cost of the property. As this is not always possible to find, there needs to be other strategies for investors to use.
However, if the expenses of the property are greater than the income (rent), the property is negatively geared. This is where the taxman can play a part and give you a refund for the difference between income and costs.
Many investors steer away from negatively geared property because of the high holding costs. If a property is costing you $100 - $200 a week out of your own pocket it is hard to grow a portfolio.
What smart investors understand is that the tax benefits you can claim back on a negatively geared property can turn the property into a cash flow positive property. It means you have to buy the right sort of property.
This works particularly well when investors buy new or near new properties where the expense claims are enhanced by being able to claim depreciation (a paper expense only) as well.
Investors can end up getting more back from their tax refund than they spent in expenses and their property is actually cash flow positive (after tax).
This allows investors to have no holding costs on the property and even receive cash flow, hence it is easier to buy and hold more property as you build your portfolio, as the taxman and the tenant are paying for your property. This is an investor’s dream.
Does negative gearing only work when you are on a high tax rate?
Negative gearing works best on a high tax rate as the more tax you pay the more you can claim back. If you pay little tax, you may not be able to claim all your expenses back.
However even on a low tax rate, investors can still benefit from buying a negatively geared property that has a positive cash flow after tax refund, but it has to be the right sort of property.
There are many ways to become wealthy through investing in property and using a negative gearing strategy is only one of them
What's the difference between positive and negative gearing?
A positively geared property is what all investors are looking for. Cash in the bank! However, finding a property where the rents are very high (e.g. 8% - 10% gross yield), covering all the expenses and where there is also high capital growth can be a challenge. Many investors do not want to take the risk of investing in mining areas where this may be achievable. So many investors just go on a gross rental yield believing that this equals a positively geared property. However, I would suggest that all investors need to do a weekly cash flow estimation first and if the property is older, allow a high maintenance budget for unexpected maintenance issues. The property may not turn out to be positively geared at all.
Negative gearing has got a bad name as investors believe it will always take cash out of your pocket. This is not always the case if the property is new or near new as the tax benefits can offset the property expenses which can put cash back in your pocket. If the penny drops on using this strategy, it can open up a lot more opportunities for investors to grow their portfolio more quickly.
Do you recommend negative gearing as a good strategy to invest in property?
I would recommend that investors use a property strategy that helps them achieve their goals. There are many ways to become wealthy through investing in property and using a negative gearing strategy is only one of them.
However, the most important focus should be on finding a well-located property with all the future drivers for growth, good rental yields and low vacancy rates. A carefully planned negative gearing strategy can help you get started into investing. It certainly did for me when I was growing my portfolio. And the benefit is that I built my portfolio quickly with little holding costs and paying very little tax.