Should you consider negative gearing for your property purchase?

Purchasing a property and taking out a loan in Australia are typically one and the same. Borrowing to buy pricey items is basically part of financial reality, because how many of us could afford a home out of our own pocket?

According to the Australian Bureau of Statistics, we (owner-occupiers and investors) commit to about $32 billion of housing finance on a monthly basis. Borrowing funds will allow you to increase the amount you have to invest, potentially amplifying your gains because you will have more of a capital base on which to earn returns.

It can also be referred to as positively or negatively gearing, depending on your circumstances. Before you say “buy my house” to your buyers’ agent, here’s some information on the matter to help with your decision-making.

Positive and negative gearing are integral parts of the Australian property market.

What does it mean to be positively or negatively geared?

Essentially, a positively or negatively geared investment is just an alternative way of saying that the amount invested has been ratcheted up by getting a loan. Think of how the gears work on your bicycle, where a mechanism allows a small effort on the pedals to convert into a bigger force at the wheels.

On top of enabling you to increase the amount you have to purchase property with, the Australian Taxation Office (ATO) asserts having a a positively or negatively geared property investment allows you to take advantage of a range of potential tax benefits, which for a rental property can include deductions on:

  • Bank fees
  • Loan costs
  • Insurance expenses
  • Commission and fees of your property agent
  • Any costs associated with repairs or maintenance
  • Rates from your local council

A recent report from the Property Council of Australia (PCA) and the Real Estate Institute of Australia (REIA) found that around two-thirds of residential property investors in our country are currently negatively geared. So what does this actually mean?

Positive gearing

The Australian Securities and Investments Commission asserts that positive gearing occurs when the rent that you receive from your investment property is in excess off all your costs like loan repayments, interest, maintenance and rates. This is most likely to happen when interest rates are low and rental yields are high.

While they can be harder to find, a positively geared investment can be great for a steady short term cash flow.

Negative gearing

Meanwhile, negative gearing is where the rental income you garner from your property is less than the interest you pay and other related costs. While they may be making a loss in the short term, what investors hope to benefit from is the capital gains as the property increases in value in the long term.

They won’t have to wait very long in the current market, as CoreLogic RP Data revealed that over the year to July 2015, the combined capital city home values in our country skyrocketed more than 11 per cent.

In addition, because your property is negatively geared and the yield from your investment isn’t covering your expenses, the ATO states that you are entitled to reduce your taxable income, ultimately decreasing the amount of tax you have to pay.

There are a number of tax benefits associated with negative gearing.

How does negative gearing benefit the property market?

The report from the PCA and the REIA found that negative gearing is benefiting the property market in a number of ways.

“They tick all the boxes by increasing supply, giving people an opportunity to get into the housing market and helping ordinary Australians build wealth for their future,” said PCA Chief Executive Ken Morrison.

Specific findings from the report include:

  • Negative gearing promotes rental property investment and the supply of new homes
  • Nearly a third of all new home construction is attributed to investors who are negatively geared
  • More than 66 per cent of negatively geared investors earn a taxable income of less than $80,000
  • This group owns almost 80 per cent of negatively geared properties

REIA CEO Amanda Lynch affirmed the importance of negative gearing to the market, as it is “overwhelmingly” mum and dad investors who profit the most.

“This isn’t some tax lurk for the wealthy, rather an incentive for people on low to average incomes,” she said.

The report concluded that the ability for investors to use their debt is a critical part of economic growth in Australia.

The risks of negative gearing

While there are a number of advantages, the Commonwealth Bank asserts that in the right (or wrong) circumstances, negative gearing can magnify the risk of property investment. This is because, regardless of the unforeseen costs that could pop up with owning a property, you still have to make your periodical home loan repayments. These situations can include:

  • Your property falling in value
  • An increase in interest rates
  • Low rental yield because you’re unable to find tenants or your current occupiers aren’t paying
  • A sudden need for costly repairs or maintenance

“The combined property values in our capital cities increased by more than 11 per cent”

Despite this, the risks are quite low, especially when you look at figures from Core Logic RP Data, which show that the combined property values in our capital cities increased by more than 11 per cent in the 12 months to July 2015 alone.

Advice from your buyer’s agent

If you would like to know more about positive and negative gearing and purchasing an investment property, you should speak with your buyer’s agent, as they can offer advice on the current market as well as exclusive access to private or off-market house sales.

 

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