Property investment can be a positive way to build wealth and protect the financial security of your future. Whilst there are many investment strategies to explore, ‘gearing’ or borrowing funds to finance a property investment, is a strategy that many investors pursue.
Negative gearing, when your investment property outgoings are higher than your incoming revenue on the property, is currently a highly topical aspect of the Australian property market. Whilst it can be a lucrative approach to investment, there are potential shortcomings that need to be taken into account prior to deciding to negatively gear a property and to how high any gearing should be. Here are just a few of the pros and cons of negative gearing.
Increased capital growth
One of the main benefits of negative gearing is the potential to pursue higher capital growth than what may be achievable if a property purchases are only to be positively geared.
Due to market influences in the Australian property market, most investment properties are negatively geared by default, as outgoings often exceed rental income on the property.
When acquiring a property to add to your portfolio, specifying a positively geared investment may drastically reduce your choice as a greater portion of the purchase price will need to be provided by the buyer to reduce interest costs which are the main component of property expenses. Focusing on capital growth as a key component of your investment strategy will allow you to increase your long-term return on investment and have a larger pool of potential investment properties to choose from.
Offset your losses
The key benefit to negative gearing is that you can offset the loss associated with your property against other income earned, reducing your taxable income. If your property is leased, then your rental income will likely not cover all of your outgoings and any shortfall can be written off as a tax deduction. In many cases, the tax deductions can exceed the losses realised on the property.
Higher income earners and/or taxpayers may prefer to opt for negative gearing as a strategy to reduce their tax returns and benefit purely from long-term growth on the property.
A faster way to grow your property portfolio
Borrowing a larger portion of the property purchase price for your investment will allow you to more quickly grow your portfolio.
Cash input required
Despite the tax benefits, when it comes to cash flow, negatively geared property investments do require some cash input to maintain. If your cash position is not stable, a negatively geared property investment may not be the right strategy.
Cash flow demand from a negatively geared property can cause financial burden and increased risk of defaulting on financial commitments. It is important to consider how a change in circumstances such as a long vacancy period, cyclical rental declines, divorce or unexpected illness could impact your position. Protect yourself with adequate insurance where possible.
A tax-deductible loss is still a loss, regardless of its deductibility. It is important that the potential capital growth outweighs these real losses so that the end result eventually is cash flow positive, whether as the result of a sale or the potential for increased rental return.
Lack of ongoing income
Property investments that are in positively geared allow you to draw an income on a regular basis if you have a steady tenant secured. Relying on capital gains alone as the profit on your investment could be subject to market fluctuations at the time of sale, or in the event that you need to release equity from the property quickly.
Commercial properties, in particular, can be subject to long vacancies and attract higher fees for leasing. Such a vacancy can place the investor under great financial stress.
Limited opportunity for expansion
The limited opportunity to financially service investment properties that are negatively geared may prevent you from growing a larger investment property portfolio. In addition, showing an income earned on positively geared properties can improve your ability to borrow more when it comes time to apply for finance for your next investment.
No matter the investment strategy you decide on, it is important to do your research and get the best possible advice from trusted professionals. Life as a landlord can be an incredibly lucrative but is not without risk and by arming yourself with the right knowledge, you maximise your chances of being successful.
About Laing & Simmons Double Bay Property Management
Laing + Simmons Double Bay Property Management is part of a high-profile franchise group yet remains independently owned by Principals Suzie Reid and Bart Doff.
The office is acknowledged as the market leader in prestige Eastern suburbs leasing, a reputation which has been forged in over 25 years leasing and managing a large portfolio of the best properties available in the Eastern Suburbs rental market.
Contact us today to see how we can help manage your investment property, or to find a rental property to suit your needs.