What is a Negatively Geared Property?

When you bought your first rental property was it a negatively geared investment or positively geared? What about subsequent properties? 

There is a lot of information out there that will help you understand the difference between positive and negative gearing a property. This post is about negative gearing, next time I will share a great article about  positive gearing.

I am not advocating one system over the other, it comes down to your investor profile and your risk assessment. What works for one person, will not work for another.



In a nutshell, negative gearing means that you take a loss on your investment income and then apply that loss to other income (your salary) and that effectively puts you in a lower tax bracket. A positively geared investment means that you get income from your investment month after month but you are taxed on it, along with your salary so it puts you in a higher tax bracket.

The Positive
A negative geared property is is a property that will not make you money month after month, but you use your expenses on the property to reduce your tax bill at the end of the year. This is often the only way new investors can get into the investment property game. Your intention when purchasing the property is gain long term capital growth, which can be a far more effective wealth-accumulation mechanism than monthly income, which is taxed.

This is particularly true if you are considering property investment to build an asset base to one day replace your salary. It's important to have the long view and realise that wealth accumulation is achieved through delayed gratification. By finding the right properties in the right locations, and then to refinance the properties to accumulate more and more properties that will provide the future cash you are looking for.

This means your aim is to grow a large asset base and then enjoy the cash flow later.  The money you can earn from a single positively geared property is minimal especially after being taxed, and is very unlikely to make a difference to your lifestyle right now. Another thing to consider is that with rising interest rates, the positively cash flow property of today, may become a negative cash-flow property tomorrow.

Negatively geared properties are purchased as high growth properties. You can effectively get higher rents and use the depreciation allowances to convert your low cash flow property into a high growth, strong cash flow property, by renovating and developing your properties. (That is unless laws change in the future). So hopefully you get the best of both worlds.

The Negative 

Negative gearing is based on the the bet that the property will appreciate in value, hence why location is so important.  There is a lot of hype about negative gearing and you have to be a savvy investor to understand that yes you can potentially make a lot of money, but you also have to understand that there are also consequences.

Negative gearing will give you immediate tax benefits (taking the loss off your overall income), but you will still have to pay the shortfall of the property. So even though at the end of the tax year you can use this as a very nice deduction on your taxes, you still have to pay money month after month to make this investment work.  You will have to continue to do so until either expenses fall or income rises.

It's assumed that you'll make money from buying a negatively geared property, provided you can hold on for the long-term and wait for property prices to increase. In a rising market this is great, but what about a falling, or stagnant market, how long do you need to wait for? The biggest loses are felt when a property is bought during a boom and then has to be sold at a lose, because the investor just couldn't ride out the stormy times.

The other issue with negatively geared properties is the number of properties that you can afford to buy using this method. Since you are paying out month after month, there is a limit to the number of properties that you can finance on a regular basis.  Therefore, you need to keep working in order to earn a salary to fund the cash drain of owning negatively geared properties. If your goal is to generate passive income and stop working as soon as possible then negative gearing is not a strategy that will make you comfortable.

So what is your view of negatively geared properties? Below are some questions that you might find helpful to ask yourself before committing to a property.

The Nine Questions To Always Ask...

•    What's the end purpose to my investing?
•    Will buying this property bring me closer to, or push me further away from that goal?
•    Am I saving tax or making money?
•    What is the annual cash in or outflow?
•    Can I afford to make a sustained loss?
•    What is my exit strategy if things get tough?
•    What has to happen in order for my property to make money?
•    How many of these properties could I afford to own?
•    Have I checked and double-checked all the figures and sought independent information to ensure the data I have is realistic?