Negative gearing and the proposed changes to it are a highly contentious topic leading up to the federal election. Some say ditching it will make housing more affordable, but others say it will send rents sky high. Simon Pressley, Property Analyst of Propertyology says that scrapping the measure would end up costing the government more over the long term due to lost taxes, despite the initial savings.
Negative gearing is a tax break for investors that borrow money to invest in income generating assets, typically shares or property. It applies when the costs of owning an asset are higher than the income it generates.
So an investment property is negatively geared if its total mortgage interest, property management fees, maintenance costs and other related expenses are greater than the rental income.
You can offset losses from a negatively geared investment property against other income, meaning you’ll pay less tax. High income earners in particular appreciate this as they pay the highest marginal tax rates, and therefore get the most benefit when their taxable income is reduced.
But negative gearing is not a license to print money. Investors are betting that their loss-making property will increase in value over time enough to cover the shortfall when they sell it.
According to the ATO, one in ten Australians that file a tax return use negative gearing in terms of rental property.
Financial planner and director of Pivot Wealth Ben Nash says “borrowing to invest can be a great way to get ahead with your money faster”.
“When done properly gearing can rapidly accelerate your progress toward your version of financial freedom,” he told The Hip Pocket.
While negative gearing is the one we hear the most about, positive gearing is another tactic used by investors.
Positive gearing is, put simply, the opposite of negative gearing; the rental income generated by the property more than covers the costs of maintaining it. The catch? These properties can be hard to come by, particularly in metropolitan areas says Bessie Hassan of finder.com.au.
“Positively geared properties are hard to find in areas where property prices are high compared to rents, so it suits someone who has time to select the right property,” she told news.com.au.
And while growth on these investments will generally be slower, having an extra stream of income and a foot on the ladder seems like a worthy trade, right? It almost sounds too good to be true, so I spoke to Ryan Clark, operations manager of Payne Pacific Estate Agents to see if this kind of investment is realistic for millennials.
“A millennial wouldn’t be able to purchase a property that is positively geared within the Sydney metropolitan area,” he said.
So where could we get in on this unicorn of property investment? Think west. Very west.
“They would need to go far out west (say the back of Bourke) where they could purchase a property that would be positively geared,” says Ryan.
And while the extra stream income would be nice, he says the lower rate of growth on the investment can be a bit of a deal breaker.
“Problem is there would be very little growth, so their investment wouldn’t be worth it. The vacancy rates are higher which would have an impact on the investment.”
Ryan’s advice for millennials like himself – stick to high growth property.
“A millennial would be better off purchasing a property in and around Sydney which would be negatively geared and there is a greater chance of capital gains. Lease out the property to a good tenant and use the rental return to smash the mortgage!”
Ben Nash agrees that positive cashflow is not not a defining factor when it comes to property investment.
“I think a lot of people get caught up in the hype of having a ‘positive cashflow’ property, but forget to consider the impact on growth,” he says.
Michael Xia on the other hand, told news.com.au that the speculation involved in negative gearing makes it a dangerous tactic.
“People who are negative gearing are hoping to gain a lot through capital growth, but capital growth by definition is speculation. No one knows what Sydney will do within the next six to 12 months, or Melbourne, or Brisbane for that matter. So you’re just gambling with the future. And I think as an investor you need to speculate less and invest more,” he said.
“Negative gearing traps you in a kind of rat wheel race because if you’re not creating an income and you can’t service those mortgages then you can’t really escape. If you go down the positive gearing path then it won’t happen over night, but over time you can escape that because you’ve got a recurring source of income.”
There’s compelling arguments from either camp and at the end of the day, it’s all going to come down to what you want as an investor. Those looking for strong capital gains are best off sticking with negative gearing, but if you’re willing to play the longer term, positive gearing will give you a little extra cash to play with, along with some (hopefully) modest growth – providing you’re lucky enough to find the right property to do it.