The ugly side of negative gearing

Negative gearing is a term you would often hear when dealing with investment properties, especially rental properties. It occurs when the cost of acquiring an investment property is more than the income it generates. This results in a taxable loss which can then be offset against other personal income that includes your salary or wage, thereby reducing your overall taxable income.

Negative gearing is seen as both a tax benefit in the short term and an investment in the long term. The assumption for investors upon acquiring property is that it will eventually appreciate in value over the next few years. A capital gain is realised when the property is sold at a price that exceeds the acquisition cost and accumulated losses of the investment.

The practice of negative gearing in the real estate industry is commonplace in different parts of the world including Japan, New Zealand and Australia.

Despite the negative connotations that come with the term, many people still choose to practice negative gearing and it’s not totally foolish to do so. Negative gearing has a few advantages. One major advantage that drives people to go towards negative gearing is the tax benefit. In Australia where many investors use negative gearing, the interest on loan for properties intended to produce income is fully deductible if the income generated is less than the interest payable. The losses incurred from negatively geared properties can also be deducted in the financial year they are incurred.

Other benefits that investors can enjoy from negative gearing is having the opportunity to develop one property into multiple properties and, therefore, creating more opportunities for generating more income later. Negative gearing can also reduce the demand for government assistance from people who cannot afford to purchase a home because negatively geared properties which are intended to be up for lease are added to their options. It also creates more jobs for people since investors who acquire properties for negative gearing will need to hire builders, realtors, construction workers and more to realise the property.

However, negative gearing also has disadvantages and many argue that these disadvantages outweigh the advantages from this practice. Some of the drawbacks to the negative gearing are:

1. NEGATIVE CASH FLOW – negative gearing only becomes profitable when the owner eventually decides to sell the property in the future and earn capital gain, meaning the property has appreciated in value and now worth higher than its purchase price. Until such time, a property running on negative gear is considered a loss. You need to have money to spare to keep negatively geared property running since the property is unable to pay for itself. That means paying out of your own pocket for upkeep, maintenance and other expenditures.
2. POSSIBLY FALLING INTO DEBT– some investors who put their properties on negative gearing fall into debt because they fail to foresee the expenses that come with the practice. It’s a vicious cycle that starts with acquiring the property, putting it into negative gearing, paying out of your own pocket for expenditures and then running out of funds to keep it running. Because you don’t want the time and money you’ve already invested in the property to go to waste, you borrow funds to keep it back up again and because you’re not really earning from it just yet, you are left with even more debt – to keep the property running and to pay for the borrowed funds.
3. RELIANCE ON CAPITAL GAIN – capital gain can both be an advantage and a disadvantage for properties that are negatively geared. You can make money from negative gearing if you can sell the property and earn capital gain but for that to happen, the market must neither be stable nor going down. Otherwise, the property remains a liability.
4. LIMITED OPPORTUNITIES – because you are dipping into your own pocket for funds to keep your negatively geared property(ies) running, your ability to invest in other ventures become limited. What you are spending to keep your negatively geared property(ies) running could be used to fund other possible investments that can, quite possibly, steadily generate income for you.
5. MISSING OUT ON FUTURE GROWTH – to make money off of negative gearing, you have to sell the property which only means one thing: missing out on its future growth. With negative gearing you have to keep the property for a long time so its value could go up and while doing that, you are spending money to keep it running. Say you hold a negatively geared property for 10 years and sell it then make a $300,000 profit from it. In the next 10 years, you could make another $300,000 from it but that is no longer a possibility because you’ve already sold the property.
6. SOCIO-ECONOMIC CLASS DIVISION – because it is nearly impossible for the working class to practice negative gearing because of the way the practice works, the overall benefits can only be enjoyed by the rich people a.k.a. those who can afford to lose some money while waiting for the big bucks. This means that the rich will keep getting rich by acquiring more and more properties and eventually earning from them while the poor remains poor from renting negatively geared properties from the rich people.
7. GOVERNMENT REVENUE REDUCTION – the tax deductions that come from negatively geared properties reduce government revenues every month. So while investors are making more money by paying less taxes the government is left with less money making it unable to efficiently provide for other programs.

Investing in real estate properties is proven to be one of the best ways to grow your money in the long run. Whether you positively or negatively gear the properties you acquire is totally up to you. If you are certain that you know your market like the back of your hand and if you are confident that you can turn your negatively geared property into a money maker in the future, then by all means go ahead and go for it

Otherwise, you might want to do your due diligence first by researching more on the topic and picking up tips from the pros or you could also consider going the other way around and opting for positive gearing instead. Negative gearing may be a popular practice but that doesn’t mean that it is for everyone.

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