Is negative gearing actually that positive in this market?

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Jospephs Gate
Colin Lee

On the 1st August 2017, the Reserve Bank of Australia’s Board decided to leave the cash rate unchanged at 1.50 per cent for the eleventh consecutive month as expected.

According to the RBA, “Conditions in the global economy are continuing to improve. Labour markets have tightened further and above-trend growth is expected in a number of advanced economies, although uncertainties remain. Growth in the Chinese economy has picked up a little and is being supported by increased spending on infrastructure and property construction”

The Australian economy is expected to increase around three percent per annum over the next few years according to some policymakers.

Generally, the low cash rate has direct correlation with the average home loan interest rate. Low interest rates have investors wondering if this is a good time to get into another investment and how they can invest smarter.

Lots of investors have done well out of capital growth in the last few years but that rate of increase is not always the same and should be considered very wisely.

Negative gearing has been very attractive to property investors for the past few decades as it allows for the ability to offset the cash (interest payments, bank fees, maintenance costs, insurance premiums and property management fees) and non-cash (depreciation) cost of owning the property against the total assessable income.

The strategy of using negative gearing as a tax strategy works when the cash and non-cash costs are higher than the rental income and would work most effectively when the capital gain or growth in the property exceeds the total cost of holding the investment over the long term.

The main goal of investments should be to turn a profit and create real equity in the property at the end of the day. The increase in equity is then used to invest in more properties to build a portfolio, if that was all part of the plan to be financially independent in retirement.

So the real question is, is negative gearing an outdated strategy, or does it still work?

There is no doubt that the property market in general has plateaued recently, so investors must look at capital growth from property to increase in the longer term.

It is never good to get into property just for the short term gain, or just to offset your taxable income. Of course more and more people who are taxed at the highest rate are looking at negative gearing to offset their tax as a strategy. Lots of investors have done well out of capital growth in the last few years but that rate of increase is not always the same and should be considered very wisely.

It may be better sometimes to save up a significant deposit to have the cost of repayment less than the rental income and have the property neutrally or positively geared, but that means it may take a longer time to get into buying the next property.

This is potentially more difficult for first home buyers and new investors wanting to get into the market with less deposits saved up. So negative gearing can is a great way and incentive to get started.

That is why spending time and investing in due diligence is key to making good investments. Good research makes it possible to still invest in property that can be reasonably expected to increase in equity and bring in good rent with low vacancy, coupled with depreciation, to cover as much of the cost of holding as possible.

 

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