The Benefits and Downfalls of Negative Gearing
Try our loan repayment calculator here. Its similar to a negative gearing calculator
One of the biggest hurdles in purchasing the first investment property is getting your head around the fact it may be “losing” money every week. What is called negative gearing is the fact the cash flow of the property is negative-Its holding costs are more than the rental income. This may be the first and biggest stopping point for many.
However it’s simply the nothing more than the cost of doing business short term. If your $300,000 property was to double in value in ten years (assuming the traditional cycle time), would you look back and stress about the $5000 in the first year, $4000 in the second year it may have cost you initially? I’m in no way saying that it is insignificant because it is very when it comes straight out of your wages or income!!
If you worked out how much per week your investment property grew in value per week by doubling every ten years I’m sure it would far out way the short term negative gearing.
There is really only one benefit to negative gearing-Tax deductions.
An income-producing asset (rented investment property) that has negative cash flow is allowed tax deductions that can be passed on to your personal tax return.
Example
$300k Property
Expenses (p/a)
Loan Interest = $21,000
Rates =$2,100
Management=$1,165
Insurance =$600
Maintenance =$500
Accounting =$400
Total =$25,765
Income
Rent =$17,160
Shortfall =$8,605 =$165 per week
Property Doubles in ten years =$576 per week
(600k – 300k = 300k / ten years/52 weeks)
So by thinking short term is not really that beneficial in term s of building up a sizable portfolio. Managing your cash flow from day one when its negatively geared can only teach you good habits on how to budget well and will set you in good stead for in time when the rent does double and the cash flow is in fact positive! You are only buying time in the market to hold your hopefully appreciating asset.
Still doesn’t seem like you can afford it? Just think- What else do I spend my money on that goes up in time with being able to borrow with such great leverage like investment property?
Credit cards? Holidays? Cars? Clothes?
So how does this work as property prices rise and rents increase?
As property prices rise the rent growth sometimes slow(as more people are buying houses instead of renting) however the capital gains are good. The rents are still growing however so the yield will increase with time on your original borrow, the interest rates are rising also so that the tax deductible amount increases.
Excellent example. I find that people really don’t understand negative gearing until they see the numbers. We’ve just put up our online negative gearing calculator, feel free to check it out if you’d like to run the numbers yourself
http://www.dolmanbateman.com.au/online-tools/negative-gearing-calculator/
Property does not “traditionally” double every 10 years. Adjusted for inflation, on average, here and around the world, property tracks inflation, as it should in a balanced economy. Since the late 90′s we’ve been living in a bubble economy, which may have changed peoples perception of “normal” – people have a short memory. However, now that prices are falling again, and will be for a long time, people will learn.
It is foolish to assume property will double, this is not a certainty, nor is it that it will rise at all! Try to calculate what happens if property stagnates for 10 years. Or what if it drops 5%/year for 5 years, then rises a few % per year and you end up with -10% over 10 years. How much money did you pump into the “investment” and whats your final performance? Dismal.
@ Peter N, Well rents also go up so it would become less negative geared over the ten years if not positive geared. So wouldn’t that make it worth it also?
You only have to look at any history chart to see that it doubles on average every 7-10 years( and i mean over the last 150 years, not just the last ten….). I must say though once our mining boom drys up we are heading for uncharted territory!!! I will be selling a lot leading up to that
Matt
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