Investors who pursue negative gearing without adequately understanding its implications could be setting themselves up to fail.
With interest rates at a record low of 2.25 per cent, there is speculation that this is generating a house price “bubble”, particularly in relation to investment properties.
For such investors, particularly those borrowing large amounts to get into investment properties, there are some lessons that need to be learnt, quickly, before they invest too much too quickly.
Large debt invariably means the property is negatively geared and there are a number of implications of negative gearing, not the least of which is what happens when rates start to rise.
In my view negative gearing is not investing, it is speculating.
Negative gearing means you make losses, and those are largely due to the interest paid on the loan. Even after the tax breaks, you still have to take money out of your pocket each year to fund those losses.
The higher your tax bracket the less of those losses you pay and the more the ATO pays.
The lower your tax bracket the more you pay and the less the ATO pays.
You are speculating that over the period you hold the property, it will increase in value more than the after tax losses you have made.
That’s not investing. That’s speculating and timing is everything.
If you buy early in the cycle you might have a chance.
Buy late in the cycle and you run the risk of property prices falling and interest rates rising, your losses increasing and having to sell at a loss.
No one knows how a particular asset as homogeneous as a specific property will perform in the future let alone an asset class such as the share market or property generally.
If you do negatively gear, my advice is to fix your outgoings, such as interest, as best as you can.
You can’t increase the rent you charge just because interest rates go up. Debt, or leverage, can be used to your advantage (e.g. to invest a greater sum in potential growth assets) provided the income earned on the assets can service the debt.
This generally means debt of no more than around 50 to 60% of the value of the assets acquired. Generally, however, most people are not prepared to do the “hard yards” and save up the other half.
Be smart and seek professional advice before you dive in. You don't just assume the water is warm because the sun is out, you dip your toe in first.
About the Blogger
Grant Field is Managing Director of MGI South Queensland and Executive Chairman of MGI Australasia, a global alliance of independent accountants and business advisors. A management consultant specialising in family and privately-owned business, Grant has over 30 years accounting and business development experience, complemented by more than 10 years experience in banking and finance.