There has often been a debate regarding the benefits of negative gearing, and the negative consequences of being positively geared! Ok, this debate might not have involved too many people – many of us would prefer to debate what colour shoe matches which outfit – however, entertain me! Humour me! Pretend….
To assist in your participation of the debate we need to first clarify terminology. In Negative gearing a property costs the owner money to maintain and keep. For example, if mortgage repayments for a rental property are $500 a week, and the rent from the property is $260, then the difference, $240, is the amount the owner has to add to the investment to maintain it. This is the negatively geared portion and can be claimed against the owner’s income – one of the biggest draws of a negative geared property.
Positively geared properties, on the other hand, generate income for the owner. For example, hypothetically, an investor – let’s call him Doug – purchases a property ten years ago in a working suburb of Perth for less than $100,000 (I know, how cheap! But that was the reality a decade ago). The mortgage on this property would be about $60,000 now if Doug borrowed to the 80% lending capacity. The rent on this property would have sharply increased in recent times, so that Doug receives far more in rent than he pays in mortgage repayments. This difference, or profit, is classed as income for Doug, meaning he will have to pay tax on it.
So, while on the surface, positive gearing seems to be the ideal, many people argue for negative gearing because it is a tax deductible investment. Moreover, good negative geared investments will still rise in value over time, even though the investor has to continue to invest to cover the difference.
When the housing market was booming, negative gearing was indeed a very sound investment strategy. However, in my opinion, this is not currently the case for two reasons. First, the reduction of high income tax brackets decreases the tax savings high income people receive, thus lessening the incentive for tax deductible investment.
Secondly, the property market has slowed down in relation to the capital growth. Many investors have typically been content to purchase negatively geared properties and accept lower rental prices because their property’s capital value (sale price) increased enough to justify it as an investment. Now though, with some suburbs in negative growth patterns, this reliance on capital growth is voided. Investors are forced to increase rental prices to make investments worth maintaining.ÂÂ
A positively geared income may result in a landlord paying tax, but it still means they have more money than they did before. Or as a speaker – wearing a suit and looking very hot… I digress – on a sales DVD I recently watched, said ‘Who cares if you have to pay more tax on extra income, it still means you have more money.’ It’s true, I would not mind earning $130,000 a year and falling into the top tax bracket, even though I would have to pay the most tax per dollar. I pay more tax, and a higher percentage per dollar, but I still would not switch places with say, a sales assistant on $15,000 per year.
Even with positively geared properties, people’s approach varies drastically. An investor who is close to retirement may be content to use the income from a positive geared investment as extra income to subsidise living expenses in retirement, as the marginal loans attached to the properties are negligible or nonexistent in comparison to the rental income.
Younger investors, however, are generally more likely to use the added income of a positively geared property towards further investments. The added income from a positively geared investment property could be used to offset a new purchase. This limits the impact of the new investment on the investor’s hip pocket. For example, my property in Port Hedland pays a substantial rental income, but my Melbourne property does not. Between the two properties I break even, and I do not have to assist in any manner the financial survival of my investment. One positively geared property pays for one negatively geared property, in my case.
An astute investor once told me that investing smartly should have little impact on your life, particularly on your ability to purchase shoes. If you can make investments that cost little to nothing from your personal salary than you’re doing something right. Success is often a result of working smarter, not harder with one’s money.
Disclaimer: While we hope you enjoy Shoestring’s column, please note it should not be relied upon in lieu of seeking professional investment advice relevant to your circumstances.
