With market values at all-time highs, many first-time buyers are snapping up residential properties as investments instead of actual residences.
According to a poll conducted by ME Bank, 15.3 percent of a young demographic are considering their first homes as chances to play landlord, compared with the 24.7 percent who plan to be occupants. This backs up an earlier poll by Mortgage Choice suggesting that a whopping 40 percent of first-time home buyers are investors.
In fact, Domain reports that young people are excited to enter the market insofar as they don’t mind doing it for a loss: Their investments are ‘negatively geared.’
Experts believe this is rooted in logistics more than anything. Most of their target residential properties, while near their workplaces, are out of their mortgages’ reach. In such situations, negative gearing comes across as the most logical thing in the world.
What is negative gearing?
Negative gearing is a common practice in bonds and shares. In the context of real estate, it means acquiring a property whose mortgage interest, maintenance, and capital depreciation, among other expenses, exceed the income you derive from it. So why are people doing it anyway?
Simple: With negative gearing, you are speculating that your asset will, over time, counterbalance the loss as capital growth and income streams—usually in the form of rentals—catch up. Negative gearing ultimately translates into profit when you sell the property with the capital gain (provided that property values are on an upward trajectory).
Australia is one of a few countries in the world where negative gearing makes perfect sense. This is because interest payments and other losses from negatively geared properties are eligible for tax breaks. Australia’s tax code has been providing this coverage since the 1930s.
Apart from loan interests, an Australian homeowner can claim deductions for council fees, bank charges, cleaning costs, insurance, utilities, and many other expenditures associated with maintaining and owning property. Breaks also extend to items influenced by capital depreciation within a span of years as set by tax authorities. Likewise, building depreciation is also eligible for claims.
After several years, when the property finally becomes positively geared, you start paying taxes on the profits as well as any capital growth made upon a sale.
When to engage in negative gearing
You are right to assume that buying a property with no income to offset the debt instrument is fundamentally risky in the short term. In the long run, you may compound such loss rather than reap profits. Negative gearing is never for everybody.
On the other hand, individuals who are solvent and financially literate may consider negative gearing. Having no child dependents and a stable, disposable income stream apart from that generated by the asset make good candidates for this kind of investment. It stands to reason too that those with a high threshold for risk and stay in high tax brackets are cut out for it.
In general, negative gearing is best conducted in places where the interest rate is locked or stays low for the foreseeable future. An economy in recession may be good timing, seeing as market values may be declining then, with the government taking a more active role in managing interest rates.
Despite what the name connotes, negative gearing may prove to be a positive venture that deigns to the tax code while creating a sound investment strategy. Success depends as much on the motivations and the circumstances of the investor as the general appeal of the property itself.
As with anything risky, it is wise to heed the counsel of an accountant or financial expert before you attempt negative gearing.