What is negative gearing?
Negative gearing is a practice common in property investing. It is a form of financial leverage that describes the purchase of an income-producing asset, such as a rental property, but when the asset will not produce enough income to cover the cost of the asset.
For example, when the rental income is insufficient to cover the loan payments, maintenance, interest, or depreciation for the asset in the short term. Ideally, the asset will eventually produce enough money to cover those costs.
Investors and financial advisors are always looking for tax breaks and negative gearing allows them to take advantage of this loss. So, negative gearing has become a popular strategy for Australian investors over the years.
Interestingly, negative gearing isn’t allowed in most other developed real estate markets overseas. Many economists claim that negative gearing inflates property prices.
When is negative gearing common?
Negative gearing is common with established regions where you’re more likely to get capital growth. This is typically common with residential property as residential house pricing has escalated faster than rental growth.
Can you negative gear a commercial property?
Yes. However, this is not very common. Commercial properties are usually structured with positive gearing.
There are rare instances of negative gearing, this may happen in an instance of a highly sought after location, where the owner is banking on capital growth or the rent increasing to then reach a positive cash flow position.
Risks vs Rewards
There are always risks and rewards involved when it comes to negative gearing and commercial properties.
- If the property is vacant, it’s a bigger impact on your cash flow
- If you lose your other means of income, you may not be able to afford to keep the property
- No guarantee of capital growth
- Using your existing tax delegations to subside your investment cost, thus reducing the overall tax
- Commonly you will have good capital growth
- Long term pain will become gain as the rental market grows
- Negative gearing will eventually turn into positive gearing