In Australia, one of the biggest benefits of investing in property, or borrowing significantly to invest in any investment class (including shares) is the presence of negative gearing. That is, you can claim a portion of your losses (your effective tax rate) back against your other earned income.
Although a loss is always a loss negative gearing allows you to
How to investment properties become positively geared?
There are several ways that this can happen without you even noticing it:
Although a loss is always a loss negative gearing allows you to
- Supercharge your investment returns by investing less cash and using leverage to maximise the growth in your invested capital
- Have lower holding costs while you wait for capital growth to give you the returns mentioned above
How to investment properties become positively geared?
There are several ways that this can happen without you even noticing it:
- You have been paying down a little bit of principal every month or have been contributing to an offset account and your interest bill becomes lower than the rent
- This is a really common way for investment properties to become positively geared
- You have managed to save so well and pay down your debt so aggressively that your investment property is now throwing off cash to you each month
- Interest rates have fallen
- Typically we pay more attention when interest rates are rising because we know that we probably need to contribute a little bit more each month
- However when interest rates are falling most people do not tend to take as much notice
- It is entirely possible for interest rates to fall so much that your property goes from negatively geared to positively geared very quickly
- The rent you charge goes up
- It is perfectly normal to increase the rent you charge ever year
- Because the incremental amount is so small (i.e. typically $5 - $10 a week) we tend not to notice it on a month to month basis
- However over a few years it definitely narrows the gap between what you are paying in interest and what you receive from your tenants
Why does this cause a dilemma?
There are several investment books (which I don't like) which bemoan the fact that people are so focused on negative gearing and promote the idea that positively geared properties are ideal because 'they put money in your pocket each month instead of taking it out. This is only right at a very simplistic level.
However it is not so simple if you think about your whole portfolio, instead if this investment in isolation. What you should actually think about is:
What the opportunity cost of having your funds invested in this property versus in another product?
As I mentioned earlier what negative gearing allows you to do is to effectively lower the cost of leverage in your portfolio. Although your property is losing money month to month (excluding capital gains) because you have 'too much' debt against it, you may be using money for other investments. For example you could have used the cash to invest in the share market - these stocks would give dividends and capital gains which will probably exceed the tax effected cost of interest on your investment property.
This is what causes the dilemma. By having too much equity invested in your investment property you are losing the 'supercharge' effect of leverage as well as tying up cash that you could be using to invest in other asset classes.
Does this mean that positively geared properties are bad?
No! It all depends on what you can do with your next dollar of investment.
It also depends on the capital growth potential of your property. If you have a low growth investment property which is (relatively) high yielding, then it makes little sense to have this negatively geared - the investment is never going to wash it's face if there is no growth AND you have too much debt against it.
If, however, the property is reasonably high growth (or you expect it to be) then you can probably afford to put a bit more debt against it, supercharge your investment property returns (because your invested capital is quite low and the returns come from the growth in the total asset value) and use this cash in other investments WHILE getting a tax subsidised rate of interest.
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