Sometimes it’s hard to work out what Australians love more: cricket or property investment. On the face of how much effort goes into property investment and the sacrifices many make to get tax refunds through negative gearing it has to be the latter.
The strategy of negative gearing — claiming personal tax deductions because rent yields do not cover mortgage costs — can have a real impact on your personal and financial independence, because despite the tax savings on income tax, negative gearing is still a loss-making investment that requires funding.
Negative gearing requires sacrifice, as it could potentially cost investors thousands of dollars every year and is only profitable if property prices increase sufficiently to cover the losses accrued. High earners find the tax deductions attractive as they’ll make the biggest savings but that should never be the primary motivation for investing.
All investments carry risks, but given the global housing climate, and especially the prohibitive costs of property in Australian cities like Sydney where even mid-to-high earners are finding it difficult to get on the housing ladder, investors need to carefully consider how much risk they are willing to take on to make negative gearing pay. And also how much of their lifestyle they are willing to sacrifice to fund their investment.
Considering these risks has led to many first-time investors and experienced heads to instead turn to less highly geared investments and even positively geared properties.
Positive gearing is a lower-risk property investment strategy where rent yields cover the costs —mortgage, insurance, council rates, levies and fees — from the get go, making your investment cash-flow positive and your finances less reliant on far away capital gains.
There are social benefits from receiving better rental yields and a positive cash flow, as positively geared properties do not require you to make sacrifices to secure the long-term viability of your investment. No more ducking out of dinner dates or eschewing well-earned holidays to pay off your mortgages.
Gearing growth into your portfolio
Negative gearing is resource intensive. You have to cover the discrepancy between your tax rebate and your costs over rent out of your own pocket and if you want to expand your portfolio you need to find the deposits from your already dwindling saving.
One of the biggest benefits of positive gearing is leveraging high yield properties to expand your property portfolio. The positive cash flow from your first property will afford you the ability to save a deposit and use the equity to assist with further property purchases. Using this strategy to acquire further high yielding properties has seen clients expand their portfolios to include properties in Australia, Europe, South America and Asia.
It is recommended that when expanding your portfolio you consult with an expert property buyer’s agent — especially when purchasing overseas. The cost can be considered somewhat expensive and superfluous to experienced investors but the long-term benefits often entirely negate those costs multiple times over.
A healthy portfolio of positively geared properties can also offer a greater degree of financial independence — even affording many investors the luxury of early retirement thanks to lower debt levels and positive cash flows.
Have your cake and eat it?
Negative gearing remains attractive to many for the tax breaks, but there is a way to get the best of both worlds. Investors wishing for positive cash flows and a tax break should consider purchasing property using their SMSF. There are many attractions for utilising this strategy — the tax rate is just 15% and if the SMSF is in pension phase, properties can be disposed of without capital gains tax liability. Seek independent financial advice, as you will not be able to use the property in the SMSF as collateral for additional funding and this might impact your ability to expand your portfolio.
Positive gearing is a smart investment strategy for investors who want to earn an income from the asset and also combat the risk of negative gearing tax breaks being reduced or removed in future political power plays. Best of all, with positive gearing you’ll be growing your investment portfolio and still be able to say yes to a little bit of well-earned indulgence once in a while.