Gearing and leverage are terms used in investing to describe ways of multiplying investment returns. The most common form of gearing is through an investment loan. This article discusses one gearing strategy in which the short term cash flow is negative, hence it is called “negative gearing.”
You are probably familiar with the concept of negative gearing, but let’s just take a moment to refresh our memory. Gearing gives you the power to get into an investment that you otherwise would not be able to afford. The loan that provides the gearing is going to require interest payments. Along with that there will be expenses related to the property. Those items make up the negative side of the cash flow – money going out of your coffers. At the same time, with property investment, the property should be tenanted, generating an income. That’s a positive cash flow. The net cash flow (positive minus negative) at the start is likely to be a negative figure. In terms of cash flow, you are losing money. So the question is, why would you buy an investment property just to lose money? And the answer is, ‘there’s more to it than cash flow!’ The growth of the property value and future growth in rents also come into the equation. Over the long term it should make you money.
With the negative gearing in the short term, there is a tax benefit. Under present laws you generally can use the loss on your investment property to offset other income and pay less tax. There are some provisos regarding this. You need to have the prospect of it becoming profitable. They are not going to allow you a tax deduction if you have no intent to ever generate revenue from the property and just get a capital gain. That’s not to say that it cannot happen that way. You may get an offer that’s way too good to refuse next year and sell the place. But your intent when you purchase it needs to be that you are going to keep it longer term, and that sometime along the way it will generate net income. You need to be able to demonstrate that it has the capability of doing that.
Just one additional thought on negative gearing. In a few cases it’s actually possible to have a positive cash flow from a property and yet be negatively geared. That happens when your non-cash deductions – building allowance and depreciation – are large enough to swing it the other way. Your tax loss includes the non-tax items, but they are not things that you have to come up with the cash to pay for at that time – they are to cover future expenses.
With any gearing strategy, positive or negative, you need to be aware that it increases risk. Both positive and negative returns are multiplied, and when it is the negative ones, that can lead to big losses. Proper risk management needs to be exercised.
Property investment loans
If you are contemplating an involvement in property investment, give the friendly credit managers at State Custodians Mortgage Company a call. They are very experienced in providing the finances for such an investment and will be very helpful to you. Call today on 13 72 62.