Negative Gearing – What Is It?

Negative gearing is a term used in connection with investments made with borrowed funds and the returns on that asset in the form of regular income cannot meet the installment amounts to be sent as interest and loan repayment.

It is customary for investors to borrow funds and purchase an expensive asset to leverage their future earnings. This is done with the expectation that the income to be generated by the asset can be used to pay off the interest and installment dues.

However, when the asset, property, for instance, is not able to yield a regular income equivalent to or more than the mortgage installment plus interest, it is said to have negative gearing.

Negative gearing then has to be covered by cash supplements by the investor, and he has to continue to pitch in with funds till the asset is sold and the capital gain is used to compensate the cash payments made through the entire stretch of ownership. Thus, negative gearing does not always imply losses, and due to lack of proper understanding investors misconstrue it as an avoidable risk.

Negative gearing exemplifies the following situations:

  • Buying property with borrowed funds
  • Paying from other sources for the gap between expenses and returns(rent) from the property
  • The cash loss compensated by income from other sources helps to reduce tax burden since the overall earning level and taxable income comes down.

Negative gearing is also referred to as leveraged speculation, since the borrowing is undertaken on the assumption that the income yielded by the asset will meet the cash outflows. This makes it a valuable tool in the hands of property investors, because by and large all properties bring higher returns than the investment in the long run. Negative gearing in the short term is compensated by positive capital appreciation in the long run.

Negative gearing is used as a property investment strategy since it involves receipt of tax benefits at the time of investment and long term capital gains. However, the infusion of funds to meet the negative cash flow requires additional income sources, which can be compensated later when the capital gains are received after a sale.

Benefits of negative gearing

Negative gearing is beneficial in specific types of investment properties. The benefits include deductions that can be availed from taxation like:

  • Interest payments for the loan
  • Agent fees paid for managing the property
  • Loan related expenses including establishment expenses
  • Advertising expenses incurred for getting tenants
  • Land tax and council related fees
  • Corporation levies on owners of property
  • Insurance premium
  • Maintenance and repair expenses
  • Depreciation costs

However, negative gearing proves useful only when properties are bought at relatively lower rates when markets are undergoing a down swing, and not those purchased at boom times when prices are high. This is because the potential for capital gains will be much lower.

Negative gearing has been used by property investors for decades as a route to accumulate properties and augment their wealth.

Tags: , , ,

About PropertyTutors

“PropertyTutors Limited believes the information in this publication is correct, and it has reasonable grounds for any opinion or recommendation found within this publication on the date of this publication. However, no liability is accepted for any loss or damage incurred by any person as a result of any error in any information, opinion or recommendation in this publication. Nothing in this publication is, or should be taken as, an offer, invitation or recommendation to buy, sell or retain any investment in or make any deposit with any person. The information contained in this publication is general in nature. It may not be relevant to individual circumstances. Before making any investment, insurance or other financial decisions, you should consult a professional financial adviser. This publication is for the use of persons in New Zealand only. Copyright in this publication is owned by PropertyTutors Limited. You must not reproduce or distribute content from this publication or any part of it without prior permission.”