Negative gearing is often a dirty term in the world of property investing. Negative gearing is when the ongoing costs of owning a property are more than the revenue you receive from it. Sometimes, people refer to negative gearing or negative cashflow before tax or sometimes after tax. A property can be negative before tax, but when you add the tax rebate you receive, it can become positively geared or have positive cashflow. From the 2020 tax year the ability to offset a loss against personal income has stopped (in most cases) and can only be offset against future profits.
Remember that there are two ways you make money from property investment; one the equity and the other cashflow. It is not necessarily a bad thing to have a property that you need to contribute to, provided you look at the overall return on investment. The important thing is to understand what those contributions equate to in your final return on investment (ROI).
Here are two examples that help illustrate leverage and negative gearing:
How does saving on a regular basis compare to saving into a property investment?
Option A – Save $500 per month into a balanced managed fund assuming an average of 5% growth per annum. Your savings would increase to $207,729 at the end of 20 years.
Option B – Purchase a property investment for $500,000 with no deposit (i.e. use the equity from your home) and top it up by $500pm. In 20 years, the property value, assuming 5% growth, would increase to $1,356,320. If you paid interest only on your mortgage, your wealth would be $856,320. It would be higher if you paid off some or all of your mortgage.
How does investing a lump sum of $100,000 into a buy and hold property investment compare to investing in a diversified portfolio (shares, property trusts and term deposits)?
Option B – If you purchase a property investment for $500,000 and put a 20% deposit in of $100,000, your investment will increase to $1,356,320 at the end of 20 years, also assuming an average of 5% growth per year.
This is a good example of how leverage creates a higher return. The significant difference in returns on property in both examples is because you receive the gain on the value of the WHOLE asset of $500,000, not just what you actually put in.