The 5 Things Every Investor Needs To Know About Negative Gearing & Property
Creating wealth by purchasing a negatively geared investment property is incredibly common in Australia. Estimates suggest that up to 30% of residential properties are owned by investors, however, it is not a get rich quick scheme. In fact, without some key ingredients the strategy can turn into a financial disaster.
Over the years we have identified 5 key things that every investor needs to know about negative gearing and it all starts with the right property in the right location. The whole strategy hinges on the property growing in value and compounding effect. The graph highlights the difference in value of a property that appreciates at 5%, 7% and 10% per annum over a 10 year holding period. The difference in value is several hundred thousand dollars which highlights the importance of capital growth.
Clearly some suburbs and cities produce better returns than others and you need to be careful with the property ‘spruikers’ who promise huge returns on investments on the Gold Coast or in remote mining towns. You also need to be wary of the ‘gimmicks’ they use like rental guarantees and incentives like furniture fit outs.
Of course, location is only one part of the property equation because you also need to decide on the type of property. A unit, a flat, an apartment or a house? One bedroom or two bedrooms with or without a balcony and a car space? New or old, an ‘off the plan’ property or an established property?
Secondly, negative gearing is a tax effective strategy so you need to make sure the property is owned in the correct structure. For example, it could be in joint names, a self-managed super fund or in a trust. In choosing the structure you need to consider a whole range of issues including other income and the future earning potential of the investors. It is a critical decision and while owning property in a self-managed super fund is certainly flavour of the month, there are a number of issues to consider before you go down that pathway. Tax certainly isn’t the only consideration.
The next important item on the list is the right loan. There are interest only loans and principal and interest loans which have different tax implications. Rates can be fixed or variable and you need to be very careful how you structure the loan to ensure the interest is tax deductible. A poorly structured loan can reduce your repayment flexibility, increase your risk profile and create headaches for tax purposes. The loan with the cheapest interest rate may not be the most appropriate for your circumstances because it may not allow lump sum repayments or it may incur early pay out penalties.
We often liaise with mortgage brokers to ensure that our clients have the right loan complete with the right features plus the correct security. Too often investors consolidate their investment property loan with their home loan which can jeopardise the tax deductibility of the interest.
The next essential ingredient is cashflow. Negative gearing implies that each year you make a loss for tax purposes so you need to fund the shortfall between rent and outgoings from other income sources like your salary or business profits. Remember, the profit on the investment is generally only realized on sale of the property. We use some intelligent software called Rent Manager to analyse your potential property investment. The software generates a 10 year forecast of cashflow, taxable income and equity. This planning tool is invaluable as it lets us prepare tax variations so you can get the tax savings each pay period rather than waiting until the end of the year when you lodge your income tax return.
The final key ingredient is quality advice. Use the experts regarding location, the type of property, the tax structure and the right loan. The advice might also extend to appropriate insurances and record keeping but this country now has a ‘property investment industry’ full of self-proclaimed property gurus but there is no substitute for independent, unbiased professional advice.
In summary, the purchase of an investment property necessitates careful planning and the wrong structure, loan or tax advice can prove a financial disaster. Over the years we have assisted hundreds of clients through the investment property process and negative gearing has become a real niche area within our practice.
To assist you we have also developed a number of practical tools and checklists including ‘The Complete Guide to Buying a Negatively Geared Property’ which is available from our offices and the ‘Rental Property Schedule’ which you can download from the links and forms section of our website.
If you have any queries contact us today.