Negative gearing - who’s right?

The darling of many property investors, negative gearing can have its pros and cons.

The darling of many property investors, negative gearing can have its pros and cons.

Australians love property investment and with good reason. Bricks and mortar has deliver solid long term returns – notching up capital growth averaging over 5% annually across our state capitals over the last ten years. Add in rent returns, currently worth around 3.4% on houses and 4.3% for units, and it's easy to see the broad appeal of residential property.

However unlike many other developed nations, property investors here in Australia enjoy another perk – negative gearing. It describes the ability to claim a tax deduction for ongoing losses on a rental property. Moreover, this loss can be offset against wage or salary income, making a rental property a very tax-friendly investment.

Low rates have heightened investment activity

The presence of negative gearing is likely to be a key drawcard for many Australians thinking of becoming landlords. That's not a bad thing in itself. A well-chosen property can play a key role in building personal wealth. In recent years low interest rates have encouraged a higher than normal level of investor activity – this is certainly something Mortgage Choice brokers can attest to.

The downside of this activity has been rapidly rising property prices. And, as ‘mum and dad' investors often target the under-$500,000 section of the market, the rising investor interest has created more competition for first home buyers, who often favour this price bracket also.

It's not all bad news though. Industry research shows a growing number of younger, Gen Y Australians are dealing with the situation by becoming investors rather than first home buyers. And, surprisingly, renters have benefitted from the growing investor activity. The greater choice of rental properties available has seen growth in rents slow to 0.7% over the past year - below the rate of inflation.

Could negative gearing be scrapped?

There has been considerable talk in the media of scrapping negative gearing. But given the popularity of property as an investment, it would be a brave government that would take such a dramatic step.

And the recent reshuffling of the federal government makes it likely any reviews of negative gearing may be shunted to the back burner for the immediate future at least.

The risk may lie with investors

The bigger issue may be whether the availability of negative gearing encourages people to invest in property for the wrong reasons. Look at it this way. An investment that continually makes a loss could hardly be regarded as a successful asset – even with tax savings. The difference with property is that capital gains over time should make up for those ongoing losses.

This is a critical issue. Without decent long term capital growth, property investors may only be buying a set of annual tax deductions.

To avoid this downside, and maximise the benefits from negative gearing, property investors need to take some important steps.

Do your homework and select a property with care. Ensure you pay a fair price, make sure your other sources of income are secure enough to cover any running losses, and most critically, aim to invest in a growth area. If you generate some tax deductions from ongoing losses along the way, good, but don't base an investment decision on tax savings alone.

For expert advice on investment loans and investing in a rental property, call Mortgage Choice on 13 77 62.

Posted in: Home loans