There’s been a significant increase in the share of property investors who are negatively geared, due largely to the higher-interest-rate environment.
The term negatively geared gets used a lot these days – often in a positive way, but it can also have some negative side effects as set out in this news story. So we will explore this conundrum further below. But first, let’s get back to the current predicament as outlined in this news story.
Before we start
If you would like to find out more about this topic, just reach out for a quick chat and I will be happy to explain it to you further.
And a quick disclaimer: anything said below needs to be confirmed with your tax accountant and professional advisors to make sure they are applicable to you and your circumstances. As with most things in life, generalisations don’t always apply to you!
Book a time: explain how investment properties can make me money – or cost me money.
The current negative gearing statistics explained
The Property Investment Professionals of Australia (PIPA) found that the share of property investors who were negatively geared rose from 57% in 2023 to 65% in 2024, based on surveys of investors.
“Just consider that 42% of survey respondents [for 2024] also indicated that their cash flows were tight with a further 11% indicating that their working income was not covering the shortfall currently, so they were drawing on savings,” PIPA Chair Nicola McDougall said.
“It’s clear that investors and tenants are both struggling in the high property cost environment at present, however investors are often doing without to ensure they can cover the shortfall between the rent they receive and the high costs associated with owning one or two investment properties.”
Quick tip if it’s been at least two years since you took out your home loan:
The market has moved a lot in that time, which means there’s a good chance you could refinance to a comparable loan with a lower interest rate – thereby improving your cash flow.
Want us to model your refinancing scenarios? Let’s talk!
Deep Dive: Investment properties are a business
Before we explain negative gearing, let’s remember this:
Owning an investment property is owning a business.
In every business, there is an asset which is created and which costs money to run but which will hopefully generate a positive return for you from the money you have spent.
Typically, there are two types of positive returns you can make from a business:
From the profits the business makes and/or
The increase in the value of the business and its assets.
This distinction is important when considering the topic of negative gearing.
Importantly, most investment property businesses are designed to make money from the appreciation or increase in the value of the property. In the Australian property market, it has been one of the best strategies to create wealth as you can borrow up to 80% (or more) of a property’s value so any increase in the value of the property is a return on the equity you had to contribute (i.e. the 20% you had to contribute to buy the property).
A simple example: you buy a $500,000 property with a loan at $400,000 and a cash contribution of $100,000. Over 5 years, the property’s value compounds in growth at 5% pa* which results in a value of $638,140 in 5 years and over $814,447 in 10 years. That is, a return of $138,140 before capital gains tax over 5 years. or $714,447 over 10 years.
As your initial investment was $100,000, this return equates to an annual return of roughly 19% pa over 5 years and 22% pa over 10 years.
* Note: over the last 30 years, Australian housing prices have increased by approximately 6.4% pa (report by CoreLogic August 2022 – link).
As a business proposition, this sounds all good and rosy – assuming the costs of borrowing and running and maintaining the property were equal or less than the income it was generating…. Right?
Well, this is where negative gearing comes into play.
What is negative gearing?
Negative gearing is a financial strategy where investment costs (like interest on a loan) exceed the income generated by that investment, resulting in a loss. This loss can be used to offset other taxable income, potentially reducing your overall tax liability.
In short, negative gearing is actually a loss the business has incurred. It is important to remember this at all times so you don’t get seduced by the benefits of negative gearing and ignore the real costs of the loss!
In the context of property investment, negative gearing occurs when the rental income you earn from your property is less than the expenses of owning and maintaining the property. These expenses will often include the interest on the loan you obtained to buy the property.
These expenses are primarily made up of two types:
Cash expenses and
Non-cash expenses
Cash expenses are where you have to pay money to someone else. Examples of cash expenses are rates, repairs, real estate agent’s management fees and body corporate fees.
However, investment properties, particularly new investment properties, can often have a significant non-cash expense – depreciation.
So let’s define depreciation
Depreciation is the accounting method used to spread the cost of an asset over its useful life, reflecting its gradual decrease in value due to wear and tear, obsolescence, or other factors. In essence, it’s the process of recognising that assets lose value over time and distributing that loss of value as an expense over the asset’s useful life. The accountant’s logic is that by making this allowance in your profit and loss statement, you are funding the future acquisition of a replacement asset by making a charge against the profits which are being generated from that asset.
Whilst it is used in accounting, the Australian Taxation Office (ATO) also allows businesses to claim depreciation as an expense.
So, for example, the non-land value of the constructed property is depreciated for tax purposes (typically 2.5% pa or 4.0% pa) whilst any fixtures and fittings can be depreciated at a higher rate (eg ovens: 13.33% pa).
Ok, you still with me? Good! Let’s continue.
Three Scenarios which apply to property investors
So imagine a three scenarios…
👏👏👏 Scenario #1: Your investment property rental income is greater than all your expenses.
This is a very safe strategy as your profit and cashflow is positive and, you will also be paying tax on your profit.
Together with your capital gain (historically 6.4% pa for housing, you are sitting safe and pretty well off.
👏👏👏 😍😍😍 👏👏👏 Scenario #2: Your investment property rental income is less than all your expenses (cash and non-cash) BUT it is greater than your cash expenses.
In this scenario, you have a tax loss AND you also have a positive cashflow!
This is the sweet spot as you can claim a tax deduction for the tax loss which can reduce your normal tax payment from your day job but you still have positive cashflow from the property. Yippee!
With your reduced tax bill, you can save that money to invest in your next property and it is costing you nothing in terms of your existing cashflow requirements to do this. Zero, zilch, nix.
😧😧😧 Scenario #3: Your investment property rental income is less than all your expenses AND it is less than your cash expenses.
This is potentially dangerous and you are entering a higher risk territory as the other income you earn from your day job will be needed to pay the cash shortfall with the investment property. I know. I have been there.
Some observations about Scenario #3
If you can afford to fund this cash shortfall, this may not be an immediate issue. For example, you either earn lots of money and/or you have typically been able to save money, then you can potentially survive with this scenario.
If you have not typically had a lot of spare cash from your day job, then this can put a huge strain on your financial resources and dare I say it, your relationships (money stress issues are right up there as a cause of marital break-ups).
When you are in a cash loss position, you need to weigh up the negative impact of this cash loss against the (hopefully), future gains on the value of the property.
💀💀💀 A well known and very bad Scenario #3
What has been a nightmare for many property investors is when they invested in inner city apartments which did not increase in value (in fact many decreased in value) and the cash loss from their borrowings plus property costs exceeded the rental income. And this is before we even start to talk about the cost of replacement cladding!
Unfortunately, you can’t magically fix this scenario but you can get some good advice as to what you should do next.
If you are in this position and you are in a world of pain, let’s have a chat about how we can assist you understand your alternatives. We also have a range of experts in property investment who we can refer you to who can do the numbers for you to work out what are your options for your current property portfolio.
Remember the sage advice, the best time to fix a problem is today.