While everything is good and well with negative gearing when the house price is on the rise, the picture changes dramatically when property price stagnates or goes down.

According to some people I know this never happens in Australia. “Haven’t you heard, mate, in property the only way is up!” Well… I’ve never been a big believer in things that “never go wrong”, or “always go great”, and that’s been working fairly well for me so far.

While property market as a whole, taken over a long period of time – such as 20 years – may “always” seem to go up, the picture for any particular house in a particular area, in a particular year can be quite different. And when you are buying an investment property – this is exactly what you’re buying. A particular house. In a particular street. In a particular year. That may or may not be a good year / street / property in terms of capital gains. And with negative gearing, when the house doesn’t increase in price, that means losses.

On contrary to a famous myth of property investing, negative gearing is not something that doesn’t cost you a dime, because everything comes off tax money. Any investor that is holding a negatively geared property is paying out of pocket expenses, which can be less or more, depending on his rental return. The rent that your tenants pay only covers so much of the total expenses, and the rest is for the investor to pay. The expenses on property – interest on the loan, maintenance, etc – are tax-deductible, but it only means that instead of paying the whole expense, you are paying a portion of it.

Without getting into calculations, basic common sense suggests that if you are holding an “asset” that loses you money, you must sell it for much more than its original purchase price to get all you’ve lost over the years back, and make some profit. And this can only happen if that particular house goes up in price. And that is a big IF.

Another scenario many property investors prefer not to think about is – what happens if the government decides to drop these tax incentives? If a day comes and they decide that they would actually like all that tax back? That there are enough rental properties on the market and they don’t need to encourage investors to create more?

And one more last thing to consider – even if everything goes according to the plan and you’ve picked a house with a great capital gains potential, but circumstances force you to sell the property before it had a chance to grow in price, guess what – a loss again.

That’s it from me, now let’s hear from you – what is your experience with negative gearing?

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Tagged as: investment property, negative gearing