Before you buy an investment property there are five things every investor needs to know about ‘negative gearing’.
Let me start by saying that 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. Without some key ingredients the strategy can turn into a financial disaster.
Firstly, the right property in the right location is unquestionably the most important ingredient. The whole strategy hinges on the property growing in value and without capital growth you aren’t going to make money. While we don’t profess to be property experts, clearly some areas and cities produce better returns than others. You need to be wary of the property spruikers who promise huge returns on the Gold Coast or in remote mining towns and their sales ‘gimmicks’ like rental guarantees and incentives like furniture fit outs.
Of course, location is only one part of the investment property equation because you then need to decide on the type of property. A unit, a flat or a house? One bedroom or two bedrooms with or without a balcony and car space? Do you buy an ‘off the plan’ property or an established property?
Secondly, because negative gearing is a tax effective strategy you need to make sure the property is owned in the correct tax structure. For example, it could be in joint names, a self-managed super fund or in a trust. In choosing a 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 flavour of the month, there are a number of issues to consider before you go down that pathway.
The next item on the list is the right loan. Should it be an interest only loan or a principal and interest loan? Should the loan be at a fixed rate or variable rate? There are numerous options but a poorly structured loan can reduce your repayment flexibility, increase your risk profile and create headaches for tax purposes.
Often the loan with the cheapest interest rate may not be the most appropriate for your circumstances because it lacks key features you might want down the track. Too often investors consolidate their investment property loan with their home loan which can jeopardise the tax deductibility of the interest. The clear message here is seek advice.
The next consideration 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 real profit on the investment is generally only realized on sale.
Using some intelligent software we can analyse your potential property investment to give you a 10 year forecast of cashflow, taxable income and equity. This planning tool is invaluable for employees as it lets us prepare tax instalment variations so you can get the tax savings each pay period rather than waiting until you lodge your annual tax return.
We have already mentioned the need for quality advice regarding location, the type of property, the right tax structure and the right loan but the right advice might also extend to appropriate insurances and record keeping. This country now has a ‘property investment industry’ full of self-proclaimed property gurus but there is no substitute for independent, unbiased professional advice.
Over the years we have assisted hundreds of clients through the process and negative gearing has become a real niche area within our practice. We have 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 are contemplating buying an investment property talk to us today.