What is Negative Gearing?

What is negative gearing, in relation to property, and how do you use it effectively? Simply put - it is when an investor has bought a property but the income that the property generates, isn’t enough to cover the mortgage. (When the income does cover the mortgage this is known as positive gearing).

The main reason to use negative gearing is when you believe that capital appreciation in the property will far outweigh any money you are putting in.

This strategy is common elsewhere in the World where rental income usually doesn’t cover the property investor’s mortgage cost. Countries such as Australia, New Zealand and Canada are known to be countries where investors use negative gearing to make money from property.

Property investors are always looking at different ways to finance investment property and this form of making money from property is also becoming increasingly popular for certain investors in the UK, since some are struggle to get the rents to cover the mortgage.

This is obviously a much riskier strategy than if you were able to cash flow your property. However, if it is impossible to cash flow a property in the location you are investing, without putting in a huge deposit, then negatively gearing the property might be a wiser solution than putting in that big deposit.

When would you use this type of strategy?

Why would someone buy a property that is negatively geared?

Well, there are sometimes tax reasons involved as you can sometimes offset the losses against any gains you have made elsewhere. When you consider you are still gaining from the capital appreciation and can potentially remortgage (if you have a good mortgage broker) and draw out the equity tax free, then you can see that this might be an attractive strategy to someone who doesn’t have to rely on the income from the rental.

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It can also be attractive to someone who wants to pick a high capital appreciation area to invest in. Normally the way it works is that in high yield areas the capital appreciation tends to be lower and in higher capital appreciation areas the rental yield tends to be lower.

Negative gearing is a strategy that only works effectively when the profit made from the rise in appreciation of the property, far out strips any losses made in the running of the property. Investors also need to have enough money put aside to cover any shortfall in the monthly and yearly running of the property.

Some property investors even use the property equity from one negatively geared property to fund the purchase of another. These are high risk investment strategies and if the housing market takes a turn for the worse or if interest rates rise and you don’t have the funds to continue to fund the month to month losses incurred on the property, you could find yourself in very hot water.

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