With smart use of equity, negative gearing, and research, big profits can be very safely achieved, writes Richard Sheppard.
You’ve no doubt heard the terms ‘negative gearing’ and ‘equity’ being splashed about in the media – but like most people, you may not really know how they work. Well, it’s no exaggeration to say that this lack of understanding could be costing you millions of dollars in long-term wealth.
The positives of ‘negative gearing’
What is negative gearing? It means that if your total property costs – including interest, rates, and maintenance etc. – are higher than the rent you receive, the difference can be claimed on tax.
People are often shocked at how little it can cost to hold an investment property after they claim negative gearing benefits. For under $50 a week, you can secure an apartment or house.
So here’s why it is so powerful.
- Even if you borrow the full purchase price of the investment property, plus costs, using the equity in your existing property as security, you will not have to put down any cash, plus you can even borrow extra to use as a buffer type cash reserve;
- Then the rent and tax benefits will cover most, if not all, other costs such as interest, rates, body corporate fees, maintenance, and vacancies.
- In such a case you could either be positively geared or hold the property for less than $50 in current markets.
- You need capital growth of just one per cent to two per cent a year to justify using your equity in this way, however far more growth is forecast in some markets, but not Sydney! Remember that the growth forecast for Brisbane, the only capital in Australia with a positive growth outlook, is four per cent to seven per cent per annum for the next three to five years. Suppose you get growth at the lower end, four percent, on a $500,000 property then it equates to about $20,000 a year. It’s like getting a free bonus for just doing something with your equity!
Better still, if you hold the property for five to ten years you can usually expect its value to increase by 50 to 100 percent over that period, and you can use that growth to pay down your mortgage or just keep investing further.
Use your ‘lazy equity’
So you can see that letting your equity – this is, the difference between the value of your home and how much you owe on it – just sit around is a wasted opportunity. Thanks to the recent Sydney property boom, many homeowners on the Northern Beaches will have $300,000 to $600,000 plus of extra equity.
It can be used safely to buy another home or unit. As a general rule, you only need about 20 percent or more equity in your existing property to get started.
Given the big rise in property values, you should have enough equity to borrow extra money as a buffer.
This article was originally written for the March 2016 edition of Peninsula Living Magazine.
Important Note and Warning: This information is general in nature and should not be considered personal tax advice. We highly recommend you discuss these concepts with your accountant, property investment adviser and investment finance mortgage broker jointly to ensure any considered concepts are suitable for your personal financial situation, as one effect of the concept may negatively impact another part of your plan.