Those are all very good questions. Negative gearing is a strategy that is only successful when home prices are rising at a greater rate than inflation plus operating and interest costs. It’s, therefore, a highly speculative strategy that relies solely on generic capital growth in the overall market. In my opinion, it can only be a smart strategy in hindsight.

I think it’s wise to give yourself more ways of winning, for example through positive cash flow and manufactured growth. Then, if home prices rise, it’s a bonus. Your positive cash flow also provides a buffer against rising interest rates. But creating positive cash flow in the current market requires a little more effort and intelligence.

Of course, a lot of people have become very wealthy through negative gearing over the past few years, investing in Sydney and Melbourne. In hindsight, were they smart or lucky? I’ll leave that to you to decide.

Those who bought these negatively geared assets years ago will have some cushion against falling prices, if there is a correction in Sydney and Melbourne. They will only lose unrealised growth gains. But those investors who buy negative geared properties just before the correction would not be so fortunate. If prices move against them, they may be unable to repay their debts and be forced to sell, likely at a significant loss. That scenario would be very detrimental to the economy as a whole.

Even if prices don’t fall, the big challenge that the government and the RBA must face now is how to spur economic growth when many people are weighed down with very high interest payments. If and when interest rates rise, this problem will be compounded.

So yes, I do believe negative gearing, together with artificially-low interest rates, has added a significant amount of risk to our economy. Both promote what economists call “malinvestment” – the unwise investment of capital in assets that do not promote sustainable economic growth. Only time will tell which of the “Johns” end up being the “greater fools.”

Here are a few other articles I’ve written on the subject that you may find helpful:
– https://www.propertyinvesting.com/john-templeton-about-market-cycles/
– https://www.propertyinvesting.com/what-type-of-borrower-are-you/

All the best,
Jason

With that said, if the economy is not doing so well (such as now) does negative gearing have a negative impact in any way? For instance, if a lot of ‘Johns’ didn’t invest wisely, and ended up having to sell their properties and unable to repay the principal and interest would that adversely affect the government or RBA etc.

Thanks for your thoughtful comment and for thinking through those numbers. I’m sure most people skim over that section :)

I think it’s important to keep in mind that what we’re measuring is the portion of the capital growth of the property that can be attributed to inflation alone. In other words, real estate should increase in value at the same rate as the CPI unless there are other supply/demand factors that cause a faster rate of growth (low interest rates, easy lending, investor tax concessions, proximity to jobs, etc.). That portion of the growth that was due to inflation represents an erosion of buying power of the total capital gain at the time of selling. I think this is useful because it gives us a clear picture of what’s really going on with house prices and what our returns really looks like after taxes and inflation.

That said, I can understand where you’re coming from. I think what you’re getting at is the value of considering the leverage that your debt gives you, to benefit from both the gains in inflation and the gains from other supply/demand factors. I would just be careful that you don’t see the outcome as rosier than it really is.

Cheers
Jason

Thank you so much for this brilliant explanation of negative gearing. I have a little bit different understanding on John’s investment case: regarding the impact of inflation, maybe you should use the amount of $50,000, rather than $500,000, since, John just invested $50,000 from his own pocket and borrow the rest of money from bank. so what he lost in the 10 years due to inflation is $10,949.7 , the impact of inflation on his lost cash flow should be included as well (since John had to keep investing money in the past 10 years from his own pocket ), let’s use 5 years as an approximation the amount should be $45000x(1.02×1.02×1.02×1.02×1.02-1)= $4684, So, the total impact of inflation should be around $15,632. if this calculation is right, John actually made a profit of $68,993, compared with his total investment $95,000 ($50,000+$45,000), it seems not bad at all (5.6% gain annually, above the inflation).
I am not an accountant , therefore my calculation might be totally wrong, it’s just my own understanding of this issue.
Thank you again for you very educational explanation on negative gearing again.
Cheers!

If you bought this house to be your Principal Place of Residence (PPOR), then you are entitled to a full CGT exemption. If you move out of the property and then rent it out, you can still claim an exemption from CGT for a period of up to six years. As it was rented out for fewer than six years and then sold, there should be no CGT event at the time of sale.

Confirm with your accountant that there are no other details that you’ve missed.

Here’s the explanation from the ATO’s website: https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Real-estate/Treating-a-dwelling-as-your-main-residence-after-you-move-out/

Hope that helps.

Jason

I have lived in my house for 2 years when I bought it first. Due to personal cirmustances, I had to leave the country and then it was rented out for 4 years before moving to my house and selling it. I have negatively geared during the 4 year period it was rented out. Appreciate if you could answer the following questions?
1) Do I need to pay CGT?.
2) If yes, is there any way I can pay back the tax office the gain due to negative gearing for the 4 years the property was rented out with interest and avoid CGT?

Thanks
Suresh

Operating costs (rates, insurance, minor repairs, mgmt fees, etc.) and interest are revenue expenses, which go to the income statement, meaning they can be deducted annually on your tax return. Capital expenses (new kitchen, new roof, etc.) go onto the balance sheet and whatever hasn’t already been depreciated reduces the capital gain at the time of sale.

Those annual losses you refer to are revenue expenses that have already been deducted at the time of sale, so they do not impact capital gain or loss.

This also explains why you need a good accountant! :)

In other words, investor has still dipped into their pocket for a loss each year = 55% of actual loss.

When property is sold for a Capital Gain, can all those 55% actual out of pocket losses be claimed for all the years you held? Are the counted as losses incurred while owning the asset?

In other words, the (Sale – Buy) = Gain minus (years x 55% losses) = actual capital gain. There is no CPI adjustment in the accumulated losses. I hope this makes sense.

“John paid out $6,864, only to get back $2,368. He’s still in the hole for $4,496 for the year.”

Rounding up…

$4500 x 10 = $45,000