Negative Gearing Explained vs Flipping Distressed Property
Published 1:58 am 11 Mar 2020
When you start investing, you’ll discover there are a lot of property investment strategies out there. In this article, DG Institute founder Dominique Grubisa looks at two of the most common and explains the pros and cons of each.
Before you get started as a property investor, you need a house investing strategy. So you jump online and find all these different property investment ideas. And now, you’re left with a question…
Which strategy should you choose?
There’s so much information out there that it can make your head spin. As a new investor, your first task is to separate the good ideas from the bad. That’s the only way you can develop a real estate investment process that works.
Unfortunately, many property investors fail at this first task.
Let’s ensure that you’re not one of them…
In this article, DG Institute CEO Dominique Grubisa looks at two property investment strategies. One of these strategies works well for new investors. The other doesn’t.
We’ll start with the strategy that lures a lot of new investors in…
The Strategy That Doesn’t Work – Negative Gearing
You’ll come across negative gearing pretty quickly when you start your research into property investment ideas. You’ll also see a lot of opinions on the strategy.
Some point to it as a great way to save money on your taxes. Others note that it’s also a great way to drain your cash reserves to the point where your investment strategy stalls.
We at DG Institute fall into the latter camp. But before we explain why, let’s take a closer look at what negative gearing actually is.
What is Negative Gearing?
Negative gearing means that you take a loss on the property you’ve invested in. Typically, it involves taking out a loan to buy a property. From there, the monthly revenue this property generates must not exceed the holding costs.
This makes the strategy sound odd from the off. However, there’s a reason why an investor might want to lose money on a property.
Australian tax laws allow investors to claim several deductions related to their investments. With a negative gearing strategy, you use the losses you make to reduce your tax bill.
The idea is that you’ll eventually make your money back, thanks to the capital growth when you sell the property.
A Negative Gearing Example
So, what does negative gearing look like in action?
Realestate.com.au provides an interesting example based on a loan of $400,000. In this scenario, the borrower has a 7% interest rate and charges their tenant $430 rent per week.
“Based on the figures above, the investor is paying $28,000 in interest but only earning $22,360 in rent, which means they have a rental shortfall of $5,640 per year.”
In this case, the investor can deduct that $5,640 loss from their tax bill. With several negatively-geared properties, the investor can lower their tax bill considerably. They may even be able to use negative gearing to get into a lower tax bracket.
So…Why is Negative Gearing Bad?
The main problem with negative gearing is that it only works for a small subset of investors. It’s only really workable for those who have a lot of cash they can use to cover the costs of holding a property.
Think about it like this.
In the above example, the property makes a loss of $5,640 per year. That money has to come out of your pocket up front. Sure, you can claim it back on your taxes at the end of the year. But you have to wait 12 months to make that claim.
In the meantime, you have a bunch of expenses eating into your cash flow.
As a new investor, it’s unlikely that you’ll have the money required to cover those costs. And even if you think you can manage it for one property, could you manage it for two, three, or four? The impact of negative gearing really mounts up when you’re building a portfolio.
The tax benefits that come with negative gearing only pay off when you sell the property several years down the line. Until then, you’re constantly having to balance your cash flow to make up for the losses you’re taking on the negative geared properties.
The Strategy That Does Work – Flipping Distressed Properties
So, negative gearing goes out the window if you don’t have huge cash reserves to make the strategy sustainable.
But what about the property investment strategies that do work for new investors?
We believe that flipping distressed properties is the best way for you to make money. And one of our clients offers the perfect example of how this can work for you.
“Our client attended the Real Estate Rescue program to learn about flipping distressed houses. Using the knowledge they’d gained, they discovered a mortgagee-in-possession property. It was off-market and available for far less than the median market price.
The client snapped up the property and got to work on it.
Over the course of several months, they spent $45,000 on cosmetic renovations for the property.
They put it back on the market and it sold quickly. Most importantly, the property generated an $85,000 profit.”
And they’re not the only DG Institute client to achieve a huge profit with this strategy. We have another who used this strategy to buy and renovate four townhouses.
The eventual profit on that deal came in at about $400,000.
Simply put, flipping distressed properties is a great way to generate a profit, especially early in your investing career.
Get Distressed Property Advice
Now that you’ve seen the advantages of this strategy, you just need to know how to find distressed properties. You can see that negative gearing isn’t the path to take if you want to generate a profit in the short term. Instead, fixing up distressed properties is the way to go.
That’s where DG Institute comes in.
Our Real Estate Rescue program focuses on helping you understand exactly what a distressed property is. We’ll show you how to find such properties and teach you how to buy them for the lowest price possible.
Finally, you’ll learn how to fix up those properties so you generate a profit.
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