From an IT and Telecoms background Sean Wheller is both an avid writer and passionate property investor. Amongst the many websites he founded is the first Property Investor Community based site in South Africa PropertyInvestorNetwork.co.za. On the IT front his passions include open source software and community. He chiefly supports Joomla and the future of self managed content websites. Through his web development company [TheWebDesignCompany.co.za], he helps small and medium size companies take control of their website content while significantly reducing costs of development. To learn more about Seans’ interests and businesses you can go to www.SeanWheller.co.za.

The term negative gearing is not very widely used in South Africa, in fact if you Google it you will find mostly Australian domain’s at time of writing. Though the term is not widely used, we found it is extensively employed as an investing strategy and often with little knowledge of its’ meaning and consequences.

In this article, we will look at negative gearing as part of property gearing and try to best explain what it is and how negative gearing affects property investments. Negative gearing, generally speaking, is an investment strategy. However, just like with any other strategy, it can be good or extremely risky, if one doesn’t know what it entails.

What is Negative Gearing?

When to Use Negative Gearing in Property Investing

• Capital growth / equity. This means they are willing and capable of spending the monthly shortfall for a period of time, to sell the property later at a much higher value. If you buy a property for R500,000 and your bond is R5,000 while the rent is only R4,000 you may be willing to spend the shortfall of R1,000 for a period of 2 years to sell the property at R800,000. The total shortfall was only R24,000 while the profit was R300,000 before tax. Anyone can see why subsidizing R1,000 per month in negative gearing could be quite attractive. This strategy is widely employed in mid to up-market areas when property prices are high and escalating higher every month.
• Tax reduction. Some investors have a very good portfolio of properties, bringing in a good monthly income. At the end of the year, they have to pay tax on the income generated. In this case some investors opt to buy a negatively geared property  to reduce monthly cash and therefore pay less tax. Though this strategy is useful, it usually goes in conjunction with capital growth and not only for tax reduction. As an example, lets say that a portfolio is generating an income of R4,000 per month. This income is taxable. If the investor now chooses to buy 4 properties at a negative cashflow of R1000 a sum of R4,000 negative cashflow is created. Now the monthly income is R4000 - R4000, which is R0. In this strategy, the investor wiped out all income with the negatively geared properties and therefore the taxable income is R0. However, he did get a return for spending all that money from the cashflow each month. The return is the capital growth on the negatively geared properties. The investor will most likely capitalize on the growth later down the road through systems such as refinancing or selling them to buy more properties.

When NOT to Use Negative Gearing in Property Investing

• When you don’t have cash. If you don’t have sustainable and consistent cashflow to feed money into negatively geared properties, such strategy could be very risky. If you can’t pay the bond for a period of time, you risk the bank having to repossess the property. The property will be put on execution (auction) or become a PIP (property in possession). That is not a nice situation and shortens your investment career or at least halts it for a while. This is easily avoided if negative gearing is not used in a situation of tight cashflow.
• When your goal is income. If your goal is to make income on month-to-month basis from property rentals, negative gearing will only slow down the process (even if you are cashflow rich to subsidize properties). It will take quite a while for the rentals to increase for the cashflow to become positive and turn the property into a cash flow positive property . In most cases this period can extend to years in timeframe. If one chooses the income strategy as their main goal, then purchasing cashflow positive properties should be of highest importance, even if such properties in certain market conditions are far and few between, otherwise it just beats the purposes.

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