The Federal Government is due to hand down its first full year Budget on the 9th of May. In the lead up to this, there has been speculation about significant changes to Superannuation and Tax in an attempt to repair the Budget Deficit and respond to inflationary pressures.

Media headlines have suggested that changes to negative gearing may be a Budget focus, with indications that investors may be limited to only deducting net rental losses from newly constructed properties in future. There has also been reported political pressure for the Government to remove negative gearing tax benefits altogether, in attempt to make housing more affordable for first time homebuyers.

While we need to be conscious not to let media noise dictate our investment decisions, given recent interest rate increases and volatility in the residential property market – is now still a good time to look at gearing as an investment strategy?

Gearing can be defined as borrowing money to invest, and while it is usually associated with property investments, you can also borrow to invest in other investments, such as shares and managed funds.

• An investment is considered ‘negatively geared’ when the income generated (dividends, distributions or rent) is less than the expenses (including interest costs and other related expenses) incurred by the investment.
• Conversely, an investment is considered ‘positively geared’ when the income generated is greater than the expenses incurred.

While it might not sound ideal holding an investment that costs you more than the income you are receiving, the current tax concession allows investors to use this income loss to offset other taxable income (thereby reducing personal income tax). While tax is important to consider, investment decisions should not be driven purely by this influence, and it is important to remember that tax rules can be subject to change over time.

Gearing also provides investors with the opportunity to invest a greater amount of capital than they otherwise would have access to. The element of borrowing carries additional risk, as the debt needs to be repaid over time regardless of the income generated, or the capital movement of the underlying asset/s. While investing additional funds can mean an amplified gain, so too can it result in a significantly higher loss for investors.

Recent changes to rental income (Melbourne rental prices increased 33.3% on average in the 12 months to December 2022) and interest rates means that the gearing position of property investors may have shifted recently, changing the dynamic of the investment.

Given investors are accepting a loss each year to access negative gearing, over the long-term the investment needs to generate a high level of capital growth to ensure the asset is providing an appropriate overall investment return, particularly given the level of risk undertaken.

While rising interest rates have resulted in higher borrowing costs, there are still great investment opportunities available across most markets.

Therefore, gearing can still be an appropriate strategy depending on your individual goals and circumstances.

Given the importance for the long-term growth of assets to make this strategy successful over the long-term, it is important to get expert advice to ensure you are investing in the right assets, and for the right reasons – not being driven by noise, speculation or the appeal of tax concessions.