Negative gearing, put simply, describes the situation where the costs associated with (typically) an investment property are higher than the income from it. In other words, when the property runs at a loss.

This is often because we have borrowed money to buy the home - or ‘leveraged' - do you recall the theory of leveraging from high school physics? Leveraging in this example is the process of ‘gearing' into an investment property and simply refers to using a little of your cash - and a lot more borrowed cash - to allow you to purchase a much bigger asset than you could with your own resources. The idea being, if the asset grows by x% in value, x% of a larger sum is much better than x% of your smaller contribution. The proportion of your own money to the borrowed money we call ‘gearing'.

Mortgage costs are the highest costs a geared investor must face. When maintenance and property management costs are added to the mortgage costs, the income - in the form of rent from the tenants - can often be lower than the total costs, particularly in the early years of owing the property. You would then describe this asset as being ‘negatively geared'.

Investors are prepared to ‘lose' money in this way for two reasons:

1. A well chosen investment property has the potential to generate capital growth that history has shown has averaged at 8 per cent per annum. In other words, the capital growth is very attractive, and more than offsets the monthly income shortfall*. 

2. The annual interest paid is fully tax deductible - along with maintenance and some other costs**. Any shortfall in income relative to the costs can be offset against income from other sources, such as the wage and salary income of the investor.

*Assumes a well-planned and well-structured investment, in a growth location, and assumes the investor has the monthly cash flow needed to cover the shortfall.  ** Tax deductibility must be confirmed with your accountant.

The government has structured these tax deductions to encourage private investments into the property market, which relieves it of the need to provide large-scale social housing.

It's a concept that works well for renters, for the government and of course, for investors. It enables investors to buy and hold a property they would otherwise be unable to afford, knowing that in time, the capital returns will make the short-term negative gearing losses insignificant.

IMAGINE THIS: USING INVESTMENT PROPERTY TO PAY OFF YOUR HOME LOAN
Imagine that you are able to buy a high performance investment property in a growing location and the property achieves better than average growth rates. In time you could have an asset that has doubled in value.

Take this a step further, imagine selling this property - paying off the loan and paying whatever capital gains tax is to be paid - and using the profit from the sale to pay off your own home loan! Clever investors who purchased in Sydney in the late 1990's and sold around 2003 could have done just this. How would you like to pay off your home loan in one go?