Understanding positive and negative gearing is important as it impacts heavily upon the type of investment strategy you should take based upon your individual circumstances.
Such factors as income, job stability, family dependants, borrowing capacity, age and other investments and committments all come into play when considering whether you are more suited to a positively geared or negtatively geared property. With that in mind, it’s recommended that you seek expert advice regarding your investment strategy before you head out and select a property.
So, what is the difference between a positively geared property and a negatively geared property? We will discuss both types of properties below so you can better understand what may be the most suitable for your own situation.
Positively Geared Property
A property is positively geared when the rent you receive from your tenants is greater than what you pay for expenses such as loan repayments, interest, insurance, rates and property maintenance. This is often referred to as a ‘cash flow positive property’.
For example, you may receive $500 per week in rent from your tenants but your expenses are only $400 per week. Therefore, you are receiving $100 per week in income from the property which means the property is positively geared, or ‘paying for itself’.
Often, positively geared properties have a high rental return as demand is high and rental availability is low.
What are the advantages?
- You are generating an income from your property without having any out of pocket expenses
- The surplus cash flow can be used to reduce the principal
- Increased borrowing capacity due to higher income
- As the property has no out of pocket expenses, if your personal circumstances happen to change due to the loss of a job for example, your property can continue to cover its own costs without adding any additional financial pressure
- Higher capacity to save due to increased disposal income and abilty to live off of the income over the long-term
- In some instances, investors use positively geared properties to balance their property portfolios as the additional income can be used to cover the shortfall resulting from negatively geared properties
What are the disadvantages?
- As you are earning an income on the property, you will be expected to pay tax on that income
- While positively geared properties can be sometimes be sourced close to cities, they are typically located in regional areas which are often dependant on a particular employment industry (for example, mining) which makes them subject to greater volatility and can therefore result in lower levels of capital growth over the long term
- It can be difficult to lock in long-term tenants due to employment demand fluctuations
Negatively Geared Property
A property is negatively geared when the rental income you earn is less than the costs associated with owning the property.
For example, you may receive a rental return of $400 per week however your weekly expenses on the property total $440. You then have a shortfall of $40 per week making the property negatively geared.
Differing from positively geared properties, negatively geared properties can often be expected to appreciate in value over time and therefore generate greater capital growth. This is generally due to the fact that these particular properties are located in a stable, high growth areas close to capital cities.
What are the advantages?
- Negative gearing is popular among investors as there are immedate tax advantages. You can reduce your taxable income by claiming the tax deductions relating to the expenses of owning the property which can then reduce your rental shortfall
- The capital returns from the property will eventually outweigh the expenses of holding the property which may result in a healthy capital gain for the investor at sale
- Negative gearing is a good startegy for high income earners to grow their property portfolios due to the tax benefits
- It can be easier to secure long-term tenants as rental yields may be lower, making the rent more affordable for tenants
- Negatively geared properties are generally less volatile as they are located in areas where a number of factors have an impact upon the rental demand (as opposed the regional areas with heavy influences from employment industries etc)
What are the disadvantages?
- Negative gearing as an investment strategy can often place greater levels of stress on the investor to meet repayments, so budgeting is essential
- If the property is sold for a profit, you will be required to pay Capital Gains Tax
- You rely on your property increasing in value in order to make a positive return on the investment
- There can be greater risks associated with this strategy due to the fact you have an ongoing shortfall so any changes to your employment or income may cause a strain financially
- Unless you earn a substancial income, it can be difficult to hold multiple properties using this strategy
- This is a long-term strategy so if a situation arises where sale of the property necessary, you may not see the returns you initially hoped for
As you can see, both strategies have their pros and cons which should be carefully considered when deciding upon your property investment plan.
You should spend some time analysing your long-term investment goals, what you can comfortably afford and the types risks involved before purchasing a property. As mentioned, it is recommend you consult with an expert to ensure you are equipped with all of the tools necessary to make a sound decision.
If you would like assistance setting your long-term property investement plan, please contact us as we would be happy to guide you through the property investment process to ensure you are on the right track to creating wealth through property.