Positive gearing vs negative gearing

As property investors, it's crucial to understand the concept of gearing, a strategy that involves borrowing funds to invest in a property.?

Gearing can be either positive or negative, each with its own set of implications for cash flow, tax benefits, and investment goals.?

What exactly is positive gearing?

Positive gearing occurs when your property's rental income exceeds the cost of owning and maintaining it. This means you earn a net profit, which you have to declare as taxable income.

For instance, let’s imagine you buy a property for $500,000 and charge a rent of $500 per week. That will mean you generate $26,000 per year. Your total annual expenses, including mortgage repayments, amount to $20,000.? As a result, you have a net income of $6,000, which will be added to your total annual income and taxed accordingly.?

The pros of positive gearing?

Positive gearing can offer immediate financial benefits, making it a popular choice for a variety of investors.?

Here’s why some investors favour this approach:

• Immediate Cash Flow: One of the most appealing aspects of positive gearing is that it generates an immediate and consistent income stream. This is particularly beneficial for investors who require a steady cash flow, whether to support their lifestyle or to reinvest.

• Lower risk: Since the property is generating more income than it costs to maintain, there’s less financial stress involved.?

• Market independence: Positive gearing doesn't rely heavily on market conditions for its success. Even if the property doesn't appreciate significantly in value, it’s still generating a steady income, making it less dependent on long-term market trends.

• Financing opportunities: The regular income from a positively geared property can enhance your borrowing power. With additional income rolling in, you may also have more options for reinvestment or for diversifying your portfolio.

Cons of positive gearing

While positive gearing offers immediate financial gains, it's not without its drawbacks. Understanding these disadvantages is crucial for making a balanced investment decision.?

Here are some key downsides to consider:

• Taxable income: One of the immediate downsides is that the extra income generated by your positively geared property is taxable.

• Lower capital growth potential: Properties that are positively geared often have lower capital growth potential compared to negatively geared properties. This can make them less suitable for investors looking for substantial long-term gains.

What exactly is negative gearing?

Negative gearing happens when your property-related expenses exceed the rental income.?

As an example, let’s imagine you buy a property for $600,000 and rent it out for $400 per week. The annual rental income is $20,800. However, your yearly expenses are $25,000, including mortgage, property management and repairs. This results in a $4,200 loss.

The good news is that, in Australia, you can offset this loss against other forms of income, thus reducing your overall tax liability.

The pros of negative gearing?

Negative gearing can initially seem counterintuitive—why opt for a property that doesn't immediately generate a profit? However, this strategy has its unique appeal and advantages, especially for certain types of investors.?

Here's why some choose to go the negatively geared route:

• Long-term capital growth. The most compelling reason is the prospect of long-term capital growth. Even though you might be making a loss on your property now, the idea is that its value will significantly increase over time. This could potentially result in a large profit when you decide to sell.

• Tax benefits: Negative gearing allows investors to offset property losses against other income streams, effectively reducing their overall tax liability. This can be particularly advantageous for those in higher tax brackets, as it can help bring down their taxable income to a lower bracket.

Cons of negative gearing

Here are some key drawbacks to consider:

• Negative cashflow: The most immediate downside is the negative impact on your cashflow. You'll be out of pocket as you need to make up the difference between rental income and property expenses, which can be financially stressful.

• Dependence on capital growth: Negative gearing relies heavily on future capital growth to be profitable. If the property doesn't appreciate as expected, you could be left with an underperforming asset.

Which strategy is right for you?

There isn’t one answer as the right strategy will depend on your financial circumstances, investment goals, and risk tolerance

Below, we outline some key considerations for you to think about:

• Financial situation: If you’re after a steady income, positive gearing can be more appropriate, as the property will generate a surplus. On the other hand, if you have a stable income and can absorb short-term losses, negative gearing might be more suitable.

• Risk tolerance: Positive gearing is generally considered less risky because it provides immediate returns. Negative gearing involves more risk due to its dependence on long-term property appreciation.

• Investment timeline: Those with a longer investment timeline may find that a negatively geared property will become positively geared as rents increase over time, offering the best of both worlds.

Choosing between positive and negative gearing is not just about crunching numbers; it's also about aligning your property investment with specific strategies that can help you achieve your financial goals.

For instance, if you are looking for a positive cashflow property, it’s a good idea to:

• Target high-demand, low-supply markets
• Opt for properties that require little ongoing maintenance to keep costs low. Newer properties or recently renovated ones can often meet this criteria
• Look for properties with diverse tenant appeal, as this can make it easier to keep the property leased
• Regularly review rent prices to make sure you're charging a competitive market rate
• Consider short-term rentals as, in some cases, they can offer higher income than long-term leases. However, be sure to factor in higher turnover and maintenance costs.

Cashflow Analysis?

• Cashflow analysis is a big part of investing and hence, we have created a cashflow calculator if you would also like to be on top of your property cashflow.

• If you would like to get a free copy, please get it through the link below:

https://auswideba.com.au/cashflowcalculator

Looking to buy a high-quality investment property? Auswide Buyer’s Agency can help. To discuss your options, book a free consultation with Ashish Malhotra.

Book a free consultation:

https://auswideba.zohobookings.com/#/customer/discovery