At its core, gearing is the process of borrowing money to invest in property – a common pathway for many investors towards a growing portfolio. Whether a property is positively or negatively geared usually depends on how much debt is owed against it. In this article, we get a better understanding of the two finance strategies and their differences.
Positively Geared Property
A property is deemed to be positively geared when the rental yield falls short of the expense of owning the property (primarily the loan repayments), but ultimately produces an income when the tax deductions and depreciation savings are factored in. Essentially, a positively geared property generates a profit for the owner that could be reinvested or used to cover other expenses.
Pros
Self-Funded Property
A loan is used to purchase a property, but the rental income completely covers maintenance, loan repayments, and other associated costs.
Positive cashflow that can be used for elsewhere
Not only does the investment pay for itself, but it creates positive cashflow that can be used for investment or other financial obligations.
Finance
It may be easier to secure finance on a positively geared property as it could be deemed as less risky due to the positive cashflow.
Risks
Capital growth
There is an ongoing debate whether prioritising positive cashflow or capital growth is more important, because typically it is rare to achieve both. Properties that are positively geared historically have less capital growth potential. Definitely something to consider and depends highly on each individual’s circumstance.
Doesn’t allow an optimal tax minimisation strategy
Income generated by your investment property is added to your personal income and subject to higher tax brackets.
Negatively Geared Property
On the flip side, a property is negatively geared when the cost of owning it outweighs the income received. As a result, the property is making a financial loss and needs to be supplemented from other income sources. Ultimately, the cash outflows are tolerable or even attractive for investors because it could reduce the taxable income they need to pay while hopefully achieving capital growth on their investment.
Pros
Reduces taxable income
The net loss from the investment property can be used to offset your taxable income. Investors can claim deductions for the expenses incurred to maintain your investment property, such as mortgage interest, property taxes, maintenance costs and even depreciation. A bigger lump sum of money is received as a tax return.
The focus can be on capital growth
Adding another regular expense that reduces your net income is generally something to avoid when trying to grow wealth. But a negatively geared investment can definitely still be worth having if it achieves capital growth in the long term. Additionally, equity unlocked from an appreciating property can be leveraged for future investment.
Risks
Requires careful money management
Owning a negatively geared investment requires upkeep from other sources of income. Investors need to keep up with these expenses to maintain the investment.
Vulnerable to interest rate changes
Both positively and negatively geared properties with a variable loan are subject to interest rate changes. However, it could potentially affect investors with negatively geared properties even more because it will force them to dip into other income further.
Which strategy is right for you?
The choice between positive and negative gearing ultimately depends on your investment goals, financial situation, and risk appetite. Positive gearing can provide you with immediate cash flow and less risk, while negative gearing can provide you with tax benefits and potential long-term gains. It’s important to do your research, consult with a financial advisor or accountant, and carefully consider the pros and cons of each strategy before making a decision.
Any advice provided is general in nature and should be considered in line with your financial situation, needs and objectives.
