Wealth building isn’t an easy task. But having the right knowledge and mindset can help you accrue great results with how you make your money and property earn for you.
We are going to be taking a look at two property investment techniques, called positive gearing and negative gearing, each with their advantages and disadvantages. In this article I hope to provide you with some insight and help you reach the most opportune conclusion that works for you.
One of the most common things you keep hearing from investors is that they need a property that’s ‘positively geared.’
Here’s what it actually means. Any property that generates rent which far exceeds the amount of your loan repayments, interest, maintenance costs and other expenses is called positive gearing. In short, you get more money in rent from your tenants than your expenses and repayments put together.
Surprised? This situation is not uncommon. It happens mostly when rents are going up thanks to strong demand and the interest rates on your debt/mortgage are low. Real estate folks also refer to such a property as a ‘cash flow property.’ Chances of getting such a property are high when a locality has problems with availability of accommodation and rental prices are higher there as well. This sort of property brings more money per week than it costs to cover its expenses.
Advantages of Positive Gearing
- Your income is increasing without any issue.
- This kind of investment is low risk even if circumstances in your life change. For example, it’s a dependable source of income even if you lose your job. You won’t feel the need to sell this investment/property since you are well set.
- It’s great for portfolio balancing. It gives investors additional funds to pay for any negatively geared investments that they have (more on this in a moment)
- It’s good for your credit score and balance sheet. Money lenders will not have any issues lending you money since you already have a dependable source of income.
Disadvantages of Positive Gearing
- The properties you own with positive gearing characteristics are liable for taxes. In short, you have to account for taxes.
- Cash flow properties are commonly found in regional areas and not in capital cities. This can potentially mean these regional areas are bound to see less capital growth with time.
Any property that nets you less income than what you spend on owning that property is called ‘negatively geared’ property. They are also referred to as ‘capital growth properties’. This is because these investments are expected to grow over time in their value and appeal, offsetting any short-term loss you may be making in the beginning of owning this property.
Negatively geared properties are commonly found in capital cities. They are almost always situated in stable areas that are growing at a phenomenal pace. This means that rents are always historically low and the gross rental returns are a reflection of that. Negatively geared properties are not expected to cover the ownerships cost in full, at least for the time being.
Advantages of Negative Gearing
- Investors who own capital growth properties can claim and avail tax deductions on their properties. By claiming tax deductions, your taxable income can significantly come down as a result of lower rental profit rates.
- Capital returns that negatively geared properties have are low in the start, but are expected to grow consistently. There comes a time when it far outstrips even the borrowing costs, making more money for the investor in the process.
Disadvantages of Negative Gearing
- A negative gearing strategy means you have to start budgeting to cover any shortfalls you face.
- If the property is being sold for a profit, the taxes will be applicable on the accumulated capital gains associated with the property.
- This calls for a long-term wealth creation strategy if you want to succeed with a negatively geared property. However, a lot can change in these years. Your circumstances may change and you might even be at more risk to sell your home.
So, Which One Is the Right Strategy for You?
To conclude, there’s no one-size-fits-all solution when it comes to the real estate investment game. It all depends on what works with your personal balance sheet, available cashflow, deposit and long term financial strategy. Taking time to plan your budget and working with an experienced team of financial experts including an accountant, financial planner and mortgage broker can help you work out the best strategy for you.