A Beginner’s Guide to Positive and Negative Gearing
If you are looking to invest in property, you will have come across the term ‘positive and negative gearing’.
Before building or selecting a property to invest in, it is important to determine what your investment ‘gearing’ strategy is. This is where an understanding of whether your home is positively geared (a cash-flow property strategy) or negatively geared (a capital growth property strategy) becomes significant.
For a better understanding of what these terms actually mean, we have compared the two strategies and outlined the benefits and drawbacks of each. Consider both carefully before purchasing your investment property!
Positive Gearing (a cash-flow property)
Generally considered the safer, more conservative method, positive gearing occurs when the rental income on your investment property exceeds the cost of maintaining it, including loan repayments, interest, rates and maintenance fees. Positive gearing allows for short-term profit, as the extra cashflow works as an additional income stream. Positive gearing works in areas where rental demand is high (so investors can charge higher rent) and when interest rates are low.
Advantages
- There is a faster short-term profit. Investors will immediately gain an additional income stream.
- Lender attractiveness. The additional funds can make the investor appear more attractive to lenders, allowing them to build their portfolio quickly.
- It is less risky. If circumstances change and the investor loses their job, they will not be under pressure to potentially pay two mortgages.
- A balanced portfolio. Additional funds may be used to pay for another, negatively geared property.
Disadvantages
- The additional funds are taxable. As with your regular income, any funds gained on a positively geared property is taxed.
- Less long-term gains. While you are immediately rewarded with additional income, it lacks the long-term payoff of a negatively geared property.
- It is circumstantial. A positively geared property can very quickly become negatively geared. If you need to reduce the rent or expenses increase, you may find yourself having to cover the extra costs.
Negative Gearing (a capital growth property)
Negative gearing occurs when the property runs at a loss – that is, the rental income is less than the costs of maintaining the home. Investors will need to use their own funds to make up the shortfall. Ideally, a negatively geared investment will grow in value over time, and the increased profit from selling it is expected to outweigh the initial financial losses. Negatively geared homes are often located near capital cities, which generally perform better and increase in value over a longer period.
Advantages
- There is a greater long-term profit. Over time the value of the property can be increased to the point where it exceeds the long-term costs of maintaining it.
- It is tax deductible. A negatively geared home allows you to claim tax deductions related to any expenses you incur, so you can reduce the shortfall in rent and ultimately reduce your taxable income.
- Generally, they are less volatile. Homes in regional areas can often be affected by particular employment opportunities (such as mining), whereas negatively geared homes are more likely to be in more populated areas, where there are less factors that can affect its value.
Disadvantages
- It is a long-term strategy. If your circumstances change, or you lose your job, you will still need to cover the shortfall in rent.
- There is higher risk involved.An investor needs to find a home that is very likely to grow over time, not decrease in value. This will require careful research. The home will also need to be sold while home prices are high, or there could be heavy losses.
- You will need to budget.Ongoing costs with a long-term investment will add up. You also need to consider you will be taxed on capital gains accrued when the property is sold.
Hotondo Homes has over 90 home designs, perfect for investors. Find out more at hotondo.com.au.
*Hotondo Homes is not an authorised financial adviser so please seek professional advice for your investing enquiries.
