Positively geared investments vs. Negatively geared investments
If you’re in the property investment market, or hoping to be, you’ve very likely heard the terms ‘positive and negative gearing’. The two terms relate to different investment strategies, with different outcomes. What works for one investor may not work for another, so it’s important to look at your options based on your own individual needs or financial constraints.
So, what’s the difference between positive and negative gearing?
Positive gearing
Positive gearing simply means that your investment property earns more income than it costs to have it, so you are receiving more rental income from your tenants than what you pay for things like the loan repayments, interest, maintenance of the property, rates and other fees. Usually this happens when rents are high due to a strong demand, or when interest rates are low.
For example, if your investment property earns $500 per week in rental income and your loan repayments and other associated costs are $450 per week, then you are positively gearing that property and you don’t have to pay anything out of your own pocket each week to continue your investment. The property effectively pays for itself.
That said, it’s not always the investment strategy of choice for many investors. Let’s look at some of the pros and cons of positive gearing:
Pros
- The risk isn’t as high – because the property pays for itself, the risk isn’t as high if your circumstances were to change such as a job loss.
- More money in your pocket – on a week by week basis you have no out of pocket expenses, and you might even be making enough from the property to make extra loan repayments or save for your next investment.
- Future lending – the status of your investment portfolio can look good, which may mean you are appealing to lenders for your next loan.
Cons
- Changing markets – depending on where you buy, you could experience a dip in demand for the property which would mean less, or no, income from the property.
- Income is taxable – just like any other income, the income you earn on a positively geared property is taxable.
Negative gearing
Negative gearing with property is when your expenses, such as loan repayments and rates, are higher than the rental income you receive from tenants. This means that you are out of pocket as you will have to contribute to the loan repayments yourself as well.
While it sounds like an odd thing to do in the short term, the goal with negatively gearing an investment property is that you will eventually make more money through an increase in its value than what you pay out, or lose, through expenses.
Let’s look at the pros and cons for negative gearing:
Pros
- Tax breaks – a lot of investors choose negative gearing because it allows you to claim tax deductions relating to expenses you incur. Investment losses reduce your taxable income which in turn reduces the amount of tax you pay.
- Appealing to tenants – often properties that are negatively geared have slightly lower rent, which is appealing and more affordable to potential tenants.
- Capital gains – if the property continues to increase in value, the capital gains from it will eventually be high enough to cover borrowing and associated costs, meaning the investor can earn more when selling.
Cons
- Higher risk – if your income suddenly changes, you may not be able to cover your costs for the property.
- Budgeting – you need to be able to budget way ahead of time, for things like maintenance, increases in interest, or if the property sells for a profit you will need to pay tax on the capital gain.
- A long game – negatively investing in property is a longer term strategy to create financial freedom, so you need to be prepared for that and not expect passive income yet.
So, at the end of the day, neither investment strategy is better than the other. The both have their advantages and disadvantages, and the benefit of either will depend on the investor and their ideal strategy.
If you’d like to discuss which option bests suits your needs, contact us today!
