Positive vs Negative Gearing: Compare the two!

In the world of property investing the terms "positive and negative gearing" are commonly talked about.

Before selecting a property to invest in, it is important to consider whether that property best suits your current investment strategy. An important way to determine whether a property is suited to you is to understand whether it is a Positively Geared (Cash-flow Property) or Negatively Geared (Capital Growth Property). To help you get a better understanding of what these terms mean, we are going to compare the two.

We will consider examples of how each investment works, the main advantages and disadvantages, and how they can work within an investment strategy. This will then help you to form a better idea of what may suit your own property investment strategy.

What is a positively geared property?

Positive gearing occurs when you receive more in rental income from your tenants than what you pay on the likes of loan repayments, interest, property maintenance, management fees, rates etc. This tends to happen at times when rents are high due to strong demand for rental property and low interest rates.

Other forms of investments like the dual dwelling properties are also a popular choice for those seeking a positively geared investment. A positively geared investment can also be referred to as a ‘cash flow property’. That's because the property is putting additional money into your pocket.

How it works:

As an example, let's imagine you purchase an investment property for $400,000 located in a location where vacancy rates are low and demand for rental properties in the area is very high.

You rent the property to tenants for a strong rental return of $500/week. The repayment costs for your property (loan repayments/property management fees/rates etc.) totals $410/week. Therefore, after all expenses this property is increasing your income by $90/week and in turn is paying for itself. In this situation the property is positively geared!

Now let's consider the advantages and disadvantages when investing in a positively geared property.

The advantages:

• Increased income - you benefit by receiving an income from the property and not having to be out of pocket. You can even use this income to make additional payments into your mortgage and own your home sooner!
• Not as much risk - if your income circumstances changes e.g. if you were to lose your job then the income will cover the costs of the investment and you are less likely to need to sell under pressure and potentially unfavorable conditions.

• Balanced portfolio - some investors may use a positively geared property to balance their portfolio, using the additional income to pay the shortfall of negatively geared investments.

• Lender Attractiveness - the additional income can increase your attractiveness to lenders for additional loans.

The disadvantages:

• Taxable - just like any form of income, the income you earn on a positively geared property is taxable.

• Slower long-term growth - often but not always, a positive cash flow investment can be located in a regional area (rather than capital cities), which commonly (but not always) see less or slower capital growth. Dual income properties can often be located in capital growth areas but also provide cash-flow.

• More volatile - these properties may be largely dependent on a particular industry of employment which can make it subject to greater volatility should employment factors weaken.

What is a negatively geared property?

Negative gearing occurs when the rental income you receive is less than the total costs involved of owning that investment property.

Often referred to as ‘capital growth properties’, negatively geared investments are expected to appreciate (grow) in value over time, and this increase is expected to outweigh any short-term financial losses. These properties are commonly located in areas closer to capital cities which typically perform better over the long term.

How it works:

As an example, let's imagine you purchase an investment property for $440,000. The property is located in a high growth, stable area where properties are renting for a more affordable amount due to a higher availability of rental properties in the area. You rent the property to tenants for a rental return of $425 per week.

The repayment costs for your property (loan repayments/property management fees/rates etc.) totals $440 per week. Therefore, after all expenses - the rental income for this property does not fully cover repayment costs and you have a short-fall of -$15 per week. In this situation, the property is negatively geared.

Now let's consider the advantages and disadvantages when investing in a negatively geared property.

The advantages:

• Tax Deductions - a common reason investors choose this strategy is that it allows you to claim tax deductions related to the expenses you incur so by claiming the available tax deductions. You can reduce your rental short-fall and ultimately reduce your taxable income.

• Capital Growth - assuming the strategy goes to plan, the capital returns from the property will eventually outweigh the borrowing levels and costs to create wealth for the investor at sale.

• More affordable for tenants - because of the affordability, it can be easier to secure a tenant for the long term.

• Less volatile - unlike a property in a regional area which may rely heavily on particular employment industries to drive up demand, these properties rely on a variety of factors and can be a less volatile investment.

The disadvantages:

• Budgeting is needed - you need to be able to budget for the ongoing shortfalls, also, when the property is sold for a profit, the tax man collects on the capital gain.

• Long-term strategy - it’s a longer term wealth creating strategy so if your circumstances change and a sale is necessary the sums may not work out favorably.

• Higher financial risk - if in the instance you were to lose your job you will need to be able to maintain any costs involved. Make sure you have a plan in place to ensure you are prepared. For example, income protection and insurance policies.

What suits your investment strategy?

The property you select will highly depend on your affordability factors as well as long-term investment goals. Before you decide to invest in any property it is essential to consider any risks involved and to grow your knowledge. Remember to always get advice from experts and to have a clear understanding of everything involved.

More information christianstevens@shorefinancial.com.au 0404 242 033