Positive or negative gearing: which is a better strategy?
When it comes to property investing, nothing polarises investors more than the debate over positive gearing and negative gearing.
Those in favour of positive gearing argue that it’s the best way to build your wealth while those on the other side of the fence say negative gearing is the only way.
The more important question is which one is less risky?
What is negative gearing?
Negatively-geared properties are also known as capital growth properties.
This is where the costs of owning the property, including principal and interest payments on the mortgage, property maintenance and repairs, real estate agent fees, insurance, and council and water rates, are more than the rental income being produced.
The strategy here is basically to “wait” for the property to grow in value and later sell it for a profit. In the meantime, you simply have to wear the costs of owning the investment property.
Read more about negative gearing here.
What is an example of negative gearing?
Let’s say you buy a $300,000 apartment unit in a newly-built apartment block in an area where there has been significant residential development.
It’s likely vacancy rates are high so in order to attract tenants, you charge around $300 for rent.
The problem is that your mortgage repayments and other property management costs amount to $400 per week.
You’re out of pocket $100 a week.
Use our negative gearing calculator to get an idea of how your investment strategy stacks up.
Negative gearing: pros and cons
- Claim losses on tax: You can claim most losses including depreciation when tax time rolls around and effectively reduce your taxable income. Independent financial advice is always essential.
- Capital growth: You’ll need a bit of luck as well but as long as you’ve invested in real estate in a location with strong fundamentals for future growth (blue-chip), you should see a good return on investment if you decide to sell at the end of a property cycle (typically 7 to 10 years). These gains should far outweigh any losses you’ve been hit with.
- Long term tenants: Although it may be harder to attract tenants, holding on to them may be a little easier than a cash flow property since the property will likely be located in an area with high vacancy rates or low rents.
Check out the property investor learning centre for more handy hints, tools and guides.
- Potentially tighter cash flow: A negative gearing strategy tends to have more success if you’re in a stable occupation and earning a regular income that is increasing over time. In this way, you can cover shortfalls in rent or property costs. If your situation changes, you’re not usually in a position to increase rent so it can really squeeze your cash flow and, at worst, force you to sell your property before realising any capital growth returns.
- Tighter cash flow affects borrowing power: With less income in your pocket, your ability to borrow the amounts you need for further property investment can be hampered.
- You’ll get taxed: Any capital gains will be taxed. Read more about capital gains tax and the cons of capital loss. Luckily, you’ll only pay tax on 50% of your capital gains.
What is positive gearing?
Positively-geared properties are also known as cash flow properties.
This is where the rental income that you receive from your tenants is more than what you pay to own the property.
This tends to happen in periods of strong rental demand and low interest rates.
What is an example of positive gearing?
You purchase a $350,000 property in an inner-city suburb where vacancy rates are low.
You’re in a position to charge $400 per week in rent.
The costs of owning the property total $350 per week so your net return on investment is $50 per week or $2,600 per year.
Check out the investment property calculator to get an accurate calculation of the weekly cash flow position of your next investment property.
Positive gearing: pros and cons
- Cold hard cash: You have more money in your pocket which you can save for a deposit to invest in more properties or simply pay off your investment loan sooner. It also provides a financial buffer should your personal situation change for any reason.
- Increase your borrowing power: Most lenders will only accept up to 80% of your rental income but at least one of our lenders will accept up to 100% when assessing your income for a home loan.
- New and old investors: People new to investing or those nearing retirement may not want to be burdened by too much debt so a cash flow positive strategy tends to make more sense.
- The (other) great equaliser: Cash flow positive properties can help keep your property portfolio in check by covering any losses you incur on negatively geared properties you own.
- You’ll get taxed: The Australian Taxation Office (ATO) will take a slice of your rental income.
- Slow capital growth: Since most positively geared investment properties are located in rural or regional towns, any capital gain benefits will have to wait since growth rates tend to be slower than in metro/city areas. This can also hamper any plans you had to access equity in order to fund future property investment.
- Low yields are your enemy: Generally speaking, the higher the rental yield, the more cash flow positive the property is. In a high property growth environment, yields are low so this can have a negative effect on your positive cash flow strategy.
- Fluctuating growth: You’re relying on good economic factors including low interest rates, low vacancy rates and even strong employment figures to keep the rent flowing in, leaving you with some surplus gains after costs. For example, towns that are relying on particular industries like mining may be high yielding one day and go bust the next.
- Unexpected costs: Mortgage repayments and rates are one thing but freak maintenance and repair costs can really throw out your cash flow. Unfortunately, you can’t plan for the unexpected.
What do you want to achieve?
It can sometimes be hard to see the big picture when it comes to property investing, especially if you’re new to the game.
Generally speaking, a sustainable portfolio is all about balance. If you have some negatively geared properties in your portfolio, aim to balance it out with positively geared properties to offset the losses.
Overall, it’s important to surround yourself with experts including a financial adviser and a mortgage broker, as well as learn and form ties with people who have gone down the investment path before you.
There’s a lot of noise out there but eventually, you’ll learn to find the sweet spot in the level of risk you’re willing to bear and what to choose when it comes to negative gearing vs positive gearing.
Lender choice is essential when it comes to supporting your investment strategy and we have around 50 lenders to choose from.
Call us on 1300 889 743 or complete our free assessment form to speak with one of our mortgage brokers.