Positive gearing and negative gearing are two investment strategies that property buyers use to get ahead in the real estate game. We explore the pros and cons of each strategy and better yet, show you how to put them into practice.
Thousands of Australians choose to invest in property in an effort to boost their bank balance, but the truth is, it’s very easy to make costly mistakes. That’s why it pays to devise an investment strategy before you sink your hard-earned cash into a huge investment worth hundreds of thousands of dollars.
First and foremost, you need to consider your cash flow and work out whether a positively-geared or negatively-geared investment is your best bet.
Positively geared investment property
Pros: A positively geared investment exists when the rental income you receive is greater than the costs of property ownership, such as loan repayments, council rates and maintenance. These types of investments are often referred to as “cash flow properties” because the property is putting extra money in your pocket each week.
Cons: Any extra income you earn is taxable, so you’ll need to split some of your profits with the tax man. Also, positive cash flow investments tend to be located in regional areas rather than capital cities, so the capital growth or long-term price appreciation is generally slower than in more populated areas.
Example: You buy an investment property for $300,000 and obtain a loan for $270,000. Your mortgage repayments and other costs of ownership total $400 per week. Your rental income is $450 per week. Therefore, you pocket an extra $50 per week.
How to make it work: Look for properties in regional towns with high levels of population growth (ie. growing demand) and low levels of housing (ie. low supply). When you find a property that looks promising, create a detailed budget or use property software to work out what the “break even” point is to cover all ownership costs. Speak to local real estate agents about typical rents in the area and look for properties that have an extra “wow factor” to allow you to lift the rent slightly above neighbouring homes.
Negatively geared investment property
A negatively geared investment exists when the rental income you receive is less than the costs of property ownership. These types of investments are often referred to as “capital growth properties” because the strategy assumes that the property will appreciate in value over time, and that this increase will outweigh any short-term financial losses.
Pros: Negative gearing allows you to deduct your property losses against your income, essentially meaning you pay less tax. This is particularly beneficial if you are paying tax in the highest tax bracket.
Cons: On a month-to-month basis, you will need to chip in money from your own pay packet to fund your investments, which can be a drain on your budget.
Example: You buy an investment property for $300,000 and obtain a loan for $270,000. Your mortgage repayments and other costs of ownership total $500 per week. Your rental income is $450 per week. Therefore, you spend an extra $50 per week to maintain your investment.
How to make it work: Look for properties in thriving populations where capital growth has historically been strong (above 8 per cent -10 per cent per year on average). Calculate your ongoing ownership costs using an online calculator. Speak with local real estate agents to find out which types of properties are most sought after with locals and aim to buy a property that matches to give yourself the best chance of having your property tenanted year-round.