Positive gearing occurs when an investment property generates a greater rental income than the cost to own and manage the property. Also known as a cash flow property, this happens when there is a strong rental demand and low interest rates.
In contrast to negative gearing — which occurs when the rental income is less than the cost to own the property — positive gearing earns an annual profit. However, there will be tax implications. While you may be earning more from the rental rate you charge, you might end up paying more tax for it.
The pros and cons of positive gearing
Like any investment, you have to look into the advantages and disadvantages that come with positive gearing. You have to consider your current financial situation and your future goals.
Passive income. Positive gearing gives you a steady source of income and capital gains as the property value increases over time. It also gives you increased income to make additional payments to your mortgage and own the property sooner rather than later.
Positive cash flow. Since a positively geared property pays for itself, it won’t affect your finances and you won’t be pressured to sell the property should your circumstances change.
Balancing your portfolio. If you own more than one property, you can have at least one positively geared property and use its income to cover the shortfall of your other properties that are negatively geared.
Easier lending. A positive cash flow and balanced portfolio will make it easier for you to secure another home loan to expand your portfolio.
Tax implications. Like any income you earn, a positively geared property will be taxable. You may earn a higher income with your investment properties, but it may not be the case after taxes.
More volatile. It might be easy to positively gear a property, but these may be located in areas with slow growth as opposed to more expensive areas, which makes it difficult to foresee its growth.
How does positive gearing work?
Let’s say you bought an investment property worth $500,000 in a location with high rental demand, and you rent it out for $570 per week.
Assuming that the cost you incur from owning the property is $465, you can cover the expenses and have a surplus of $105 per week.
$570 – $465 = $105
Having such rental income would mean that your property is positively geared.
Is a positively geared property worth it?
The straightforward answer is: it depends.
Positive gearing might be right for you if you’re confident about the future and willing to take on some risk. The strategy can be used by people who are confident about their investment returns, as well as those with an eye on future earnings from the rent or sale of their properties.
However, if your main concern is minimizing risk (rather than maximizing expected return) then you may need to reconsider.
Before you make any decisions, ask yourself some important questions about your finances now and in the future. Be sure to consider the pros and cons of both positive and negative gearing. It’s also a good idea to consult with an experienced financial adviser.
- What is your current financial situation?
- What are your goals?
- Are you willing to take on extra risk?
- Do you have enough money to cover the costs of negative gearing?
- Do you have enough money for a deposit (if applicable)?
Positive gearing is a useful tool for investors, but it can be complicated. Make sure you understand the basics before investing in a property with this strategy.
If you’re considering investing in property, it’s also worth consulting an experienced adviser who can help you navigate the positives and negatives of positive gearing.