The methodology behind positive gearing is simple: make more money on your investment property than you spend.
Making consistent profit sounds good, right?
So, it makes you wonder why only 40% of investment properties in Australia are positively (or neutrally) geared.
While positive gearing is one of the more conservative investment strategies, there are many benefits.
But you’ll need to weigh up whether the benefits outweigh the cons with your financial circumstances.
Here’s what you need to know.
Understanding Positive Gearing as an Investment Strategy
The term “gearing” essentially means that you’ve used a mortgage (or home loan) to purchase your investment property.
On the one hand, if you don’t make enough money in your investment property to cover the costs of running and maintaining the property, your investment is negatively geared.
But, if you are making enough profit to cover the expenses incurred (and maybe a surplus too), then your investment property is positively geared.
A key benefit associated with negative gearing (and why people tend to steer towards that strategy rather than positive gearing) is tax benefits.
Having a negatively geared investment means you can reduce your assessable income in your tax return by deducting the loss from your property. But generally, this should only be advisable if you believe the property will increase in value over time, Investing purely on the basis of reducing your taxable income with a lazy asset is a red flag.
However, there could be benefits associated with positive gearing because you’re making a profit at the end of the day, not a loss.
What Else Should You Consider?
It’s easy to find a negatively geared property (60% of Australia’s investment properties are negatively geared) because Australian property prices when compared to their rental yield, are so high. So, more rental rates wouldn’t even cover all the property expenses. But, positively geared properties are in high demand.
So, they’re harder to find – not impossible, but definitely more challenging.
It’s also worth noting that if you can find a property that you can potentially positively gear, you’ll have to put far more capital – the more you’re able to pay upfront, the less you’ll have to borrow.
The less you have to borrow, the less you’ll have to spend on monthly mortgage payments – allowing for more room for positive gearing.
This means that it would be a higher initial cost to acquire the property but smaller costs further down the road.
What Are The Benefits of Positive Gearing?
The two most significant benefits of positive gearing are passive income and positive cash flow.
Using the positive gearing strategy means you’ll essentially have a property that pays for itself.
What’s more, positively geared properties are typically found in areas where there are high rental demand and a solid rental return. So you’re likely to continue receiving enough income and positive cash flow from the property to pay for itself and generate a surplus too.
Leila bought an investment property in Cronulla for $625,000.
She could enter into a rental agreement with a tenant at a weekly rental rate of $705 per week.
Assuming that it costs $580 per week to manage the property, Leila can cover the expenses with the weekly rental and have a surplus of $125 per week:
$705 – $580 = $125
Other benefits that come with the positive gearing investment strategy include:
- Increased lending power – you can secure an additional home loan when you’re ready to increase your property portfolio.
- Flexibility to manage your portfolio – you’re less likely to be significantly impacted by any economic changes. For example, where one property might not be doing so well, you’ll have the surplus from the positively geared property to even it out.
- Tax deductions – while you may end up having to pay income tax on your investment property, there are many tax deductions you can claim to reduce your income tax liability. For example, you’re entitled to claim a tax deduction for the interest you pay on your home loan. You can also claim tax deductions for many of the rental expenses you incur.
For a complete list of tax deductions, you can claim, make sure you head over to the Australian Tax Office (ATO) website.
Are There Downsides to Positive Gearing?
All investment strategies have their upsides as well as downsides. It’s all about establishing whether the upsides outweigh the downsides concerning your financial circumstances and future goals.
Here’s what you’ll have to weigh up when considering positive gearing:
- Income tax: as with any form of income you generate, you’ll be liable to pay income tax on the income you receive from your investment property.
- Unexpected costs: there’s always the possibility that your investment property won’t always be positively geared because you can end up incurring unexpected maintenance costs, for example.
With positive gearing, it all comes down to meticulous planning. If you’re up to date with the property market and its fluctuations and you put any surplus aside for unexpected costs, you can successfully manage to keep your investment property positively geared.
Gearing Your Property for Positive Results
Structuring your home loan correctly is a crucial step you’ll need to take to gear your investments positively.
If you’re steering towards a positively geared investment strategy (instead of negative gearing), k to a mortgage broker to help you with the best home loan options to help you reach your goals. You should seek professional advice from a qualified mortgage consultant to help you lay out a solid foundation in achieving your goals.
When it comes to positive gearing, you’ll need to keep your monthly expenses low. A mortgage broker can:
- give you an idea of how much initial capital you need to obtain a loan with lower monthly repayments;
- help obtain a product that’s most suitable for you; and
- help avoid ( or minimise) having to pay Lenders Mortgage Insurance (LMI).
Positive gearing involves having a higher monthly return on your investment property than the expenses you incur.
In other words, a positively geared property pays for itself, and you end up taking home a profit too.
While positively geared properties may be harder to find, it’s an investment strategy worth investigating.
After all, who wouldn’t want to see immediate positive returns and cash flow on their investments?
But, to successfully positively gear your property, you’ll need a team of property professionals in your corner to help manage your expenses, take advantage of available tax deductions and keep on top of market fluctuations.
At The Mortgage Agency, we’ll:
- compare hundreds of home loan products on the market to find the best one suited to help you with positive gearing;
- work closely with your accountant, real estate agent and financial planner to ensure that you’re always getting the best outcome; and
- we’ll sweat the small stuff, so you don’t have to.
Contact us today to see how you could end up with a positively geared investment property!