What is positive gearing & how does it work?

When it comes to property investing, we often hear media commentators and experts talking about negative gearing – but it’s not the only outcome for investment property owners or investors in the share market. A property can also be positively geared, and an investor could build up a portfolio made up of a combination of positively and negatively geared properties. Positive and negative gearing can apply to other investments, such as shares, but in this article we will focus on property.

According to the Australian Taxation Office (ATO), around 30% of Australians own an investment property with 40% of those being neutrally or positively geared. That means the majority (60%) of investment properties are actually negatively geared.

So, what exactly is positive gearing and why is it less common than negative gearing?

Negative gearing versus positive gearing – what’s the difference?

 Negative gearing is an investment method where you borrow money to invest (gearing) and the ongoing income the investment generates (usually rent) is less than the ongoing expenses (loan interest, maintenance costs etc.), according to ASIC’s Moneysmart.  In contrast, positive gearing is where you borrow money to invest and the ongoing income you earn from the investment is higher than your ongoing expenses.

With negative gearing, as there will be a cash shortfall, the investor will generally need to pay the difference out of their own pocket. In order to make money from their investment in the long run, the owner will be hoping the property increases in value over time (earning them a capital gain when they sell it) or that it starts earning a profit in the future.

When it comes to positive gearing, you might use the extra cashflow generated to pay down your mortgage, save for another property, or for day-to-day expenses. It’s important to note that a positively geared investment is different to a positive cash flow investment. An investment which is positively geared generates more income than expenses before tax, while a positive cash flow investment generates more income than expenses after tax and deductions are taken into account, and requires a different strategy. So, while a positively geared property might give an investor extra income each week or month as the rent is paid, a positive cash flow property will only put more money in the investors pocket after they’ve lodged their tax return for the year. A financial planner may be able to help you understand the differences and decide which strategy is right for your circumstances.

The key differences are summarised in the following table:

Positive gearing Negative gearing
How it works Earnings (rent) > expenses (interest, maintenance etc.) = ongoing net profit Earnings (rent) < expenses (interest, maintenance etc.) = ongoing net loss
Possible tax implications May need to pay tax on investment earnings (see the ATO website for further information) May be able to claim investment losses as an income tax deduction (see the ATO website for further information)
Impact on cash flow Extra cash flow – more money in your pocket to spend each week or month Will need to cover the cash shortfall between the investment cost and earnings
Potential earnings Ongoing income + capital gain (if the property ultimately sells for more than what you paid for it) Capital gain only, assuming the property sells for more than what you paid for it 
Availability of properties Can be hard to find, and may be in regional areas where capital growth tends to be slower and rents higher relative to property prices Often easier to find suitable properties in major cities and towns, where loan repayments are likely to outstrip rents due to higher property prices

How can you calculate if a property could be positively geared?

A property with the potential to be positively geared, put simply, is one that could attract a rental income that exceeds the ongoing costs. The costs include the mortgage repayments, and these could be reasonably low if the purchase price or interest rate was low, or the investor put down a large deposit to reduce the amount they borrowed.

By identifying your ongoing costs, such as mortgage repayments (including interest), maintenance requirements, management fees, insurance and tax on the investment income (rent), and subtracting this amount from the yearly rent the property is likely to fetch, you may be able to estimate whether the property has the potential to be positively geared. If the figure you’re left with is greater than zero, you may be able to positively gear the property. If it’s less than zero, the property is may be more likely to be negatively geared.

You may be able to find some price guides for your property costs online, along with median rents for the property type and suburb, or you might like to speak to a local property expert who can walk you through what your costs might be based on their experience. 

What to consider before positively gearing an investment property

Before deciding whether positive gearing of an investment property is right for you, it’s generally a good idea to talk to your accountant or financial planner, and consider the following:

  • What will your ongoing costs be? Don’t forget to include maintenance expenses, property management fees, strata or body corporate fees (if applicable), insurance premiums, council rates and utility bills, along with the interest you’ll be paying on the mortgage.
  • How much rental income will the property bring you? Remember to allow for potential periods of vacancy between tenants – you can find out the average for your property’s suburb online through sites such as realestate.com.au or domain.com.au.
  • What will the potential tax implications be? Refer to the ATO for a guide or speak to a qualified tax accountant.
  • What’s the potential for capital growth to offset any short-term losses? You may want to speak to a local property expert, or research historical price growth in the area.
  • How will any future interest rate changes affect you?
  • How do the property and its possible earnings fit into your overall investment strategy? For example, are you planning on holding onto the property for several years, so you can benefit from the potential capital growth? Or are you more focused on the income you’ll be earning from it right now?

How do fluctuations in the property market and interest rates affect gearing strategies?

When rents are high due to demand and interest rates are low, it may be easier for an investment property to be positively geared. In times of high interest rates and slow rental price growth, the opposite is generally true. This is because high interest rates mean higher repayments on investment loans, making it more difficult to find a property that can produce a rental yield in excess of the payments. According to property website Real Estate View, a good example of property that could be positively geared is in rural areas that are experiencing rapid industrial and employment growth, thus boosting demand for rental properties and allowing owners to charge more in rent. This is presuming the repayments on the mortgage plus other expenses are less than what is charged in rent.

How do I know if positive gearing is right for me?

Whether or not positive gearing is a suitable investment path for you will depend on your risk appetite, how you plan on setting up your investment portfolio, whether any suitable properties are available, your income and how you manage your tax affairs.

When making any big financial decision, it’s always wise to seek advice from experts in the field. Chat with your accountant or financial planner or check the ATO or ASIC MoneySmart websites for further information.

Header Image Source: ITTIGallery (Shutterstock)


Emily Boyd Canstar

About Emily Boyd

Emily Boyd is a freelance journalist and editor from Melbourne. She has a Masters degree in International and Community Development, and is a self-confessed research nut who loves to take tricky topics and make them more accessible and digestible to empower her readers. She’s also a mum of three and an enthusiastic amateur baker.

 

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