Positive vs Negative Gearing explained
What is Gearing?
Properties are positive or negatively geared based upon their cash flow over the financial year. Positive gearing is when the regular income generated by an asset (in this case a property) exceeds the ongoing costs of the investment. Negative gearing means the cost of owning a property exceeds any profits you make.
The most common form of positively geared property is an investor charging rent to tenants, that covers their loan repayments, management costs, maintenance, etc.
Negatively geared properties don’t generate enough passive cash flow to cover these expenses.
Benefits of positive gearing
- Additional cash flow through passive income
- The asset essentially ‘pays for itself’
- Having a positively geared property and passive cash flow can make securing another investor loan for another property easier.
Benefits of negative gearing
- Claim losses at tax time
- Property value can still appreciate over time despite running at a loss.
Negative gearing misconceptions
Branden Sarafov, Founder of Property Comet, points out a major misconception on the topic of property gearing.
“One misconception about property investing is that buying property for tax incentives is a viable investment strategy.
“This is far from the truth, tax incentives with negatively geared property should not be your main focus when investing.
“Tax depreciation benefits should be supplementary to your overarching strategy.
“Property investing should be geared towards capital growth, and/or cash flow depending on your circumstances. If you purchase an investment property that is negatively geared, it can be rationalised if the property has strong potential for capital growth.
“However, purchasing a negatively geared property purely for tax incentives is redundant. To put this into perspective, you should run your property portfolio like a business, you wouldn’t start a business to lose money every month simply to minimise tax. Similarly, property investing doesn’t meet its full potential if you are investing simply for tax purposes.”
Which is better?
The way a property is geared shouldn’t be the focus of an investment strategy.
Positive or negative is supplementary to the overarching approach and goal of the investor. There appears to be an over-emphasis on the way an individual will gear a property to reduce their income tax. Purchasing property should focus on growth, cash flow, or a blend of both.
An individual’s circumstances and ambitions will dictate the type of property they purchase and income will determine their borrowing capacity. These variables may influence an investor’s approach to invest and the parameters they may be required to work within. If you had to choose one approach it would make sense to pick positively geared property as this strategy puts more money into your pocket than negatively geared property. However, neither should be at the forefront of an investor’s decision. An investor should focus on finding high-demand properties which will provide capital growth over time.