When you buy a property, it’s important you understand if it’s positive geared or negative geared.
You should also be aware if it’s possible to change the ‘gearing status’ of a property by adjusting the rental income or undertaking renovation work.
But firstly, what is positive gearing and negative gearing?
Positive gearing, also known as a cash flow property, means that the rental income generated exceeds the mortgage repayments and all associated costs, such as utility bills, council fees, strata / body corporate fees and so forth.
For example, your property rents for $1,000 a month but the combined monthly mortgage repayments and associated costs are $800. This means you make a profit of $200 each month.
Contrarily, negative gearing, also known as a capital growth property, works in the reverse.
For example, your property rents for $1,000 a month but the monthly mortgage repayments and associated costs are $1,100. This means you make a loss of $100 each month.
Why do investors willingly make a rental loss on their property?
In countries where negative gearing is legal, such as Australia and New Zealand, many investors negative gear their properties because the rental loss can be used as a tax deduction. This is particularly beneficial if you have additional income from a second job, business profits, shares, bonds, etc.
Many investors expect that negative geared properties will have strong long-term capital growth.
This is because, though the rental income of a negative geared property may be low due to presently poorer demand, the area itself and the property will become more desirable, gentrified and/or better connected to high employment areas, such as the city, in the long-term.
Thus, in theory, profits made from the sale of a negative geared property should far exceed the months or years of making a rental loss.
Take note, this theory is not a proven science and there are more risks involved, so ALWAYS research the area thoroughly before purchasing. I’ve listed some buying tips for you here.
Additionally, if you want to buy a negative geared property, you should hire a good accountant who understands the regulations and loopholes so you get the best tax deductions.
Which is better – positive gearing or negative gearing?
Unless you have a large sum of money and can afford to make regular rental income losses without losing sleep at night, then I think it’s better to purchase a positive geared property.
As discussed in my previous post, I only buy properties which have a 5% annual rental yield. (You can learn how to calculate the rental yield of your desired property here).
Now saying that, two of my properties were negative geared when I bought them, and remained so for the first two or three years after purchase. This is because my husband and I had two incomes to cover the rental losses.
Additionally, we knew if we renovated the run-down apartments ourselves for roughly $5,000, we could increase the rent by 50%. Thus, converting the negative geared properties into positive geared properties – which we did do.
Serious investors may tell you that negative gearing is a better investment option because of the tax deductions and long-term capital gain. This can be true but at the same time, you take more risks when purchasing a negative geared property.
Remember, if your property is negative geared, then any expenses not covered by your rental income will need to be paid out of your OWN pocket.
Can you afford this now and in the long-term?
If the interest rate rises, can you afford higher mortgage repayments?
If you lose your job tomorrow, do you have extra savings to cover your mortgage repayments for the next few months?
If you answered ‘yes’ to the above questions, then maybe negative gearing could be an option for you to explore further.
However, if you answered ‘no’ to the above questions, then positive gearing is probably the wiser path for you to take at this stage of your life.
So do you prefer negative gearing or positive gearing, and why?
Please note, though I own a few properties, I am not a legal, financial or professional property expert. I’ve written this post to share my personal experiences and would love to hear your opinions and views.
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