If you’re considering investing in property, you’re likely to have come across some different property finance strategies on property forums and real estate news sites, with negative gearing and positive gearing being the two main prominent ones.
In this article, positive gearing is going to be our focus. Only 40% of residential properties are positively geared properties, and while it doesn’t receive much attention from property experts or real estate blogs, having a positive cash flow property is a great option for first-time investors who want to reduce their risks and take advantage of low interest rates.
Keep reading to learn how positive gearing works, the advantages and disadvantages, and what to consider if you’re thinking of positively gearing your property.
What is positive gearing?
In a nutshell, positive gearing is when your rental property generates more income than it costs in expenses to run. So, if your property makes you more than you pay, you have a positive cash flow and a positively geared property.
Keep in mind that this includes all your holding costs. You need to include maintenance, property management fees, council rates, insurance premiums and the like, when calculating your expenses, and not just mortgage repayments.
For example, say your property costs $450 a week in holding expenses, and you’re getting $500 a week in rent – that’s a positive cash flow of $50 a week, and a positively geared property!
What are the advantages of positive gearing?
There are a few key benefits of a positive cash flow property that make it an attractive prospect, especially for first time investors:
A positively geared property has three main pros. It gives the investor extra cash flow, helps make it easier to get approved for another loan, and is a more financially secure option.
1. Extra cashflow
Because the property will be paying for itself each week, plus making a profit, you’ll essentially have a new income stream. This way, you can pocket extra cash on a regular basis.
2. Boosts your serviceability
Since you’re actually profiting off your property, banks will look upon you more favourably when deciding whether to grant you another loan. This puts you in a great position to expand your portfolio and move past your first property – something which the vast majority of owners fail to achieve, partly because of negative cash flow.
3. Financial security
If the unfortunate happens and market conditions change for the worse or personal circumstances take an ugly turn, the good news is you likely won’t have to sell your property to cover any shortfalls. This is when positive cash flow is a big plus.
What are the disadvantages of positive gearing?
As with most things, positive gearing does come with a few drawbacks which are well worth noting before committing yourself to anything:
The main cons of a positively geared property is that you lose out on tax benefits, you risk buying low capital growth properties, and the profits themselves are quite slim.
1. Losing out on tax benefits
Because your positively geared property is now acting as a new source of income, it ends up being taxable like any other form of income. In the end, you’ll only get to pocket a portion of those weekly profits, depending on your personal tax bracket.
2. Low capital growth
Experts often say that positive gearing results in slower and lower levels of capital growth because of their, often, regional location. This means that you shouldn’t be expecting a big payout when you decide to sell. But then this is by no means an iron clad rule, and you may well find exceptions if you look in the right places at the right time.
3. Slim profits
even before tax, the profit you make on a positively geared property isn’t going to be a king’s ransom. Property research firm, Propertyology released a breakdown of positive cash flow suburbs in Sydney which shows just how modest the earnings can be:
- An 80% deposit on a house in Bardia with a median price of $625,750 will get you $66.23/week
- An 80% deposit on a house in Lansvale with a median price of $665,000 will get you $52.04/week.
So, when should you positively gear your property?
Whether or not positive gearing is the best option depends on what you value for your investment. Negative gearing means you’ll have to cope with ongoing financial losses, and for some investors that’s a sacrifice they’re fine making to get tax reductions. We suggest reading up more about negative gearing before making a decision.
If you’d rather secure an additional passive monthly income from your rent and you want a lower risk option, then positive gearing is better for you. Having a positive cash flow certainly helps your financial security on a day-to-day basis. That’s why we recommend new investors or those who are in humble beginnings to positively gear their first property.
Keep in mind though, that you could be missing out on high capital growth by positively gearing if your property is located in a regional area, as these properties often have low rental yield but higher capital growth rates. This isn’t always the case, and it does depend on the market a lot of the time, so it’s something to look out for and take into consideration.
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