Weighing Up Positive and Negative Gearing

There are positives and negatives to everything, including property investment strategies. If you are considering investing in property for the first time you probably have some questions around using a positive or negative gearing strategy.

Like with all financial decisions, the best option is always dependant on your unique circumstances. When it comes to positive or negative gearing an investment property, factors such as your income, borrowing capacity, financial goals and time frames and the level of risk you are comfortable with are all considerations.

Despite personal factors determining the options available to you, there are some general pros and cons to both positive and negative gearing an investment property which I have outlined below.

Positive gearing

A positively geared investment exists when the rental income you receive is higher than the expenses for the property. This type of investment is often referred to as a ‘cash flow property’ as the property is putting additional money into your pocket.

The Pros

  • Increase your income

  • Not as much risk if your income circumstances changes e.g. if you were to lose you job then the income will cover the costs of the investment and you are less likely to need to sell under pressure and potentially unfavorable conditions

  • Are used by some investors to balance a portfolio by using the additional income to pay the shortfall of negatively geared investments

  • The additional income can increase your attractiveness to lenders for additional loans

The Cons

  • The income you earn on a positively geared property is taxable

  • Often positive cash flow investments are located in regional areas (rather than capital cities), which commonly (but not always) see less or slower capital growth

Negative gearing

A negatively geared investment exists when the rental income you receive is less than the costs of owning the property. Often referred to as ‘capital growth properties’, negatively geared investments are expected to appreciate in value over time, and that this increase will outweigh any short-term financial losses.

The pros

  • A big pro and a common reason investors choose this strategy, is that it allows you to claim tax deductions related to the expenses you incur so by claiming the available tax deductions, you can reduce your rental profit and ultimately reduce your taxable income

  • Assuming the strategy goes to plan, the capital returns from the property will eventually outweigh the borrowing levels and costs to create wealth for the investor at sale

The cons

  • You need to be able to budget for the ongoing shortfalls

  • When the property is sold for a profit, the tax man collects on the capital gain

  • Some property experts argue that investors who use tax breaks to own properties are willing to pay more for purchases, pushing up prices and negatively impacting affordability for first home buyers

  • It’s a longer term wealth creating strategy so if your circumstances change and a sale is necessary the sums may not work out favourably if the market if flat (i.e. you need the right conditions for sale to ensure the eventual profits outweigh the expenses)