Property Investment – Is Positive or Negative Gearing Better
With many of our clients owning or looking to purchase an investment property, a question we’re often asked is whether a positively geared property is more favourable than a negatively geared property.
Firstly, let’s understand what both concepts mean.
Positive Gearing refers to a situation where the cashflow from an investment property is positive – that is, the rent you receive exceeds the outgoings on the property – typically interest on a loan, council rates, insurance, repairs and maintenance, etc.
Positive Gearing tends to occur in periods of strong rental demand and low interest rates. Exactly what we’re experiencing right now! More and more now we see clients with positively geared properties or with diminishing rental losses.
Negative gearing refers to a situation where the outgoings on a property exceed the rental income received – resulting in a rental loss. This of course requires the owner to contribute to the ongoing cashflow of the property in order to meet commitments.
Negative gearing tends to occur more in locations where rental demand is lower, resulting in lower rental income, and/or when interest rates are higher. Depreciation on a newer investment property can also contribute to a rental loss, without necessarily impacting on cashflow.
PROS AND CONS
There are pros and cons to both positive and negative gearing. Let’s consider some of those.
POSITIVE GEARING: PROS
Cash is King
More money in your pocket means you can consider other investments, pay down your loan quicker or fund other aspects of your lifestyle.
Increased borrowing capacity
Positive gearing essentially means higher income. So, if you’re looking to borrow further, your borrowing capacity is likely to be greater where you have a positively geared property.
Offset negative gearing
Those with a property portfolio may have both positively and negatively geared properties. A positively geared property can provide sufficient income to offset a shortfall from a negatively geared property. This means you won’t have to dip into your pocket to fund any shortfall.
POSITIVE GEARING: CONS
A rental profit is taxable income, meaning you’ll pay tax on any surplus.
You’re relying on good economic factors including low interest rates, low vacancy rates and even strong employment figures to keep the rent flowing in, leaving you with some surplus gains after costs. All factors you can’t control or necessarily predict.
NEGATIVE GEARING: PROS
This is typically the key benefit of negative gearing. A rental loss is essentially a tax deduction, meaning the loss you incur will be partially offset by a reduction in the tax you pay.
So, in a very simple example, a $100 rental loss might only cost you $60 after tax, where your tax rate is 40%.
NEGATIVE GEARING: CONS
With a month-to-month deficit, you’ll need to contribute an amount to keep on top of interest and outgoings. This may impact on your lifestyle and place extra pressure on household finances.
Reduced Borrowing Capacity
As opposed to a positively geared property, a scenario where a property ‘loses’ income on a monthly basis is likely to result in reduced borrowing capacity. This may impact on your ability to invest further or buy your dream home.
Tax vs Cashflow
As detailed above, a positively geared property will typically mean a higher tax bill, whilst a negatively geared property will typically reduce the tax you have to pay.
Many clients we speak to just assume that a lower tax bill is advantageous but forget about the cashflow aspect.
In the earlier example, we talked about a $100 rental loss reducing tax by $40. Sure, a $40 tax reduction is great, but in cashflow terms, you’re still $60 out of pocket. As opposed to a $100 rental profit, where tax payable increases by $40 but you’ve got $60 left in your pocket at the end.
It’s important to consider all of the pros and cons of each strategy and determine what’s best for you.
WHAT’S YOUR END GOAL?
This should be your key consideration when deciding on an investment property that’s right for you. Property investment is definitely not a case of ‘one size fits all’.
Some investors may be looking to increase cashflow and be less focussed on capital growth.
In that case, they’re more likely to prefer a property that’s positively geared.
On the flipside, others may be looking to reduce or minimise tax, and may consider an investment that is negatively geared, but with better capital growth prospects.
HOW WE CAN HELP
With tax, financial planning and lending specialists on board, the team at BCV Financial Solutions is well placed to advise on your next property investment.
We collaborate across our teams to deliver advice tailored to YOU and your situation. We can assist you in understanding what your property investment options are, how they’ll impact on your tax and cashflow on an ongoing basis, and whether any particular approach best suits your wealth creation strategy.