Property Investing 101: Understanding Negative Gearing vs Positive Gearing
Delving into property investing involves vernacular such as negative gearing and positive gearing. These terms can be a little confusing and misleading, so it’s important to understand what they mean before you invest in property.
What Is Negative Gearing?
Negative gearing occurs when the amount of money an investor borrows is greater than the market value of their investment property and the property generates a loss.
For example, an investor may purchase an investment property for $500,000 and borrow $600,000 to acquire the asset. If the property cost $500,000, the investor would be 'positively geared.' However, if the property costs $600,000, this investor is ‘negatively geared’ and is losing $100,000 per year.
In other words, you’re borrowing money to make a loss. When you’re negatively gearing, you’re hoping to make more money in the long term by:
Pocketing the tax benefits;
Increasing the capital gain on your property;
Once you grow your property value, it's time to sell it for a profit. Keep in mind that despite its definition, negative gearing should be approached as more of a financial strategy than an investment strategy.
So even if the ATO sees property as negatively geared, it could still be cashflow positive if you wind ways to make the most on depreciation and offset accounts.
What Is Positive Gearing?
less than the market value of their property. For example, a positively geared investor may purchase a $500,000 property and borrow $400,000. If the property costs $400,000, the investor is positively geared.
Positively geared investors generally want to keep the market value of their property around 80 per cent of the market value of their mortgage to be cashflow positive.
Keep in mind that while you're positively geared, you need to be aware of the changes in interest rates and property values. If interest rates increase, you may have trouble refinancing your loan, which could put you in a negative situation.
If property values decrease, you may have to sell your property at a loss. While positive gearing doesn't bring any tax benefits, you can significantly reduce your loan if you're able to generate more income rent than your total expenses.
The Bottom Line: Negative Gearing vs. Positive Gearing: Which Is the Ideal Option for You?
Negatively geared properties are generally geared towards investors who have a longer time horizon so they can recoup the negative cash flow and make a profit by increasing the value of the property.
Negatively geared properties are also useful for those who have income from other sources and will be able to cover the rent shortfall and expenses with their income from other sources.
Positively geared properties are generally geared towards investors who have a shorter time horizon and will be able to make a profit from their investment by increasing the value of the property.
Positively geared properties are also useful for investors who have enough equity in other investments and/or plan to live in the property and don't want to deal with the hassle of being negatively geared.
Negatively and positively geared properties can be profitable, even if the interest rate and market conditions are volatile. However, the longer you are negatively or positively geared, the more you need to stay on top of the market to ensure you make the maximum return on your investment.
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