AS PUBLISHED IN BUILD IN COMMON – TILT MARCH 2019 (CLICK HERE)
There are two main types of property investors, and their different strategies at the time of purchasing an investment, usually results in the debate arising: negative gearing vs positive gearing. This is an important question. So, let’s explore what these two terms mean and how different types of property investors work within these situations.
Negative gearing is a situation where the costs of holding a rental property (including interest on the mortgage, property management fees, rates, body corporate fees, maintenance costs etc) exceed the income generated through rent received on the property.
It results in a position where an investor has to use income from other sources to support that investment over the short term. Whilst there are currently tax benefits associated with negative gearing, this is simply a consequence of this type of investment strategy – and not a reason that an investor should consider buying a negatively geared property.
But you may be asking, why would anyone invest for a negative outcome? That simply does not make sense, does it?
Well the answer is simple.
Negative gearing is simply a consequence of a Capital Growth investment strategy.
Investors usually find that a negatively geared property turns to become a positively geared property over time. When investors are buying in locations that have shown historically good capital growth over time, they are usually in areas where the growth in the value of those properties pushes the property prices higher than the rental income received.
No-one would invest for a negative outcome. But investors looking for the benefits of compounding capital growth, which is a very powerful way to build long term wealth, do expect a short period where the rental returns are not sufficient to cover the costs of holding the property. However, the capital growth benefits they are generating, far outweigh the additional costs of having to support that investment over the first few years.
The alternative to a negative geared property investment position, is positive gearing. This is a situation where the rental income received from a property is greater than the costs of holding that property, so the result is that the property produces an income every week for the investor.
This is a consequence of a cashflow investment strategy.
For many people a cashflow property investment strategy appeals, because it can help to replace income earned through other sources. Done well, it can even replace normal income earned through employment – but this would require a fairly large portfolio of investment properties.
You may be asking why wouldn’t we all just buy positively geared properties – because they do exist? Well the reason is very simple. Often cashflow comes at the compromise of capital growth. This means that, whilst the property may be generating income now (which an investor may have to pay tax on), it is not helping to build long term wealth because the compounding capital gains are small.
Another thing to consider is this. Why do tenants pay MORE to rent a property than it would cost them to BUY and OWN that property? Again, the answer is generally simple. These types of properties are typically located in lower socio-economic areas or in regional areas and therefore this can present as a greater risk for a property investor.
For a lot of investors, a good balance between the two strategies can provide the benefits of both strategies. When you buy a property in an area with reasonable capital growth, but with a decent holding yield, it is quite often neutrally geared – which means it does not generate income now, but it mostly pays for itself. These types of properties present the lowest level of risk for a property investor, because the income they generate helps to offset the holding costs, but they still get some benefits of longer term capital gains to slowly build their wealth into the future.
There is no right or wrong strategy when it comes to property investment.
The strategy you choose depends on your goals and personal circumstances. When it comes to negative gearing vs positive gearing, we always say that there is no “one size fits all” approach. It is important to devise a plan that is best suited to you and your personal goals and circumstances. It is best to get advice if you are unsure of the most beneficial strategy – because getting the fundamentals in place early, sets you up for a better outcome in the future.