If you're thinking about investing in real estate, you've probably read about various property finance techniques on forums and news websites, with negative gearing and positive gearing being the two most well-known.
Positive gearing will be the topic of this article. The percentage of favourably geared residential properties is only 40%. Having a positive cash flow property is a great alternative for first-time investors who want to lower their risks and take advantage of the low borrowing rates, even though it doesn't get much attention from real estate gurus or real estate blogs.
Read on to find out how positive gearing functions, its benefits and drawbacks, and what to think about if you're considering positively gearing your property.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
What exactly is the term "positive gearing"?
In a word, positive gearing occurs when the income from your rental property is more than the amount of money required to maintain it. Therefore, your real estate investment is said to be favourably geared and to have positive cash flow if it results in a higher income for you than the expenses associated with it.
Keep in mind that all of the costs associated with holding this property are covered by this. Include not only your mortgage payments but also other expenditures associated with owning a home, such as insurance premiums, property management fees, and other comparable charges, when you calculate the total amount of your monthly expenses.
For example, if the holding costs for your property are $450 per week and the rent is $500 per week, then the property is favourably geared and has a positive cash flow of $50 per week.
What benefits does positive gearing offer?
A positive cash flow property has a few major advantages that make it a desirable possibility, particularly for novice investors:
Three key benefits come with a favourably geared property. It provides the investor with additional cash flow, makes it simpler to obtain authorised for another loan, and is a more secure alternative overall.
1. Additional revenue
In essence, you will have a new cash stream because the property will be generating a profit each week in addition to paying for itself. This means that you will no longer be dependent on just one source of income. You should be able to consistently make additional money with this method.
2. Increases your suitability
When determining whether or not to provide you another loan, financial institutions will see you more favourably if they see that you are earning money from the property you own. This places you in a terrific position to diversify your assets and move past your first property, which is something that the vast majority of owners struggle to achieve owing in part to inadequate cash flow. You now find yourself in a position where you are in a fantastic position to do both of these things.
3. Assurance of resources
The good news is that even if something unexpected takes place and either market conditions go worse or your personal circumstances get worse, it is highly unlikely that you will have to sell your house to make up for any shortfalls. Having a positive cash flow is extremely useful in this situation.
What negative aspects of positive gearing exist?
As with other things, positive gearing has several disadvantages that you should be aware of before making any decisions:
The primary drawbacks of a positively geared property are that you forfeit tax advantages, run the risk of purchasing properties with limited capital growth, and the rewards themselves are modest.
1. Missing out on tax advantages
Because it is now functioning as a new source of income, your positively geared property will ultimately be subject to taxation in the same manner as any other kind of payment. In the end, you will only be able to keep a portion of your weekly earnings because it will depend on the tax rate you fall into.
2. Minimal capital growth
Positive gearing, which frequently places properties in a regional position, is said by industry professionals to result in slower and lower levels of capital growth. This suggests that even if you do decide to sell, you shouldn't anticipate making a big profit from the transaction. However, this is by no means an ironclad regulation, and if you look in the relevant locations at the suitable times, you might be able to locate some exceptions to the norm.
3. Narrow profits
Even before paying taxes, the profit you get off of a favourably geared property won't amount to a significant sum. The following list of Sydney neighbourhoods with positive cash flows, which was produced by the real estate research firm Propertyology, is illustrative of how meagre the potential earnings might be:
- If you buy a home in Bardia for the median price of $625,750 and put down an 80 percent deposit, your weekly payment will be $66.23.
- A home in Lansvale with a typical price of $665,000 will nett you a weekly rent of $52.04 if you put down an 80 percent deposit on it.
So when should your property be favourably geared?
Positive gearing could be the best decision for your investment, but it also could not be the best choice depending on what you place the most value on for your investment. Negative gearing demands you to accept continuous financial losses; yet, there are investors who are willing to make this sacrifice in exchange for the opportunity to reduce their taxable income. We strongly suggest getting more familiar with negative gearing before making a decision.
Positive gearing is preferable if you'd prefer to obtain an additional passive monthly income from your rent and you choose a lower risk option. There is no question that having a positive cash flow is important to your day-to-day financial security. Because of this, we recommend that first-time investors or those who have limited means gear their first property in a good direction.
However, you should bear in mind that positively gearing an investment property in a rural region may cause you to miss out on considerable opportunities for capital growth. This is due to the fact that properties in rural areas typically have lower rental yields but higher rates of capital growth. This is not always the case, and the majority of the time, it is dependent on the market; therefore, it is something that should be kept in mind and taken into consideration.
Negative Gearing Explained
There are numerous methods for property financing available to investors. Although negative gearing has certainly been discussed frequently, you may not be aware what it implies for your bottom line. You have to make a wise and well-informed choice because thousands of dollars are on the line (and you run the danger of having to pay a lot of taxes on your investment property).
Utilizing negative gearing effectively can help you offset your income and pay less in taxes. Before choosing to negatively gear your investment property, it's crucial to comprehend the particular workings of this investing technique. In addition, whether this investment strategy should be permitted to continue in its current form in the future is a topic of intense discussion.
We go in-depth on negative gearing, its benefits and drawbacks, as well as any possible tax and legal repercussions for you as an investor, in this tutorial.
What is negative gearing?
When the revenue you receive from your investment in real estate—typically rental income—is less than your outgoing costs, this is known as negative gearing. As a result, you consistently experience a net loss.
How does negative gearing work?
Although it's most frequently associated with real estate investing, negative gearing is a tactic that may be applied to a variety of investment kinds.
Talk about gearing. Financial slang for borrowing money to purchase an asset is gearing (such as property).
When you negatively gear a property, your mortgage and other property costs exceed the income you receive through rent. As a result, you can deduct your expenses from your taxes and your income is no longer subject to taxation.
Although negative gearing is the most common method of financing real estate, the percentage of investors that use it is at its lowest point in 14 years.
Negative gearing may seem like a strange strategy, but it's becoming a common choice for Australian investors. According to the AFR, 60% of real estate investors have negative gearing.
To understand why investors might (or might not) select this investment approach, let's examine both sides of the argument.
What are the advantages of negative gearing?
The two main advantages of negative gearing are:
- Tax savings: As a property investor, you'll be able to deduct any losses you incur from your taxable income, which may assist to reduce your property tax payment.
- Capital gains: Investors also rely on the appreciation of their property when it comes time to sell it in order to offset any losses they may have experienced over the course of the investment.
Read our advice on how to earn the maximum tax deductions from your investment property if you're seeking for more methods to reduce your taxes.
What are the disadvantages of negative gearing?
However, negative gearing has certain negatives, some of which include:
- Reduced cash flow: Since you'll always be losing money, a negatively geared property won't be able to provide you with passive income. This might have an effect on your cash flow and make it difficult to pay for upkeep, repairs, and unforeseen expenses.
- Although the ultimate goal of negative gearing is for the property's value to rise, this doesn't always occur in practise. A negative gearing technique may leave you more susceptible to losses when the market changes (rather than providing stable and consistent returns over the lifetime of the investment).
What other financing strategies exist?
Even while negative gearing gets the most attention, there are a variety of other strategies to invest in real estate, each having advantages and disadvantages.
Positive gearing explained
Positive gearing adopts the opposite strategy, as one might anticipate. In this instance, the amount borrowed for investing and the revenue received from your investment are greater than your outgoing costs.
Positive gearing can provide a dependable source of passive income if you're searching for steady, consistent earnings. Additionally, if the value of your property rises, you might be able to sell it for a profit in the future.
However, because of the additional income you receive, you might have to pay tax on your investment profits, which is something you'll want to avoid as investor. Additionally, it can be more difficult to locate homes that fit this strategy, so you might need to expand your search for investment properties to smaller, regional areas (where capital growth isn't as strong).
Neutral gearing explained
What happens when your expenses are covered by the money you borrowed to invest plus the income you earn from that investment? This is referred to as a neutral gearing strategy.
As a result, you are effectively breaking even and your tax payment is neither advantageous nor disadvantageous.
Given that it won't deplete the fund's assets, this strategy can be advantageous for investors who use a self-managed super fund (SMSF).
Neutral gearing is a relatively uncommon occurrence. In reality, it's challenging to balance your revenue and expenses over a year, especially when taking vacancies into account. Because of this, the majority of real estate investors intentionally either favourably or negatively gear.
What are the tax implications of negative gearing?
The potential tax savings are, as we've already indicated, one of the negative gearing's main attractions. When filing their taxes with the ATO, investors in Australia are permitted to offset their losses against their income to reduce the amount of tax they are required to pay.
That implies that you can benefit from tax deductions as an investor, such as:
- Income tax deductions (such as interests, maintenance expenses and recurring costs such as agent fees, cleaning costs and even insurance)
- Deteriorating resources (such as furniture, carpets, and curtains)
- Capital works (such as additions, modifications, or enhancements to increase the earning potential of your investment property)
In some cases, these savings can help investors to increase their property portfolio, too.
Many investors who have negative equity in their properties want to profit from an increase in value when they sell. Making a financial gain, however, does result in tax responsibilities (known as capital gains tax).
As a result, the amount of tax you owe can significantly increase when capital gains are added to your income. Understanding CGT and how it could affect your profits when it comes time to sell your investment property is crucial if you want to lower your tax liabilities.
It follows that tax season will now be more challenging. If you're worried about that, a property manager can be of assistance.
Is negative gearing legal (and will that always be the case)?
Although negative gearing has certain alluring advantages for investors, it is not without its detractors. Many detractors claim that negative gearing makes it more difficult for first-time homebuyers to access the housing market by driving up property prices.
Recent years have seen a strong position on negative gearing from both political parties. Prior to the 2019 election, the Labor party intended to limit the use of negative gearing, while the Coalition made a strong effort to protect the practise.
More than a quarter of Australians earning over $80,000 reported net rent losses, compared to just 13.1% of Australians earning under $80,000, according to recent ATO statistics. This showed that a negative gearing technique works best for people with greater salaries.
To increase the supply of affordable rental property in Australia, several pundits are now urging the government to change the tax breaks offered to negatively geared apartments.
Although negative gearing is still a viable choice for investors, future policy changes and their impact on taxes may be a topic of discussion.
The bottom line - is negative gearing worth it?
Although negative gearing can be a useful tactic for lowering your tax burden and releasing substantial capital gains, there are important drawbacks to take into account.
Negative gearing can be a beneficial approach to take into consideration if you're willing to tolerate a higher level of risk and are able to live without a stable rental income. Negative gearing may also assist you in lowering your tax liabilities to prevent overpaying taxes on your investment property.
In the end, you'll have to decide whether a negative gearing plan is a right choice for your needs after taking into account your financial situation and investment objectives.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
Summary
Having a positive cash flow property is a great alternative for first-time investors. The percentage of favourably geared residential properties is only 40%. It provides the investor with additional cash flow, makes it simpler to obtain authorised for another loan, and is a more secure alternative overall. The primary drawbacks of a positively geared property are that you forfeit tax advantages, run the risk of purchasing properties with limited capital growth, and the rewards themselves are modest. Negative gearing requires you to deal with continual financial losses, but some investors are willing to make that sacrifice in exchange for tax savings.
Negative gearing may seem like a strange strategy, but it's becoming a common choice for Australian investors. When you negatively gear a property, your mortgage and other costs exceed the income you receive through rent. As a result, you can deduct your expenses from your taxes and income is no longer subject to taxation. Negative gearing is one of the most popular strategies to invest in real estate. Negative gearing may leave you more susceptible to losses when the market changes, while positive gearing can provide steady, consistent income.
What happens when your expenses are covered by the money you borrowed to invest plus the income you earn from that investment? This is referred to as a neutral gearing strategy. Investors can offset their losses against their income to reduce the amount of tax they are required to pay. Recent years have seen a strong position on negative gearing from both political parties. More than a quarter of Australians earning over $80,000 reported net rent losses. Negative gearing may also assist you in lowering your tax liabilities to prevent overpaying taxes on your investment property.
Positive gearing is generally seen as lower risk than negative gearing, as it provides more predictable returns and consistent income. The surplus income may cushion investors from any interest rate hikes, increased home loan repayments and unexpected property (or life) costs.
A property is positively geared if it earns an annual profit. ... Negative gearing in investment property may allow you to reduce the tax you pay on other income such as your regular wage or salary as the annual loss made on your rental property could reduce your overall taxable income.
Positive gearing tends to be more prevalent in periods of low interest rates and/or strong rental demand. When demand for rentals is high, the cost of leasing typically goes up – putting more money into the landlord's pocket and making it more likely the property will be positively geared.