As we move into property investing, it’s very important to understand the dollars and cents of your investments – the gearing position. It gives you a real snapshot of your hard-earned dollars’ true financial makeup and whether those are working for you. After all, that is why we all decide to invest in the first place!
Gearing is determined by your gross profit (rent) versus any expenses incurred. The gearing positions are explained as follows:
- The positively-geared property will yield more rent than all the expenses combined. On the other hand;
- The negatively-geared property will yield less rent than the total expenses combined. And lastly;
- The neutrally-geared property will provide a balanced investment, where it neither is profitable or costs you to hold the property.
It is worth noting expenses on a property can include the following:
- The interest component on your loan
- Maintenance and repairs costs
- Property management fees
- Water levy
- Council levy
Ideally, it’s generally better to invest in a rental property that is positively geared. However, this statement should only be taken as a grain of salt. With investing, there also are other valid reasons someone might purchase a property even when it might be neutrally or negatively geared. These benefits of investing can include:
- Capital gains – the knowledge and experience of the housing sector potentially inclining over a certain period in the future
- The opportunity to develop or improve the lot in a way that may generate further rental yields or a more saleable lot in the future
- Purchasing an investment in an area that you may want to potentially live in one day, ultimately sacrificing some cash-flow to ‘get your foot in the door’
Some of the most common ways to improve gearing are:
- Provision of a tax depreciation schedule – a non-cash deduction available from the Australian Tax Office to provide tax relief to the property investor. The schedule produced by a Registered Tax Agent that is practicing Quantity Surveying, will substantiate claims made by the investor on how much depreciation that is incurred during the time of ownership.
- Improving the loan structure can ultimately reduce the interest rate on a investment loan. Speaking to your lender or a mortgage broker can potentially save you thousands in interest per year and boost that cash-flow leading to a more positively-geared property.
There are also some key differences between gearing and cash-flow. Did you know you could also have a negatively geared property providing you with positive cash-flow? Read more about it here.