When it comes to property investment strategies, positive gearing is considered one of the more conservative approaches, with most investors leaning towards negative gearing.
According to the Australian Taxation Office (ATO), around 30% of Australians own an investment property, with 40% of those being neutrally or positively geared. That means that 60% of investment properties are negatively geared.
But is negative gearing the right investment strategy for you?
It helps to weigh up all your options, and depending on your circumstances, you should consider positive gearing as a strategy. This article will cover all the bases of positive gearing, including what it is, how it’s calculated, its tax consequences, and the pros and cons.
What Is Positive Gearing?
Positive gearing means that you used a home loan to buy your investment property. A positively geared property means your investment property rental return is higher than your home loan repayments and other property costs.
In other words, you are consistently making a profit from your investment property, and you could use the surplus income to reduce the size of your home loan.
What Does It Mean to Have a Positively Geared Property?
Having a positively geared property means that the investment property is paying for itself. The rental income generated from the property exceeds all associated costs, including mortgage repayments, maintenance, and other expenses. This results in a positive cash flow, providing the investor additional income.
How is Positive Gearing Calculated?
To understand how positive gearing is calculated, let’s look at an example:
Bruce purchased his first investment property in Melbourne for $485,000 in a suburb just outside the city. Bruce managed to rent out the apartment for a strong rental return of $575 per week.
Assuming that the property costs he incurs from owning the property amount to $460 per week, Bruce can cover the expenses with the rental return and have a surplus of $115 per week, leading to positive cashflow.
$575 – $460 = $115
This means that Bruce’s property is positively geared.
Advantages of Positive Gearing
As with any investment strategy, you must weigh the advantages and disadvantages of positive gearing, especially considering your current financial circumstances and goals.
Some of the potential advantages of positive gearing your property include:
- Passive income: Purchasing an investment property in an area with high rental demand and a strong rental return means you’re likely to generate a steady income stream while waiting to realise the property’s long-term capital growth.
- Positive cash flow: If your property is positively geared, it’ll pay for itself. As you can see in Bruce’s example, his rental income covered his expenses for owning the property. This means he doesn’t need to use part of his other income to cover the home loan repayments. A positive cash flow means less pressure if your financial circumstances change.
- Increased lending power: If your investment property generates enough income to cover your expenses and then some, the positive cash flow boosting your income could make it easier to secure another home loan to expand your property portfolio.
- Balanced property portfolio: If you own more than one investment property and utilise more than one investment strategy, having at least one positively geared property means you can use the additional income to pay the shortfall if your other property is negatively geared.
Strategies to Achieve Positive Gearing
You can deploy several strategies to achieve positive gearing for your investment properties.
Buy with a Bigger Deposit
One way to achieve positive gearing is to buy with a larger deposit to reduce mortgage payments. This strategy can help lower ongoing costs and increase the likelihood of positive cash flow.
Purchase A Cheaper Property
Another strategy is to focus on buying cheaper, high-yield properties. These properties often have lower purchase prices but can still generate strong rental returns, making it easier to achieve positive gearing.
Are There Tax Implications for Using a Positive Gearing Strategy?
Just like the income you receive from your wages, the income you generate from your investment property is subject to tax. You’ll pay tax depending on your income tax bracket. You can access the income tax rates on the ATO’s website.
The key benefit of a negatively geared investment is that you can offset the loss from your income. In other words, you’ll deduct the loss from your assessable income, resulting in a reduced taxable income.
However, there are various beneficial tax deductions that you can claim on your positively geared property that can also reduce your taxable income. So, by claiming all your investment property tax deductions, you can reduce the amount of income tax you pay each year.
The top three investment property tax deductions include:
- Depreciation: As a building ages, its structure and its assets are subject to general wear and tear. In other words, each year, the value decreases and thus depreciates. The Australian Tax Office (ATO) offers property investors the opportunity to claim the depreciating assets as a tax deduction as long as the property is used to generate income.
- Interest on your loan: If you had to take out a bank loan to purchase your investment property, you can claim any interest charged on the loan as a rental property deduction. This is the most significant investment property tax deduction you can claim.
- Rental expenses: As a landlord, you are liable for all kinds of expenses. The good news is that you can claim these expenses as rental property deductions each year.
To access a full list of tax deductions you can claim, check out our ultimate guide on investment property tax deductions.
Disadvantages to Consider When Opting for a Positive Gearing Strategy
While there are many advantages to buying and opting for a positive gearing strategy, there are some other factors you should take into account.
Positively Geared Property Are Typically Harder to Find
Negatively geared properties are much easier to find in Australia—they are everywhere. Since 60% of investment properties are negatively geared, positively geared properties are in high demand.
High demand means higher prices and lower rental yields. The lower the rental yield, the harder it is to have your property produce a positive cash flow.
While positively geared properties are harder to find, they aren’t impossible to find. These properties do exist; you need the right team in your corner to help you find these properties. You can read more about property professionals who can help you in our five steps to buying an investment property guide.
Higher Initial Cost
Other than higher property prices, you may have to have more upfront capital when purchasing your property. By paying more in cash, you’re decreasing the money you have to borrow from the bank. Smaller mortgage repayments will make generating a profit from your rental income easier.
Increased Volatility
In times of high interest rates and slow rental price growth, repayments on investment loans are higher, making it more difficult to find a property that can produce a rental yield high enough to cover all your expenses.
Key Takeaways
- Positive gearing occurs when rental income from an investment property exceeds all associated costs, including mortgage repayments and other expenses.
- Approximately 40% of investment properties in Australia are neutrally or positively geared, while 60% are negatively geared.
- The advantages of positive gearing include a positive cash flow, increased lending power, a diverse portfolio, and the ability to generate passive income.
- Positively geared properties are typically harder to find due to high demand, which can lead to higher prices and lower rental yields.
- Strategies to achieve positive gearing include buying with a larger deposit to reduce mortgage payments and focusing on purchasing cheaper, high-yield properties.
- Claiming all available tax deductions, especially depreciation, can significantly impact your investment’s profitability.
- While positive gearing offers immediate financial benefits, it’s important to weigh the advantages against factors like higher initial costs and potential market volatility.
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Tuan is an award winning Quantity Surveyor and leads Duo Tax Quantity Surveyors – Australia’s fastest growing provider of Tax Depreciation.
