What is a Positive Geared Property
Anyone interested in becoming a serious property investor who is doing their research will very quickly come across the terms ‘negative and positive gearing.’ These are commonly used phrases which describe the type of investment strategy an investor might be adopting when it comes to purchasing property. Positively geared properties will be properties that bring in cash flow on an ongoing basis (hence the alternative description of ‘cash flow properties’) whilst negatively geared properties will be more interested in both the tax advantages of making a yearly loss and the future capital growth returns (hence the description – ‘capital growth properties.’) For a fuller description of negative gearing, click here. In this article we will be taking a more detailed look at positive gearing, in order to help you assess which type of strategy is best for you and your investments.
What Is Positive Gearing?
As you get more and more acquainted with property investment you will hear about gearing a great deal, but usually it will be negatively geared properties that you come across. That’s because it is far less likely that new (and even semi-experienced) investors will be able to afford to set up positively geared properties. Because of the great expense of buying a property and the statistic that most investors purchase their property using a deposit of between 7.5% and 12%, it is very difficult to get a property set up to be positively geared.
A positively geared property is a property for which the owner and investor receives more back in rental income than they pay out in costs. In other words, the combined total of their loan repayments, rates, management fees, interest charges and property maintenance is less per month than the monthly rent they are charging the tenants. This means that right from the start they are seeing a small profit and have some extra money going into their account each month.
How are positive cash flow properties achieved? Such a scenario usually occurs either when the investor has a larger deposit (and therefore has a smaller mortgage) or when there is a ‘perfect storm’ of high rents, strong demand and low interest rates. Whatever the situation, any positively geared property will result in extra money for the investor and is therefore seen as a ‘cash flow property.’
How Does Positive Gearing Work?
To best understand positive gearing it is worth looking at the costs and returns of a positive cash flow property. To take an example, consider an investment property that has been purchased for $400,000 in an extremely popular location. Let’s say that this location has very low vacancy rates for rental properties and that there is additionally a very strong demand for more rental properties to come on the market. Now, after purchasing this property you find out that you are able to rent it out to tenants at the very strong rate of $500 per week. You also calculate that your repayment costs on the property (the aforementioned rates, management fees and loan payments) come to a total of $410. In such a scenario your income would be increased by $90 per week and your property would be paying for itself. Consequently, the property would be considered to be positively geared.
The Advantages of Positive Cash Flow Investing:
An Increase in Income
– Of course the primary benefit will be that you will see a small increase in your personal income combined with the fact that you won’t be losing any money on your investment.
Potential to Pay Down Mortgage
– If you so choose, you can take that extra income and pay down your mortgage quicker every month by over-paying.
Less Risk on Your Investment
– Should your personal circumstances change or should you be unlucky enough to lose your job, then you would
- (a) not have to worry about finding any money for the mortgage
- (b) not have to sell the property when you are under pressure and (c) have that small extra income to help you each week.
A More Balanced Portfolio
– Having one or more positively geared properties in your portfolio means there is the possibility open to you of adding negatively geared properties at a later date. Even if you add negatively geared properties your portfolio will still be balanced as the added income you already receive will counterbalance the shortfall on those negatively geared properties.
Greater Attractiveness to Lenders
– this positive gearing and balance means you will look like a good bet when you go and speak to mortgage lenders about additional loans for additional properties.
The Disadvantages of Positive Gearing:
There aren’t many disadvantages to gearing a property positively, but the following represent the only slight disadvantages:
Your property will still be subject to tax and that extra personal income you are receiving on the property will also be taxable. It may well push you into a higher tax rate too.
Potentially Slower Growth
Positive cash flow properties are often located in regional areas that might be slower to achieve capital growth.
These are, however, very minor disadvantages and it is not impossible to achieve the ideal, which is a dual income property that achieves both positive gearing and an income from strong rental returns whilst also offering capital growth. Normally such properties are to be found in up and coming areas of the big cities, although it is not always easy to find them. If you do, then you will be off to the perfect start with your property investment portfolio!