Once you've made the big decision to step up into the property investment game, all the jargon involved can be a little overwhelming. Terms like positive and negative gearing can be confusing. The good news is you are not alone, together with your financial advisor we can help with some of the basics.
The reality is there's no one pathway to building a property portfolio. But deciding whether to pursue a positive or negative gearing strategy is one of the first major forks in the road you'll have to navigate.
So, what does positive and negative gearing mean?
"Put simply, it's all about profit and loss," John says. "When you buy or build a home to rent out, how that investment shakes out defines whether it is positively or negatively geared."
Add up the rent you get from your tenants across the financial year, then deduct your mortgage repayments, interest rates, and maintenance costs. The figure you're left with tells you which situation you're in.
- If you're in profit, your investment property is positively geared
- If you're left with a loss, your investment property is negatively geared
But here's the thing: "Despite what your first impression might be, neither option is necessarily better than the other," John says. "They're just different but equally valid investment strategies."
Hold up. Do you mean making a loss isn't necessarily bad?
Yep, you read that right. While the benefits of positive gearing are obvious, the approach has its drawbacks to consider, just as negative gearing has its plus points.
It pays to sit down with a financial advisor to discuss your options and figure out which tactic works best for you. But here's a primer to get you started.
The pros of positive gearing
"There's a lot on the line when you decide to get into property investing, and obviously, the aim of the game is to make money at the end of the day," John says. "So, on face value, positive gearing your investment property seems like a no brainer."
And it certainly has its benefit, goodness knows we're living in a time of upheaval. While the property market has primarily ridden out the COVID storm without major hiccups, and owning real estate might be a safe bet, we're all aware that circumstances change quickly.
"One of the real benefits of positive gearing is that even if you lost your job tomorrow, you wouldn't have to worry about taking on a second lot of mortgage repayments because your tenant already has that covered", says John.
Of course, one possible hiccup could be if your tenant runs into financial strife. Still, you can investigate getting insurance to cover that scenario.
"Positive gearing also means you could end up owning your investment property outright faster," John adds. "While many investment properties are on interest-only payments, you can opt to pay down that debt. In that situation, every payment potentially bumps up your profits."
Positive gearing also gives you more to play with if you need to make repairs or renovations that could add value to your investment property. Some of that work might even be tax-deductible.
The cons of positive gearing
If you're struggling to think of any downfalls to making money, the old adage about death and taxes being the only things you can't escape might make the point a little clearer.
"If your rental property is positively geared, then you need to fork out tax on that profit," John says. "Of course, putting that in perspective, if you're being taxed, you're making money."
It is also possible, for whatever reason, that you might need to drop the rent you can ask for. So even if you start with a positively geared property investment, it can wind up negatively geared, with you making up the difference.
The pros of negative gearing
So how is it that you can be in the red but still in a good financial position? Put simply, property investment is a business, and anyone who runs a business will tell you that it opens a bunch of potential tax deductions.
"When you look at it that way, if you're on a relatively good income and you want to try and minimise the tax that you're paying, then negative gearing an investment property might appeal," John notes. "You're offsetting part of that loss by reducing the amount of tax you have to pay."
There may also be long-term benefits. "If you own the investment property for longer than a year, speak to your accountant about possible concessions on capital gains," John says. "This can be appealing if you do decide to sell on. If the property has had solid capital growth, this profit may outweigh your initial losses."
The cons of negative gearing
If that seems like a canny approach, bear in mind the risks involved. "You need to be pretty sure you're in a strong financial position to cover the gap between your rental income and your costs until you might make a profit on selling up," John says.
"Negative gearing only works in areas where property prices are rising," John cautions. "It's a long-term game, so you need to do your homework and be sure you can make a profit when you sell in the long run."
It's also worth noting that while your property might be negatively geared, to begin with, it could become cost-neutral or positively geared as the market moves and interest rates come down.
Make sure you seek financial advice
Like any investment, there are calculated risks involved. While we've tried to be as helpful as possible, this article should not be considered professional financial advice. It contains general information only, and you should seek out independent, professional advice on your personal situation before making any financial decisions.
If your financial adviser thinks property investment is a good idea, based on your current financial situation, then talk to one of Invest by Metricon's friendly experts today.
If you feel ready to start your property investment journey, learn more about Invest by Metricon today. Invest by Metricon offers an end-to-end process that allows you to obtain a rent-ready, premium home in one of Australia’s leading estates, simplifying your investment journey. With new build investment opportunities across Victoria and Queensland, you're sure to find something that suits your investment strategy, no matter where you live.
