Negative vs positive gearing is a common discussion among property investors. Discussions that revolve around gearing are fixated on which approach is optimal for an investor. Should an investor tailor their investing approach to suit one or the other? The following will be discussed.
What is gearing?
Firstly, before comparing the two options it is important to outline what they are. Properties can be categorised as positive or negatively geared based upon their cash flow over the financial year. If at the end of the financial year the property puts more money into your pocket taking into account expenses, then the property is positively geared. Likewise, if the property requires additional funds to hold then it is negatively geared.
Note, properties can change their gearing over time. A negatively geared property can increase rent and pay down the loan to become positive. While a positive property may have an equity cash-out and become negative. The tax implications of these two approaches are different. A negatively geared property can reduce your overall tax burden whilst a positively geared property may require you to pay additional tax. However, the positively geared property does provide additional cash flow the negatively geared property does not.
A major misconception
One misconception about property investing is that buying property for tax incentives is a viable investment strategy. This is far from the truth, tax incentives with negatively geared property should not be your main focus when investing. Tax depreciation benefits should be supplementary to your overarching strategy. Property investing should be geared towards capital growth or cash flow depending on your circumstances. If you purchase an investment property that is negatively geared, it can rationalised if the property has strong potential for capital growth. However, purchasing a negatively geared property purely for tax incentives is redundant. To put this into perspective, you should run your property portfolio like a business, you wouldn’t start a business to lose money every month simply to minimise tax. Similarly, property investing doesn’t meet its full potential if investing simply for tax purposes.
Which is better?
As mentioned, the way a property is geared shouldn’t be the focus of an investment strategy. Positive or negative is supplementary to the overarching approach and goal of the investor. There appears to be an over-emphasis on the way an individual will gear a property to reduce their income tax. Purchasing property should focus on growth, cash flow, or a blend of both.
An individual’s circumstances and ambitions will dictate the type of property they purchase. While the income of an investor will determine their borrowing capacity. Each of these variables may influence an investor’s approach to invest and the parameters they may be required to work within. If you had to choose one approach it would make sense to pick positively geared property as these put more money into your pocket than negatively geared property. However, neither should be at the forefront of an investor’s decision. An investor should focus on finding high-demand properties which will provide capital growth over time.
Positive vs negative gearing is a question that shouldn’t be at the forefront of an investor’s mind. Rather, the investor should ask what is my goal and what am I trying to achieve? The next step is to identify a property that will work towards achieving this goal for the investor. The concept of positive vs negative gearing shouldn’t play a role within the decision-making process of where and what to buy.
Gearing should be considered in a cash-flow analysis to determine the holding costs of a property and if this aligns with what the investor wants to achieve. If the goal is cash-flow, then purchasing high yield properties will be the focus and they are inherently positive geared. If the goal is solely capital growth then the investor isn’t concerned with additional holdings costs which may negatively gear a property. The gearing of a property doesn’t determine the property purchase nor should it be at the focus of your investment decisions.