Positive vs Negative Gearing: What’s the Difference?

When it comes to property investment, there are two main types of gearing: positive and negative.

Before we get into the differences between the two, let's clarify what gearing means. Gearing is when an investor utilises debt to increase the return on investment on a property asset. 

In other words, it’s the act of leveraging capital or borrowing money for a shot at generating more income.

By knowing these technical phrases, you'll discover more about this high-potential investing strategy in the Australian real estate market. 

Find out more about the positives and drawbacks between these two methods below!

What is Positive Gearing?

Positive gearing occurs when the income generated from a property investment is greater than the costs associated with holding that investment.

Dubbed as "cash flow" properties, these investments are favoured by many Australian investors. That is because they offer the potential to generate income via rent that would exceed the costs associated with ownership, such as interest payments and property management fees.

Positively-geared investments typically thrive when there's a high demand for your rental property (and thus, more cash flow coming in) and when interest rates and miscellaneous payments are low. For a deeper insight into this investment option, check out the Joust positive gearing guide for more information.

Pros and Cons of Positive Gearing

It's important to weigh the pros and cons of both types of gearing that best fits your financial situation.

Here are some benefits of having a positive-gearing property:

• Better borrowing power: When your asset is positively geared, it gives the lender more confidence in your ability to service the loan.
• Higher cash flow: More cash is generated under this scenario, which can be put towards other investments or saved.
• Ideal for new investors and retirees: The idea of having a negative cash flow may be too much of a burden for inexperienced investors and those of age, making positive gearing a better option in that regard.
• Buffers negative cash flow assets: If you do have a negative-gearing asset, the positive cash flow of other investments can help offset these costs.

Meanwhile, there are some limitations when it comes to positive gearing. These include:

• Higher taxable amount: One drawback of positive gearing is that the percentage of your revenue is lower as you'll have to pay a taxable amount to the Australian Taxation Office (ATO).
• Reliance on external factors: Your ability to gain a positive net cash flow from the property is reliant on several factors outside of your control, such as market conditions, vacancy rates and interest rates.
• Low yield can be disastrous: If the rent doesn't cover the costs of holding the investment, you could be looking at negative cash flow and large losses in capital value.
• Slow growth is commonplace: Many positively geared properties situate themselves in regional or rural areas, which naturally entails slower growth rates and more difficult access to equity.

What is Negative Gearing?

Negative gearing, on the other hand, occurs when the costs of owning a property investment are greater than the income generated from it.

This can happen when the interest on a loan taken out to finance the investment is greater than the rent earned on the property.

One major benefit of this type of investment is that it helps lower your tax bracket, saving you money on personal income taxes.

Pros and Cons of Negative Gearing

Here are the pros of having a negative-gearing property.

• Claim tax benefits: When taxation month comes in, you'll be able to reduce your taxable income, even on your personal income.
• Growing capital: Depending on when you purchased your investment, you could be seeing ROIs that exceed any losses.
• A steady flow of tenants: As your property will likely be located within the city, you'll have no shortage of clients and cash flow to support your investment.

The cons that are associated with negative gearing are:

• You'll encounter shortfalls: Negative gearing can lead to big losses if the property is sold at a loss. You'll need to ensure you have positive cash flow-generating assets to offset this.
• High risk and volatile: If interest rates increase, you may have a harder time offsetting a larger negative cash flow than you once were able to.
• Dependent on asset appreciation: If the loss your property incurs is greater than the rate at which your property appreciates, you could be holding onto a falling sword.
• Better-suited for savvy investors: Given the number of risks involved in negative gearing, it may not be the best option for novice investors.

Conclusion

So, which one should you choose? Ultimately, you’ll need to consider a few things and speak to a specialist before investing, including your personal financial situation. 

If you’re risk-averse or you need the stability of a steady income, then positive gearing may be more suitable. However, if you’re comfortable with taking on some risk and you have a high tolerance for volatility, then negative gearing may be the better option.