If you’ve been researching property investing for the first time, you may have heard terms like positive or negative gearing.
Gearing refers to borrowing money to invest in property. To be positively geared means that you earn enough rental income on your asset to cover all the costs of holding the property; such as loan repayments, insurance, property management fees, council and water rates and strata levies, with some left over to make a monthly cashflow profit. Negative gearing means the costs of the property outweigh the rental return, so you need to add your own money each month to make your repayments.
Why choose positive gearing?
Investors who chase positive cashflow property are usually after an asset that can pay itself off over time, while delivering a good return and capital growth to boot. The steady income provided by these properties means investors can continue to expand their portfolios by borrowing for more assets, without having their borrowing power encumbered by having to use income to service debt on their other properties.
They may also choose to use the extra income to reduce debt and therefore pay less interest by shortening the term of their mortgage. There is also less financial risk involved because the property is looking after itself. Losing your job or getting sick won’t mean your investment is in trouble right away.
The flipside is the income you make on your investment properties each year is subject to tax. This strategy is therefore suited to those with a lower income, who want assets that can help them in retirement, without worrying about their income being pushed into upper brackets.
Why go for negative gearing?
Those who choose negative gearing are often after a long play when it comes to capital growth, but the short term benefit of reducing their taxable income. Plainly speaking, someone earning a high salary can pay less tax by making a monthly loss on their property, while accumulating larger capital gains. For this reason, this strategy is usually employed by higher income individuals.
Often, these investors will invest in assets that they believe have significant growth potential, so they can reap the equity rewards later in life while benefiting from paying less tax year to year.
Why not have both?
Anyone who follows B.Invested founder Nathan Birch would know positive gearing and strong cashflow has always been one of the main pillars of his investment strategy. It has helped him build an extraordinary portfolio of more than 220 properties.
But after building his foundation wealth, he found himself in a position to make some negative gearing purchases to offset some of the passive income he generated from the rest of his portfolio. Despite building his wealth from affordable properties on city fringes, he has also made a few blue chip purchases in his time.
The point is, whichever strategy you favour doesn’t mean you can’t combine elements of both when it suits. Having both in your portfolio can mitigate risk through diversification, safeguard your wealth against market volatility and allow you to adapt and evolve your strategy as your own financial and life goals evolve over time.
Begin with strategy
That brings us back to what should be the start of any property investing journey… your strategy. Positive, negative, or combined, there is no one size fits all strategy as there are many factors at play, such as risk tolerance, financial goals and capabilities, time constraints and the odd curveball that you may not have seen coming.
Once you have settled on a strategy, it helps to stay focused on it and not be side-tracked by emotion or individual properties that don’t meet your metrics. Stay on track and you’ll be a better chance of reaching your goals. If you need help figuring out what your strategy looks like or you need more information, reach out to the Investor Relations team at B.Invested.