Positive gearing is a great way to invest and can be very profitable. Unlike negative gearing where your rental income is less than your expenses, positive gearing is where your rental income is more than all your property costs. This surplus can then give you a positive cash flow.
In this article we will go through positive gearing, the pros and cons of positive gearing and how it fits into your investment strategy.
Whether you are an experienced investor or just starting out, understanding positive gearing will help you make better decisions and get more returns.
What is Positive Gearing?
Positive gearing is when the income from a rental property is more than the expenses of owning and maintaining the property.
These expenses include loan repayments, interest rates, property management fees and maintenance costs.
For example, if your rental property generates $30,000 per year in rental income but your annual expenses (mortgage and maintenance) are $25,000, you have a positively geared property with a $5,000 surplus.
One of the key benefits of positive gearing is it provides positive cash flow. This can help investors manage their finances better by having extra money to cover unexpected expenses or invest in another property.
Plus properties that generate a surplus can also improve an investor’s overall financial stability and growth. For a comprehensive overview, check out this guide to property investing.
Benefits of Positive Gearing
Positive gearing can provide several benefits to property investors. First it gives you a steady income stream as your rental income covers all expenses and the surplus is an extra income.
This extra income can be used to pay off debt faster, invest in another property or support your lifestyle.
Plus with a consistent positive cash flow you will be less likely to struggle to pay your property expenses. This can be especially helpful during economic downturns or when unexpected expenses come up.
Lenders may also be more likely to finance your future investments as you have proven you can generate income so it will be easier to grow your property portfolio and achieve your long term goals. For insight into the best places to invest, see best place to invest in Australia.
Plus the surplus income can help offset other taxable income, reduce your tax liability. In some cases investors can also get tax deductions on property expenses.
Examples of Positive Gearing
Let’s look at two examples:
Example 1: Urban Apartment in Sydney
Sarah buys a 2 bedroom apartment in Sydney. She chooses this property because of high rental demand and low purchase price. Here’s her investment:
- Purchase Price: $500,000
- Annual Rental Income: $35,000
- Annual Expenses:
- Loan Repayments: $20,000
- Interest Rates: $5,000
- Property Management Fees: $3,000
- Maintenance Costs: $2,000
- Other Costs: $1,000
Total annual expenses are $31,000. With an annual rental income of $35,000 Sarah has a positive cash flow of $4,000.
This surplus also gives Sarah extra income and increases her borrowing power so she can consider investing again.
Example 2: Suburban House in Brisbane
John buys a 3 bedroom house in Brisbane for long term stability and positive cash flow. Here’s his investment:
- Purchase Price: $400,000
- Annual Rental Income: $30,000
- Annual Expenses:
- Loan Repayments: $18,000
- Interest Rates: $4,000
- Property Management Fees: $2,500
- Maintenance Costs: $1,500
- Other Costs: $1,000
John’s total annual expenses are $27,000. With an annual rental income of $30,000 he has a surplus of $3,000.
This positive cash flow helps John manage his finances better and has a buffer for unexpected expenses.
Disadvantages of Positive Gearing
While positive gearing has many benefits it also has some drawbacks:
- Higher Upfront Costs: Positively geared properties are often more expensive so you need a larger upfront investment. This means you need more capital to get started which may not be possible for all investors.
- Lower Capital Growth: Properties with positive cash flow may not grow in value as quickly as negatively geared properties. This slower growth can impact the overall return on investment in the long term.
- Tax Implications: Since your surplus income is taxable you will have higher taxes. While positive gearing can reduce your taxable income the extra income generated still needs to be reported and may increase your overall tax liability.
- Market Sensitivity: Positively geared properties are often in areas with lower capital growth. These areas may be more sensitive to market fluctuations which can impact rental demand and property values.
How Positive Gearing Works
Positive gearing is simple. Here’s a step by step process:
- Choose a Rental Property: Select a property with high rental yields. Look for properties in areas with high rental demand and low purchase price. Do your research and consider location, amenities and market trends. You can find real estate for sale in various areas to compare options.
- Calculate Expenses: Include all costs, mortgage repayments, interest rates, maintenance costs and property management fees. You need to know all ongoing costs to determine if a property will be positively geared.
- Calculate Rental Income: Work out the expected rental income. Make sure it’s more than the total expenses to get a positive cash flow. You can use online tools and market reports to estimate the rental income for properties in your target area.
- Monitor and Adjust: Once you have a positively geared property, review your income and expenses regularly. Adjust your strategy as needed to maintain a positive cash flow. This may involve renegotiating leases, managing property improvements or optimising property management.
Positive Gearing vs Negative Gearing
Positive gearing and negative gearing are two different investment strategies, each with its own pros and cons.
Positive Gearing: This strategy is about generating more income than expenses and getting immediate positive cash flow and reducing financial risk. But it comes with higher upfront costs and slower capital growth.
Negative Gearing: This strategy is about making a loss on a property where expenses are more than rental income.
The loss can be offset against other taxable income and may result in tax benefits. Negative gearing is used to capitalise on long-term capital growth even though it requires investors to manage ongoing losses.
Here is the summary table:
| Aspect | Positive Gearing | Negative Gearing |
|---|---|---|
| Cash Flow | Positive | Negative |
| Initial Costs | Higher | Lower |
| Tax Benefits | Limited | Significant |
| Risk Level | Lower | Higher |
| Property Appreciation | Slower | Faster |
| Ideal for | Income generation | Long-term capital growth |
Choose between positive and negative gearing based on your financial goals, risk tolerance and investment horizon.
To understand more about why some consider negative gearing to be problematic, read why is negative gearing bad and to understand recent changes, see negative gearing changes.
FAQs on Positive Gearing
What is positive gearing?
Positive gearing happens when the rental income from a property is higher than the mortgage and other related expenses. This results in a surplus that contributes to the investor’s overall income.
Is it better to be positively or negatively geared?
While positive gearing provides immediate cash flow benefits and could lead to higher tax obligations due to increased taxable income, negative gearing allows investors to deduct losses against other income, potentially reducing tax liabilities while aiming for long-term capital growth.
How can you achieve positive gearing in Australia?
To achieve positive gearing, ensure the rental income surpasses all property-related expenses, including mortgage interest, maintenance costs, and management fees. Choosing properties in high-demand rental areas or improving property features to command higher rent can help.
What does ‘gearing’ mean in relation to mortgages?
Gearing in mortgages refers to the ratio of a property’s debt compared to its value. It typically involves using the equity in one property to secure additional financing, which can be used for further investments or other financial strategies.
Summary
Positive gearing is important to understand. It gives you a steady income stream and lower investment risk. But you need to consider the higher upfront costs and tax implications. Mix both positively and negatively geared properties in your portfolio to get a balance of capital growth and income generation.
