Negative versus positive gearing, part 1

What is Gearing?
Adding borrowed money to your existing deposit to invest in a capital asset, such as property, is called gearing.  We have potentially increased our risk and our opportunity through borrowing money to buy a more expensive asset.

The first thing to consider in any type of gearing is whether you have mitigated your risk to hold onto the property. If you are confident that you can sustain the repayments and expenses associated with holding that property then we can focus on your return on investment (ROI).

Not only do we have the potential for a return on our 20% deposit but also on the 80% we have borrowed.  This gives us the opportunity to have five times the return we would have had if investing our deposit only.  This is the benefit of gearing.

How does positive gearing work?
When we borrow money to purchase an asset and we make money while we hold it, it is called positively gearing.

Many investors see positively geared property as an ‘easy’ way to achieve their results.  However, to create financial choices we need to consider overall returns, rental yields (Holding Phase) plus capital gains (Exit Phase).  Positively geared properties tend to have higher rental yields but lower potential for capital growth.  The reward is in holding phase and may not translate to the exit phase of a strategy.

Property types that are often positively geared are National Rental Affordability Scheme (NRAS), properties with lower Loan to Value Ratios (LVRs) and properties with very high rental returns.
Well managed renovations can also be positively geared when the capital improvement results in an increase the value (equity) in the property and a subsequent boost in rental yield.

Sounds too good to be true, right? Well, it kind of is. Be mindful that any additional income earned from positively geared property is taxed at the top marginal rate unless it is an NRAS property which attracts special concessions offering a refundable benefit.

Keen to hear about the frequently discussed topic of Negative Gearing? Then head on over to Negative Versus Positive Gearing, Part 2