What is Negative Gearing?

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negative gearing

Negative Gearing

At the moment, a day rarely goes by without someone in the media quoting ‘negative gearing’. But what exactly is negative gearing and how does it impact you?

negative gearingImage Source: Flickr

Definition

The gearing of a property is reserved to investments and the type of return they provide to their owner. To work out the gearing of an investment property, you need to consider outlay versus return. The outlay takes into consideration any interest-only mortgage repayments, as well as any other expenses the property requires, such as rates and insurances. The return, however, is the value of your rental income. A simple guide is as follows:

Negative Gearing: annual financial outlay is more than the annual return

Neutral Gearing: annual financial outlay and return identical

Positive Gearing: annual financial outlay is less than the return

Example

An investment property worth $300,000 with a $250,000 mortgage may require interest-only repayments of $15,000 per year. The cost of maintenance, rates and other fees may total $5,000. In this case, the annual outlay to maintain the investment property is $20,000.

If the rental return totaled $18,000 in a year, the outlay would cost $2,000 more. This property would be negatively geared.

If the rental return totaled $20,000 through the same year that the outlay cost $20,000, this property would be neutrally geared as you are not making nor losing money.

If the rental return totaled $22,000 in a year, the property would be considered positively geared, as the property has increased your income by $2,000.

So which one is better?

Which Gearing Is Best

The property market is typically driven by capital growth. Buying an investment property that will be worth more in a year will usually be better than any type of gearing it creates. For example, if the $300,000 house has a capital growth of $20,000 in one year, then no matter if it was negatively, neutrally or positively geared, it will still be worth more than you have outlaid. The issue with negative gearing though is that you have to be able to cover the deficits left between the outlay required and the rental income the property yields. Capital growth is only a major consideration when it will be used as equity to fund another purchase, or when the time comes to sell the property.

How Can You Work Out Your Gearing Before Purchasing A Property?

Understanding an investment’s rental capacity and upkeep costs are vital to buying the right property for your situation. One of the most valuable tools when purchasing your investment property is to employ a full service firm that handles both buyer advocacy and professional property management. The buyer agents in your team will help ensure thorough research is conducted to purchase a home in the most appropriate area, and to help negotiate advantageous sale prices and conditions. The professional property manager will play a crucial role in establishing the climate for your rental. Even before purchasing a property, a skilled property manager will have a plan in place to capitalize on a particular property and ensure you understand the rental landscape of the area and to prepare potential tenants upon sale and settlement.

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