When you’re new to property investing it’s easy to get lost in the sea of terms you are learning. Take it one step at a time. Let’s dive into two important concepts that, if understood correctly, could be the differences between making you heaps of cash or losing it: positive and negative gearing.
What is positive gearing?
Positive gearing means that the income that you receive from a rental property is more than the expenses associated with that rental property.
So for example, the rent may be $600 per week, but the mortgage repayments, rates and insurance are $550 per week. This would mean there is a weekly surplus of $50 – ‘positively geared’.
What is negative gearing?
When a property is negatively geared it means that the rental income from the property is not enough to cover the expenses of the property.
For example, the rental income may be $600 per week but the mortgage, rates and insurance payments are $650 per week. This would mean that the owner is out of pocket $50 per week and would have to contribute $50 per week from his/her own funds to make up the shortfall.
So positive gearing sounds great, but is negative gearing bad?
Not necessarily. Properties that are negatively geared are often in areas of strong financial growth, so even though the owner has to contribute some funds from their own pocket to cover costs, the capital gains over time makes it worth it.
Also, because a property is negatively geared at the time of purchase doesn’t mean that this will always be the case. It could just take one or two rent increases and the property is either cost neutral or positively geared.
Properties that are positively geared are great from a cashflow point of view, but the owner should also consider what the capital gains growth might be and how much maintenance is to be done on the property.
It may be cash positive now, but if the house is run down and a lot of money needs to be spent on it then this could wipe out any profits and/or send the property into negative cashflow if money needs to be borrowed for repairs.
The ultimate rental property is in a strong capital growth area, has low maintenance needs and it is also positively geared.