Negative & positive gearing explained
25th Jan 2010
Put simply, gearing is borrowing money to invest. By adding borrowed funds to your own funds, you increase the total amount invested. So the returns, as a proportion of your original capital, are 'geared up', or magnified.
So, what's the difference between positive and negative gearing in relation to property.
If you buy a negatively geared property, the rental income you receive is not enough to cover the interest payments and other expenses associated with holding the property. So each month, you have to put your own cash in to cover the shortfall. In a sense, you are making a loss, but the tax office allows you to claim this against income that you have earned from other sources. The effect of doing this is that your overall income is reduced, which means you will pay less tax. (It is important to remember that you can only benefit from the tax advantages of negative gearing if you are earning income from other sources.)
Positively geared properties on the other hand do generate enough rental income to cover the interest repayments and associated expenses. If there is more money coming in than going out, you have made a profit which will be subject to tax. The positive cash flow generated from these properties can be put towards paying down existing debt or further investment.
The ultimate goal for most property investors is to have a portfolio of positively geared properties generating an income to fund their lifestyle. However, negative gearing is a good strategy for investors when they are getting started because it allows them to purchase real estate at minimal cost to themselves.