If entering the world of real estate investing, you must have heard real estate investors talking about positive gearing and negative gearing. In case you are still wondering what they are, keep reading this article.
Sure enough, educating yourself on real estate is essential. Learning the terminology associated with real estate investments is a must, especially, if you are a beginner investor. In this blog, we are going to define positive gearing and negative gearing in addition to providing you with examples of both. We are also going to compare the two in terms of advantages as well as disadvantages. So, keep reading to find out more about positive and negative gearing in real estate investing.
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What is positive gearing in real estate investing?
A positive geared property is also referred to as a “cash flow property”. A positive geared property occurs when you rent out your investment property and what you receive from rent is more than what you need to cover for other expenses. And by expenses, we mean the loan payments, taxes, maintenance, insurance, and so on. In other words, you are left with a profit after you have paid all due expenses. This happens when the rent rates go up due to the high demand for rental properties and the low-interest rates.
An example of positive gearing is when you purchase a property for $200,000, and you rent it out for $2,000 a month. You pay $1,000 monthly on the bank loan and need an average of another $600 per month to cover all other expenses associated with owning and running your rental property. This means that your property is making you $400 each month including all expenses.
Related: How to Find Positive Cash Flow Properties in the US
What is negative gearing in real estate investing?
A negative geared property is when you receive less rental income than what you need to pay for the expenses on your rental property. Negative geared properties are also known as “capital growth properties”. This means that such properties depend on appreciation in value over time, which makes them a long-term investment rather than a short-term one.
An example of negative gearing is when you buy an investment property for $200,000 and rent it out for $800 a month. Meanwhile, the monthly expenses on your property are $900 including loan payments, maintenance, and so on.
Why are positive gearing and negative gearing important?
Understanding both negative and positive gearing is essential for you as a real estate investor. It helps you understand the different strategies for real estate investments. It also helps you determine what investment strategy to go for based on the goals you have set for yourself.
What are the pros and cons of positive gearing investment properties?
Pros of positive gearing:
- More rental income: Positive gearing provides you with a monthly rental income. It leaves you a margin for profit. You can also use that profit to cover the loan and therefore pay it faster, or you could even use it to invest in more rental properties.
- Better chances for loans: When you invest in a positive gearing property, you have better chances to get additional loans. The rental income you are receiving will make lenders including banks more interested in giving you any additional loans you apply for, which also means you can use it to your advantage and invest in more rental properties.
- Cover other property expenses: This is in case you have multiple investment properties and some of them are negative gearing properties. You can use your rental income from a positive gearing property to cover for the shortfalls on a negative gearing one.
- Less risk: Positive gearing properties are associated with lower risk rates. After all, you are making money off of them. Besides, if you ever had to give up your full-time job, you will have a stable income to pay your bills.
Cons of positive gearing:
- Less capital growth: Positive gearing properties are usually located in areas that do not experience much capital growth. This makes positive gearing properties a good investment strategy in the short term rather than in the long term.
- Not steady: Positive gearing properties sometimes depend on a particular factor which moves in line with the overall housing market. These factors could be a specific field of employment that keeps it going. Therefore, if this factor weakens or diminishes, then the whole housing market will be affected in that area.
- Taxes: Of course, your rental income is subject to taxes and is not subject to tax deductions.
What are the pros and cons of negative gearing properties?
Pros of negative gearing properties:
- More tenants: Negative gearing properties charge less for rent, which means they are more likely to attract tenants than positive gearing properties. Besides, negative gearing properties are usually located in areas closer to major cities which makes them even more attractive for renting.
- Tax deductions: Negative gearing properties are subject to tax deductions. This means that you can reduce the effects of shortfalls on your real estate investment.
- Capital growth: Such types of properties depend more on appreciating over time. This means that negative gearing properties bring about wealth to their owners in the long term upon selling them rather than renting them out.
- Stability: A negative geared property is less dependent on factors that might affect it. This is due to the location and the low rental rates. Such properties are usually located closer to major cities which makes the demand for them higher.
Cons of negative gearing properties:
- Higher risk: Negative gearing properties are associated with more risk compared to other properties. If you happen to lose your job, you should be able to cover for expenses associated with your rental property. If not, you might be forced to sell it.
- Long-term investment: The profits on a negative gearing property come in the long term. This means that you won’t be able to benefit from it until it appreciates in value and you are able to sell it.
- Careful planning and budgeting: You must be able to set plans that serve you even in the worst case scenarios as well as a careful budgeting system taking into consideration the shortfalls of the rental income.
Related: What Are the Best Low-Risk Investments in Real Estate?
Bottom line
Now that we have introduced you to the terms positive gearing and negative gearing, you get to decide what to go with. They are both profitable, of course; however, they both have some risks to consider. You can always study the two investment strategies further and decide on which one is more suitable for you. You can also check out Mashvisor to learn more about the real estate investment investing business and the various real estate investment strategies. Mashvisor provides real estate investors with a wide variety of information and data that will help them with their investments.