What Is Positive Gearing

Investing in property or other income-generating assets often involves a financial strategy where borrowed money is used to purchase the investment. One such strategy, commonly used by real estate investors, is known as positive gearing. This concept plays a major role in determining the overall financial return of an investment. Positive gearing not only impacts an investor’s cash flow but also influences tax obligations and long-term wealth creation. It is essential for any investor, especially those new to property investing, to fully understand what positive gearing means, how it works, and when it might be the right strategy to pursue.

Understanding Positive Gearing

Positive gearing refers to a situation where the income generated by an investment is greater than the costs associated with owning and maintaining that investment. In simple terms, the investment is making a profit on a regular basis, even after covering all expenses including loan interest, property management fees, maintenance, insurance, and other outgoings.

This strategy is commonly used in real estate but can also apply to other types of investments like shares or businesses. When an investor finances the purchase with a loan and still earns more than what they spend on interest and other costs, the investment is positively geared.

How Positive Gearing Works

To break it down, here is how positive gearing operates in practical terms:

• An investor purchases a rental property for $500,000 using a combination of personal funds and a mortgage loan.
• The loan costs the investor $20,000 per year in interest payments.
• The investor also pays $5,000 annually for maintenance, insurance, and property management.
• If the rental income from the property is $30,000 per year, the total income exceeds expenses by $5,000 annually.

That $5,000 is considered a positively geared return, and it will be treated as taxable income.

Advantages of Positive Gearing

There are several benefits to using a positive gearing investment strategy. For many investors, this approach provides steady income while still enjoying the benefits of asset appreciation over time.

Reliable Cash Flow

One of the main attractions of positive gearing is that it provides a consistent, passive income stream. This income can help investors cover personal expenses, reinvest in other opportunities, or pay off debt faster. A predictable surplus is often desirable, especially for investors seeking financial stability or those approaching retirement.

Lower Risk Compared to Negative Gearing

Positive gearing typically involves less financial stress than negative gearing. Since the property generates enough income to cover its costs, the investor is not required to contribute additional funds each month to keep the investment afloat. This can reduce the risk of financial strain during economic downturns or when interest rates rise.

Attractive to Conservative Investors

Positive gearing appeals to those who prefer a more conservative approach to investment. It allows them to focus on maintaining a healthy cash position rather than speculating on future capital gains. This is particularly beneficial during uncertain market conditions when property values may fluctuate.

Potential for Capital Growth

In addition to earning income, the investor may also benefit from long-term capital growth if the value of the asset increases. This combination of positive cash flow and asset appreciation can enhance overall returns and build wealth over time.

Disadvantages of Positive Gearing

Despite its benefits, positive gearing may not be suitable for all investors or in all market conditions. There are some important drawbacks to consider before choosing this strategy.

Higher Tax Liabilities

Since the profit earned from a positively geared property is treated as taxable income, investors may face increased tax bills. Unlike negative gearing, where losses can be used to reduce taxable income, positive gearing does not provide any immediate tax breaks. This can make the strategy less attractive for high-income earners looking for tax offsets.

Limited Growth Areas

Properties that generate strong rental returns and qualify as positively geared are often found in regional or less expensive suburbs. These areas may not experience the same level of capital growth as more popular urban locations. As a result, the potential for long-term wealth creation may be lower in positively geared investments compared to others that focus on high-growth suburbs.

Reduced Focus on Capital Gains

Investors who concentrate too heavily on positive cash flow may miss opportunities for significant capital appreciation. In some markets, properties with higher rental yields may appreciate more slowly over time, which could impact overall investment returns if selling at a later date is part of the plan.

Positive Gearing vs. Negative Gearing

It’s important to understand the difference between positive gearing and its counterpart, negative gearing. While both involve borrowing to invest, their financial outcomes are very different.

• Positive Gearing: The income exceeds the expenses, resulting in a surplus that is taxable.
• Negative Gearing: The expenses exceed the income, resulting in a loss that can often be claimed as a tax deduction.

Positive gearing focuses on short-term gains through cash flow, while negative gearing is more reliant on long-term capital growth to turn a profit. The right strategy depends on an investor’s financial goals, risk tolerance, and tax situation.

When Is Positive Gearing the Right Strategy?

Positive gearing is best suited to certain situations and types of investors. For example, those who prioritize immediate returns and financial security may prefer positively geared assets. It’s also ideal for retirees or people with fixed incomes, as the steady cash flow can supplement other sources of income.

Ideal Conditions for Positive Gearing

• When interest rates are low, making it easier to maintain a positive cash flow.
• In property markets with strong rental yields and stable tenant demand.
• When investors want to avoid the risks and cash shortfalls associated with negatively geared properties.

Tax Considerations

As the net income from a positively geared investment is added to the investor’s taxable income, it’s important to consider how it will affect their overall tax bracket. This income can push the investor into a higher tax bracket, especially if they already earn a high salary.

Investors should consult with a financial advisor or accountant to ensure they structure their investment correctly and plan for any additional tax liabilities.

How to Identify a Positively Geared Property

Finding a property that offers positive gearing involves thorough research and financial analysis. Investors should calculate all costs associated with the property and compare them against expected rental income.

Steps to Take

• Look for properties in high-yield areas with affordable purchase prices.
• Estimate rental income using local market data and listings.
• Calculate all expenses including mortgage interest, insurance, council rates, property management, and maintenance.
• Ensure rental income exceeds total expenses before making the investment.

Positive gearing is a powerful investment strategy that provides consistent income, minimizes financial risk, and supports wealth building through both cash flow and potential capital gains. While it may not offer the same tax advantages as negative gearing, its stability and predictability make it an appealing option for many investors. With careful research and planning, positive gearing can be a valuable part of a diversified investment portfolio. By focusing on sustainable income and choosing the right assets, investors can achieve long-term financial goals with greater confidence and reduced risk.

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