NEGATIVE GEARING: If your total costs (interest + property expenses) are greater than your income (rent + tax deductions) then you are negatively geared.
NEUTRAL GEARING: If your total costs (interest + property expenses) are equal to your income (rent + tax deductions) then you are neutrally geared.
POSITIVE GEARING:If your total costs (interest + property expenses) are less than your income (rent + tax deductions) then you are positively geared.
Everybody would love to have an investment property that pays for itself completely. There are some realities we have to consider in achieving ownership of positively geared property, and investors need to have realistic expectations about how they can make their property investment loss-free.
A LARGE DEPOSIT : The bigger your deposit, the less you need to borrow. By lowering your borrowing costs, the rent you collect along with the tax benefits you receive can cover loan and property costs (e.g. real estate agent management fees, council rates, insurances etc.), and the closer you are to creating a positive cashflow property.
HIGH RENTAL YIELD: The rent that a property generates needs to be greater than the loan costs. It may also need to be slightly more to assist with the property expenses. With newer properties, the depreciation on the building and its fixtures and fittings will help you achieve a reasonable tax deduction that will assist in making your investment property positively geared.
LOWER INTEREST RATES: The cost of borrowing money from a lender has a significant impact on whether a property is positively geared or not. When interest rates are low as 5%, it is far easier to establish a positive gearing property. When rates are at the 7% mark, it is very hard to achieve a positive cash flow property with a small deposit.
For example, many investors want to borrow 100% of the property value plus purchase costs by using the equity in their home. Purchasing a property for $500,000 along with the associated government costs and other expenses would require a loan of about $520,000.
You would need to use a realistic long-term interest rate average of at least 7%; hence the interest would be $36,400 per annum or $700 a week. You would therefore need to find a $500,000 property that receives $700 per week in rent to just break even on the interest. Add to that cost the other property expenses, such as council rates, water rates, property manager’s fees, maintenance costs, body corporate or strata for units, insurance etc. The tax deductions on depreciation and expenses may not be enough to cover the shortfall – thus the rental yield would need to be higher.
There aren’t too many residential properties achieving a 7% and over rental yield. If rents were that high then most tenants would buy a property with interest equal to rent. Rents often go up when rates go up. Thus, when rates are low, there is an opportunity for renters to buy their own home.
You’re more likely to find higher rental yields in regional Australia. According to major banks, this is often in areas with lower population, lower capital growth and higher risk. Chasing high rents to be positively geared only at a cash-flow level at the expense of capital growth by choosing the wrong areas can compromise your overall momentum. ‘Total Return Property’ (income + capital growth) can greatly assist the creation of positive geared property even if you have a slight cash shortfall for the first few years. Reading DPN’s ‘The Value of Capital Growth’ is highly recommended to ensure you understand the value and impact of capital growth on your wealth – and help move you towards owning positive cashflow properties that any investor would envy.