What Is Negative Gearing
(with permission - Nicols ' Age' Newspaper) To understand negative gearing, start by dropping the word negative. Focus on the word gearing. Gearing is borrowing money. It is another word for leverage. Click here to find out more about leverage Negative, Neutral or Positve GearingThere are three different types of gearing - negative, neutral and positive. The outcome of the property cash flow is what determines whether it is negative, neutral or positive gearing. Cash flow is the money in and money out effect of running the property from year to year.Negative means that the income is less than the expenses. Neutral means the income is the same as the expenses and positive, means the income is greater than the expenses. However, this tends to change with a property that starts out as negative. Rents usually increase and it progressively changes the cash flow to become positive geared. Click here to learn more about cash flow result of leveraged investment property Why Negative GearingThe reason most people talk about negative gearing, is that it is the most common way to start up a property.In simple terms, if property has been growing in value (capital growth) to the extent that we would want it too, say 9% p.a., then the income (rent) will not grow at the same rate. Rent usually only averages about 5% to 6% p.a. increase. Hence, the result is that a property usually starts out negatively geared and as rents do grow, it becomes positive over time. On the other hand, to start with a positive geared property most often means that the capital growth in the location of purchase has not been very good. Also, that the property is dilapidated and will require cash flow for repairs and maintenance. Whereas, a negative geared property is usually new and requires negligible maintenance by comparison and will usually grow by at least 2% p.a. faster. With compounding effects, negatively geared property blows positively geared out of the water. Remember, the most common purpose of property is to create wealth. The income will come as the property turns into positive gearing over time. In reality, a negative geared property only remains negative for maybe 7 years. Rents increase and it is common for a property to become positively geared in 5 to 7 years. But of course, that assumes you borrow all of the funds required. In fact, if you have cash to put into the property, a new property may well become positively geared from the outset without compromising growth. It will also depend on your tax saving potential, which is governed by your personal income and deductibility of the property. New properties generally have higher claim ability through higher depreciation. Click here to learn more about depreciation Positive Gearing Not So PositiveOn the other hand, to start with a positive geared property most often means that the capital growth in the location of purchase has not been very good. Also, that the property is dilapidated and will require cash flow for repairs and maintenance.Negative Becomes PositiveNegatively geared property is usually new and requires negligible maintenance and by comparison to positively geared property, will usually grow by at least 2% p.a. faster.For these reasons and with compounding effects, negative gearing blows positive gearing out of the water. Remember, the most common purpose of property is to create wealth. The cash flow of a property that started as negative, will become positive gearing over time.
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