23 Jul Positive Gearing into Property
Positive gearing lets you make a profit on your investment from day one. Provided there is no capital loss, this can be a great way to make money. Problem is: everyone else has thought of that, too. Positive gearing a decent property investment is hard.
Positive gearing into property is the opposite of negative gearing. It is jargon for borrowing to buy an investment where the expected assessable income is more than the expected deductible interest cost (and other costs). Income is greater than expenses, and your assessable income increases accordingly.
In the context of housing, if you borrow the full purchase price, this means buying on a rental yield of at least 5% (or more if the interest rate is higher). Rents of this scale are unusual. Few residential properties generate rents of more than about 3% (maybe 4%) of the cost or value of the property. This makes it very hard to positively gear property that is largely or fully debt-financed, especially in the years immediately following a purchase.
Very occasionally, you can find a house that is so cheap that the rent is higher than the prevailing borrowing rate. This is usually a sign that the house has a relatively low value. Low value means two things: either the house is not that good; or it needs a lot of work. Either way, low value means few people want to buy the property. This usually hinders longer-term capital growth.
So please, take great care if you encounter claims of positively-geared residential property. There is usually a catch – with the most common catch being that the property can anticipate lower capital growth.
Positive gearing is possible, however, by just borrowing a portion of the full price of the property. For example, if you borrow $300,000 to buy a property worth $600,000, you only pay interest on the $300,000. If interest rates are 5%, this means $15,000 of interest. If you throw in another $2,000 of holding costs (rates, insurances etc), then the total cost of holding is $17,000. If the property then returns 3%, then this equates to $18,000 – the tenant rents the whole property, not just the half you borrowed to buy! This would give you positive cash flow of $1000 per year. Provided the capital value does not fall, you make a profit from day one.