What is property gearing, anyway?
First things first: "gearing" simply means borrowing money to invest. When you take out a loan to buy an investment property, congratulations—your property is now "geared." It's not complicated, but understanding the difference between negative and positive gearing could save you thousands in tax and potentially make or break your investment journey.
Negative gearing: the tax-saving strategy
What is negative gearing?
Negative gearing happens when the annual costs of owning your rental property exceed the income it generates. In simple terms: you're making a loss on paper.
Let's break it down with some real numbers:
- Annual rental income: $25,000
- Annual costs (mortgage interest, maintenance, fees, etc.): $30,000
- Result: $5,000 loss
This might sound terrible (who wants to lose money?), but here's where it gets interesting: that $5,000 loss can typically be offset against your other income—like your salary—reducing your overall taxable income and potentially putting you in a lower tax bracket.
The cash flow hack you need to know
If you know your investment property will be negatively geared, you don't have to wait until tax time to benefit. You can apply to the ATO for a PAYG Withholding Variation, which reduces the tax taken from your salary throughout the year, improving your immediate cash flow.
The negative gearing risk factor
A loss is still a loss. Before diving into negative gearing, ask yourself:
- What happens if your property sits vacant for months?
- What if property values take a dive instead of rising?
- How will you manage if interest rates spike but you've locked in rental rates?
Smart investors have clear answers to these questions before proceeding, and the financial support of a great broker to help them understand and navigate options.
Positive gearing: the cash flow strategy
What Is positive gearing?
Positive gearing is when your rental income exceeds your property expenses, creating actual profit in your pocket each year.
For example:
- Annual rental income: $20,000
- Annual costs: $15,000
- Result: $5,000 profit
This profit counts as income, so you'll need to set aside funds for the tax bill. But unlike negative gearing, you're making actual money which may mean you’re able to generate passive income for your lifestyle.
The long game: why investors choose negative gearing
Negative gearing might seem counterintuitive at first—why would you deliberately choose an investment that loses money in the short term? The answer lies in the long-term strategy.
Capital growth is the real payoff
Most savvy investors who opt for negative gearing are playing the long game. They're willing to wear short-term losses for potentially significant capital gains down the track.
Here's how the math can work in your favor:
- You purchase a property for $600,000
- It costs you $5,000 per year after tax deductions (negative gearing)
- Over 10 years, that's a $50,000 loss
- But if the property grows at just 5% per year, after 10 years it's worth approximately $977,000
- That's a capital gain of $377,000, far outweighing the running losses
This strategy works particularly well in high-growth areas where property values tend to increase significantly over time. Many investors in Sydney and Melbourne have built substantial wealth using this approach despite the initial negative cash flow.
Building an asset base faster
Another advantage is that negative gearing can allow you to enter the market sooner or purchase a higher-value property than you might otherwise afford. Since the tax benefits offset some of your holding costs, you might be able to:
- Buy in a better location with stronger growth potential
- Purchase multiple properties sooner, building your portfolio faster
- Access properties that would otherwise be beyond your immediate cash flow capacity
The Compound Effect
Remember that property investment is one of the few investments where you can leverage other people's money (the bank's) to buy an appreciating asset. When you combine this leverage with the tax benefits of negative gearing, you're potentially accelerating your wealth creation timeline significantly.
Which gearing strategy is right for you?
Your optimal strategy depends on your financial situation and goals:
Consider negative gearing if:
- You have a solid income and want to reduce your tax bill
- You're focused on long-term capital growth
- You can comfortably cover any shortfalls without stress
- You've done your research on the property's growth potential
Consider positive gearing if:
- You want your investment to boost your immediate income
- You're nearing retirement or planning to live off rental income
- Cash flow is more important to you than tax benefits
- You're just starting out and can't afford ongoing losses
Minimising risks in your gearing strategy
Regardless of which approach you take, protect your investment by:
- Location, location, location: Choose properties near amenities that appeal to a wide range of tenants to minimise vacancy periods.
- Budget for all scenarios: Have reserves to cover periods without rental income and unexpected major repairs.
- Protect yourself: Comprehensive landlord insurance isn't optional—it's essential. The small premium can save you thousands if things go wrong.
- Get professional advice: Every investor's situation is unique. Working with a mortgage broker who understands investment strategies can help you navigate the complexities of property investment.
Ready to start your property investment journey?
Understanding gearing is just the beginning. Whether you're drawn to the tax benefits of negative gearing or the immediate returns of positive gearing, having the right loan structure is critical to your success.
Our team specialises in helping investors find the right mortgage solutions for their strategy. Book a free strategy session today to discuss how we can help you build a property portfolio that works for your financial goals.
