Buying

Gearing: A dummy’s guide

Without doubt, “gearing”, such as negative gearing or positive gearing, has a significant impact
on Australia’s property market. It affects everything from rental and home prices, to
housing stock and even the rental vacancy rate. But what exactly is gearing?

 

Gearing (in laymen’s terms)

 

Gearing is the process of borrowing money for the purpose of buying an investment
property. Given the practical costs of owning a home, this is a process that generally
requires a high, stable income. This differs from the regular purchase of a home. Most people buy a home with the intention of living in it, however investment properties are commonly purchased as
secondary property. In most cases, investors are searching for tenants to help offset
the costs of home ownership.

 

Property gearing

 

• Is designed to make a profit;
• Involves borrowing money to purchase a property;
• Differs from purchasing a home to occupy or use it;
• Makes a rental income for the owner;
• Requires a high income to maintain ongoing costs.

 

Positive Gearing

 

Positive Gearing is when the rental income on an investment property exceeds the
cost of maintaining it, thus generating more income than losses. This occurs if a
property is purchased and used to make a short-term profit through rent, usually at
times when interest rates are low, and rental rates are high. The rent collected
exceeds the cost of repayments, maintenance and interest, and the owner gains an
additional income stream.

Positive gearing is primarily practiced in areas that are experiencing substantial industry and employment growth, particularly in rural areas. This surge increases demand for rental properties, which inturn allows owners to charge higher rents, and to make larger profits from the geared property. Income on a positively geared property is taxed, so people who own positively geared homes should be prepared to maintain them well, and sell while the price of their property is still high, lest they make a loss.

 

The Advantages of Positive Gearing

 

• Faster Profit- The gains from rent are immediate. Investors gain a new
income stream and a short-term payoff;
• Stable Income- The property pays for itself, letting the investor maintain the
property without relying too heavily on an alternate source of income;
• Builds upon itself- The extra income can help aid an investor’s
attractiveness to lenders, allowing investors to build up their investment
portfolio.

 

The Disadvantages of Positive Gearing

 

• Less Long-term Gains- The immediate gains from rental income lack the
payoff of a long-term investment;
• Can Turn into a Loss- These investments require work on the part of the
investor. Without adequate work, these properties can quickly begin to run at
a loss;
• Taxes- The added income from the property will likely see you move into a
higher tax bracket.

 

Negative Gearing

 

Negative Gearing is when a property runs at a loss for the owner, with the costs of
maintenance exceeding the rental income. These kinds of investments are used to
make long-term capital gains profit. The property is bought with the expectation that
its value will grow over time, thus outweighing any short term financial losses.
Negative gearing creates a taxable loss, which investors offset against their primary
income as a tax saving. The plan is to use your ordinary income to pay off the shortterm
costs of the home, and then go on to profit off the sale of the home when its
price has increased.

 

The Advantages of Negative Gearing

 

• Greater Long-term Payoff- The profits earned from selling a property that
has grown over time far exceed the long-term costs;
• Low Interest Rates- Interest rates in Australia are currently low. This makes
negative gearing a popular alternative for investors;
• Potential for Development- Because of the long-term nature of negative
gearing, investors can spend money on developing the property and
increasing its market value over time.

 

The Disadvantages of Negative Gearing

 

• Difficult to Find- Careful research is needed before buying a home. You
need to ensure that the property will grow over time, rather than shrink in
value;
• Possible Loss- Investors need to sell while home prices are high, otherwise
they face making an enormous loss as the price of their home falls;
• Costly and Expensive- A high income is needed to maintain this investment
strategy, with the home incurring costs over a long-term period of time.


Taxes and Negative Gearing

 

As at 2015, Australia’s current tax laws encourage negative gearing. Those who own negatively
geared properties can reduce the impact of the financial loss from their property, by
offsetting it against assessable income.

You can claim a tax deduction from the following expenses:
• Advertising for Tenants;
• Body corporate fees and charges;
• Cleaning, Gardening and Maintenance;
• Deductions for declines in value;
• Insurance and Legal Expenses;
• Loan Interest and Borrowing expenses;
• Water, Land Tax and Council Rates;
• Stationery, telephone and postage.

The current dialogue about abolishing negative gearing is about these tax
incentives. If negative gearing laws are abolished, then the cost of maintaining an
investment property will increase dramatically. This will increase rents, and make the
costs of owning an investment property far more substantial.

 

The Advantages and Disadvantages of Gearing

 

The effect of gearing on the Australian property market is complex, with a variety of
impacts on both rental and housing affordability. Gearing typically drives up the price
of homes in Australia, but also drives down the price of rent. While property gearing may stimulate housing supply, it also lowers the number of homes available on the market. This drives up the price, and reduces their affordability for regular home buyers. Meanwhile, those who buy properties for investment often develop and build residential properties, increasing the rental market. Investors are more willing to shoulder costs, and are more likely to search for long-term tenants. This means lower
rents, and more affordable rental housing.