When it comes to investing in property, we often get asked about positive or negative gearing and what it means for the owner. While investing in property can be an extremely rewarding and lucrative strategy, a lot of thought and due diligence should be done around your personal circumstance as well as the area you are looking to invest in, in order to buy a property that is going to help you achieve your investment goals.
There are two main strategies that many potential investors consider, positive cash flow or capital growth. With a positive cash flow property, your rental return will be higher than the repayments and expenses each month, and when you invest with capital growth in mind, you are generally looking for an increase in value in your property over time to allow you to build equity and leverage that equity to help grow your asset portfolio.
Below we have outlined some of the key points when it comes to positive and negative gearing, starting with the basics. As always, please seek professional advice when deciding on an investment strategy for your personal circumstance.
What is negative gearing?
In simple terms, negative gearing is when an investment property incurs costs – such as mortgage interest, repairs, utilities and management fees – and these costs amount to more than the annual rent received. It’s important to note that any property can be either positively or negatively geared, it depends on how much debt you have against the property. Further, any loss made on an investment property can then be offset against the owners taxable income, ultimately reducing any personal tax owed.
By owning an investment property that is negatively geared, you are able to take advantage of a raft of tax benefits that help landlords offset the costs of owning the property. These benefits make it enticing to many people, however it is important to fully understand your options when it comes to negative gearing and how you can use it to grow asset portfolio.
What is a positive cash flow property?
A positive cash flow property is an investment property that will start to make the owner a return instantly. A property that has a high rental yield, where the rental return exceeds the outgoings will achieve a positive cash flow status and the owner will see an instant return on investment (ROI).
What is the difference between a positive cash flow property and a positively geared property?
It is important to remember that a positive cash flow property can be different to a positively geared property. A positively geared property may not initially generate an income or pay for itself, however once tax deductions and depreciation is calculated, the investment more than pays for itself.
What are the benefits of a positively geared property?
There is an instant return on the capital invested and therefore an instant return on investment once this occurs, so it is either a way to greater cashflow or for more leverage. Once a property becomes positively geared it also increases the opportunity for the investor to grow their property portfolio by leveraging the equity in their combined property assets and then borrowing further to buy more property.
The need for providing housing for the community is something that is often forgotten when considering property investment and when properties fall into this category it indicates that the investor is seeking a long term investment strategy and as such this provides stability in the housing sector.
This also leads to providing increasing demand for the construction sector through a more stable rental market, so it creates a strong foundation.
What is a rental yield and how is it calculated?
The yield of a property is the ratio of annual rental return, be it either gross (before expenses) or net (after expenses) to the capital value of the asset, also referred to as ROI. This is a helpful number when looking to purchase an investment property so you can compare ‘apples with apples’ across a number of different locations and property types. The calculations are as explained as:
Gross rental yield = (annual rental income/property value) x 100
Net rental yield = [(Annual rental income – annual expenses) / total property cost] x 100
Rental yield is also used to determine the value of an asset through reverse engineering from the rental return achieved to then determine market value through comparisons to other similar properties. As an example, if a property has a net return (after deductions/expenses have been paid) of $30,000 and the evidence in the market shows that such properties have a net yield of 5% then the value of the property would be determined to be $600,000. Conversely if you purchased a property for $800,000 and the current tenant is paying an annual net rent of $40,000 then the net yield would be showing 5%.
What factors can impact a property’s investment performance?
There are many things to consider when it comes to buying and owning an investment property and we have outlined a few key areas for consideration below. Having an investment strategy in place will help you to have more control of your assets, and how well an investment performs now and into the future, so always speak to a professional financial advisor before making any decisions for your personal circumstance.
Capital growth: Capital growth is when the value of your property increases beyond the amount of debt you have against it. Investing for capital growth means that you may not see an instant return on an investment, although this can change over time. Capital growth varies from location to location and a number of factors can impact how a property grows in value, for example the economy, interest rates, updated infrastructure as well as population growth. Investing in property in high growth areas will help investors build equity in their assets and further build on their portfolio.
Rental return: The rental return achieved for a property can rely on a few factors, including location, presentation and the quality of tenant. The location of a property can have a huge impact on your rental return, with in demand areas close to transport, shopping centres and business districts. More regional properties have less demand and therefore cannot charge high rents. The quality and presentation of a property will also have a significant impact on your rental return. Presentation is key for achieving better returns, so the better the condition the better quality the tenant and ultimately a higher rental yield.
Risk profile: Risk is always a factor in any investment no matter what it is or where it is. There can be both calculated risks such as loss of rent, personal injury claims, locality issues, surrounding developments and planning prospects and then there can be unforeseen risks such as rogue tenants, neighbours, rezoning, natural disasters, etc. However, any risk needs to be mitigated by planning strategies around quality insurance, professional asset management, tenancy selection and proper maintenance and improvements to the property.
It is also important to note that it is quite rare to purchase an investment property that has all three performance objectives above, i.e. achieves high capital growth, is low risk and produces high rental returns. Two of the three may be obtained quite easily, for example a low risk property with a high rental return may not see a great deal of capital growth and a low risk property in a high growth area may not see a high rental return straight away, however this can change over time.
If you are on the search for your next investment, need advice on a property Purchase or need someone to manage your investment, please get in touch with our team on 02 9949 7077.