Positive gearing into property

Positive gearing 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), with a resultant increase in assessable income.

In the context of housing prices, this means buying on a rental yield of at least 5% or more. This is a very unusual phenomenon. Most residential property will not generate rents of more than about 3% (maybe 4%) of the cost or value of the property. This means it’s very hard to positively gear property that is largely or fully debt-financed, especially in the years immediately following a purchase.

Sometimes positive gearing works OK, but it’s usually a sign that the house has a relatively low value. This either means that the house is not that good or it needs a lot of work or such that it is falling in value and not worth buying.

Take great care if you encounter claims of positively geared residential property. There is usually a catch.

Positive gearing of other types of investments can be a different proposition. For example, in early 2008 our AFSL Dover recommended clients borrow to buy bank shares, which at the time were selling on after tax yields of as much as 13%. This meant that if a client borrowed $100,000 to buy ANZ shares, they received $13,000 of assessable income. Interest rates were 6%, so the client paid $6,000 of interest. The client made $7,000 cash profit on the deal. That is before capital gains.

It can make a lot of sense for a young person to adopt a strategy like this as an alternative to buying a home. But remember, you would need to make a reasonably large investment for this to be a genuine alternative to purchasing property.

In residential property, positive gearing is much more easily achieved when you don’t borrow the full price of the property. For example, if you borrow $300,000 to buy the property worth $600,000, you will only pay interest on the $300,000. If interest rate of 5%, this is $15,000. But you will collect rent on the full value of the property. 3% of $600,000 is $18,000. This situation would give you positive cash flow of $3000 per year (although that is before other holding costs such as rates, maintenance et cetera).

To learn more about this topic or to discuss how you could benefit, please give our office a hour. The first hour is free and we would love to help.