Gearing, and what it really means…
You’ve probably heard the term negative gearing thrown around, and maybe positive gearing? There’s also such a thing as neutrally geared. But what does it all mean?
Well basically gearing refers to the fact that there is a loan against the investment property. If it was owned outright 100% then it would not be geared at all. That’s the first part.
The second part refers to the financial position of the investment. So essentially negative gearing means that the cost of owning the property is more than the rental income being received.
So essentially you are losing money each year owning the property.
Positive gearing means exactly the opposite, that the rental income being generated is more than all of the costs involved with the property, like interest on the loan, maintenance rates and all that.
If an investment property in neutrally geared, it simply means that it’s breaking even. So the income is about the same as the expenses. It’s covering itself essentially.
So why would anyone want to be negatively geared and losing money each year? Well, this strategy is based around the belief that the underlying value of the property will be increasing all the time, and ultimately when the property is sold, this will make up for all the losses along the way.
People also like the fact that they get a tax deduction for the losses each year.
If the property is positively geared, that means you’d pay a little tax on the income that’s received over and above the expenses of the property.
People don’t like this, they’d rather a deduction and a tax return than paying a little extra tax on income.
Let me just say that you should never make an investment decision based on tax. A tax deduction just means that your losing a dollar to save 30c (or whatever you tax rate is).
The investment decision should always be based on the belief that over the long term the whole exercise will yield positive results.
Food for thought in the complicated world of property, where there is a huge push toward collecting negatively-geared investment properties.