Negatively geared property

When a property investor negatively gears a property, the investment is running at a loss in income terms. The investor can offset this loss against other income, making it tax deductible. However, unless there are substantial depreciation claims which bolster the tax savings, it probably will remain an after tax loss.

Therefore the only likely reason a property investor who wants to make money would negatively gear would be that they expect the property to grow in value at a greater rate than the loss they are incurring.

As previously stated, gearing is a double-edged sword. If growth rates are good, not only will a greater level of gearing multiply returns exponentially, it will also multiply losses exponentially if there is a decline in property values. Put simply, a negative gearing strategy is purely a growth strategy and the greater the rate of capital growth, the shorter the time frame needed to recoup initial purchasing costs, holding costs and selling costs.

This means that the risk is lower in times of higher growth rates. Therefore,  successful negative gearing needs an understanding of the causes of capital growth as well as knowledge about why properties grow at different rates and an ability to pick those properties that meet high growth criteria.

Positively geared property

Positively geared property occurs as a result of higher net income returns and/or lower levels of borrowing.

Properties that are positively geared due to low levels of borrowing are still dependent on capital growth rates to generate an acceptable return on invested capital. The risk associated with gearing, however, is significantly reduced as the property is cash flow positive, but so are the returns on invested capital.

Properties that are positively geared because of higher net income returns do not necessarily have lower growth rates, but they may exist in areas where rental demand is high due to the prevalence of a single industry. The investor must be sure that the area chosen has the capacity to continue to deliver both the strong rental demand and a resulting property value growth by doing a thorough analysis of the strength of the industry and the area.