Which one is better when it comes to property investment?
My friend is big into borrowing money from banks and investing them into property and this in investment vocabulary is called ‘gearing’.
When one does as my friend, there are 3 possible scenarios that one may find themselves during their ownership of the investment, such as: Neutral gearing, negative gearing and positive gearing.
Neutral gearing – where the total costs involved for owning your investment such as loan repayment, interest, maintenance expenses etc. is equal to the income you make from it.
Negative gearing – where the total costs involved of owning your investment property is higher than what you earn from it in terms of rent. So you pay out of your pocket towards the shortfall. One invests in such property, because they expect the investment to grow in value over time, and this increase is may offset any short-term financial losses. Consider this as a long-term wealth generation strategy.
- You may claim tax deductions related to the expenses.
- Eventually when you sell this investment, your profits will outweigh the cost you paid to create this wealth.
- Since you charge lower rent, it may secure tenants for long term.
- You need to budget for the additional out of pocket expense for long term.
- If your circumstances change unfavourably then this strategy may not continue to work for you. You need to have a back-up plan such as income protection, insurance to tide over.
- When you make profit on sale, you are liable to pay tax on it.
Positive gearing – where the total costs involved of owning your investment is lower than the rent you earn from it resulting in profit. This tends to happen at times when rents are high due to strong demand for rental property.
- Increased income, which you can use to pay off your mortgage sooner.
- You do not have to worry about mortgage payments.
- This income is taxable
- The investment may see a slow growth in value.
- The growth and demand for this property may depend on some type of industrial development in the vicinity.
Decide wisely as per your current property portfolios and devise your strategy.