Weekly Commentary – 30th Sept 2014
Take your investor knowledge up a gear
Buying property is often the biggest purchase decision people make. As a result, gaining potential clients’ trust early in the buying process is essential for the success of our businesses. Developing rapport and building trust starts by understanding a client’s needs and goals.
When it comes to property investors, their decisions are, or should be, based on logic and potential financial returns. To better understand investors and best support them, you’ll need to understand their property gearing strategy. Below I’ve summarised the ins and outs of positive and negative gearing and the important considerations for each.
Positive and negative gearing explained
There are basically two ways investors can make money through property investment; through income returns or capital gain. When the investment income is greater than the investment expenses the property will have positive income returns – this is a positively geared property.
Properties that return less rental income than the costs of owning the property are negatively geared. They’re expected to appreciate in value over time and are often called ‘capital growth properties’. This investment strategy relies on the property increasing in value over time to outweigh any short-term financial losses.
Pros to positive gearing
Clients looking for more immediate returns may be attracted to a positively geared investment. It may also be suitable for clients seeking a lower risk investment because as long as the property is tenanted the rental income will cover the investment costs. Like any additional income, a positively geared investment can increase one’s attractiveness to lenders if they were to apply for additional loans down the track. Some clients may use a positively geared property to balance their portfolio. The additional income can help pay the shortfall of their negatively geared investments.
Important considerations for positive gearing
This investment will supplement an income however it’s also taxable. Encourage clients to put a small amount aside each month to ensure tax time isn’t stressful.
Positive gearing is usually a short term strategy but might not make a significant difference to someone’s lifestyle or financial position. Often positively geared investments are located in regional areas and may return a high rental income because of mining or infrastructure activity. This can cause (but not always) less or slower capital growth.
Pros to negative gearing
The payoff is delivered at sale if the property has produced above average increases in value over the long term. Investing in capital growth property is a long term approach and should form part of a broader wealth strategy. Down the track this may involve the investor using the equity in one property to purchase another. To do this they will need a property that is increasing in value over time which is why a property with high potential for capital growth is necessary.
Clients with a negatively geared investment can also claim tax deductions relating to any expenses they incur on the property. So an advantage to negative gearing is using this loss of income to reduce the amount of tax investors pay on other earnings.
Things to remember about negative gearing
Negative gearing relies on the eventual sale of the property providing the returns so investors need to be comfortable with putting money in long term. It is good to build some equity early on so that if income or circumstance were to change, such as job loss, repayments could still be met.
Can investors get the best of both worlds?
A positively geared property usually won’t be a high capital growth property because of its location. To get the best of both worlds, investors should look at ways to increase rental returns on high growth properties. For example, renovating a property can increase the rental income and depreciation allowances.