What is negative and positive gearing?

Negative gearing is where the week to week cost of an investment is more than the immediate return you make from it.  For example someone might receive $1,000 in rent for their investment property but the total cost might be $1,500 per month.  The benefit is...

...that in most cases this $500 loss can be deducted from their taxable income.  So if you earned $4,000 per month before tax it would then become $3,500.  After tax $4,000 becomes $3,145 and $3,500 becomes $2,795.  This means that in real dollars it has only cost $350 and not $500.  However, this $350 per month loss is a bet that the value of the property will eventually increase and the yield will more than compensate the losses over the years.

A positive geared investment property earns more than the ongoing cost.  The rental might be $1,000 per month and the cost only $800.  The downside is that positively geared properties generally don't share the same capital growth as their negatively geared counterparts.

On ASIC's webpage they have a great tip that everyone should heed before looking at negative gearing 'judge the investment first, not the tax benefit'.  I have spoken with many people with narrow minded strategies that aren't suited for their lifestyle or have purchased bad investments on a whim.  After talking with them i get the impression that very little research was conducted before purchasing their investment.  When it comes to investing educating yourself is the greatest investment you will make.  The more you educate yourself on your potential investment the more likely they are to succeed.

Steve McKnight is a great evangelist for the strategy of purchasing positively geared properties.  He has a couple of great books that are definitely worth a read.  The basic philosophy from one of his books "0-130 Properties in 3.5 Years" is that you can use the excess cashflow from your positively geared properties for further real estate acquisitions.  Over a period of time even positively geared properties should appreciate in value yielding a capital return.  A big issue I have seen with people looking for positively geared properties is they are not realistic with the costs.  There is a lot more to consider than just the mortgage repayments alone.

Positive and negative gearing can be an affective investment in any financial strategy.  Before making any decisions make sure you are well informed.