Here we explain the difference between positive cash flow and negative gearing, two different property investment strategies.
Are you getting into property investing and trying to choose the right investment strategy? Unsure whether a positive cash flow or negatively gearing might work better for you? We're going to look at two case studies to help you better understand your options. Read on!
Give me the main points
- Starting with a substantial deposit contributes to a positive cash flow.
- Getting more rent than what you pay out equals positive cash flow.
- Starting with a low deposit could mean you end up negatively gearing your property.
- With negative gearing, achieving long-term capital growth is the goal.
We’ve talked about the differences between positive cash flow and negative gearing. But let's have a look at how this might work in practice.
An example of positive cash flow
Chris is a hairdresser—a chopper of considerable talent. He started out as an apprentice a decade ago and worked his way up. A couple of years ago, he went out on his own and started up 'The Do'—a thriving salon on a busy shopping strip.
Over the past decade, Chris has steadily saved a $170,000 deposit to buy an investment property. He looked for ages, just missed out at a couple of auctions—but then saw the perfect inner-city apartment. He took the plunge and used his $170,000 as a (40%) deposit towards the $425,000 cost.
He found tenants easily enough, and now the property generates $2,000 rent a month. The mortgage plus other expenses total $1,000 per month. For Chris the chopper, that’s $1,000 of positive income a month (or $12,000 per year).
If percentages are your thing, dividing $12,000 by Chris's initial $170,000 investment results in a 7.05% return.
This is a positive cash flow.
An example of negative gearing
Reveka's a builder. She doesn’t own a business, but works for someone else.
Over the years, she’s saved up enough money to buy a trendy apartment in a slowly-gentrifying outer suburb as an investment. The existing tenants pay around $20,000 a year in rent.
Unfortunately, Reveka started out with just a 15% deposit. This means she’s highly geared (in debt) and is facing a large annual interest bill of $25,000. There’s around $4,000 in expenses, too—rates, insurance... repainting the front room, fixing the garage door, installing a new back gate (and so on).
Overall that’s a loss of $9,000 a year. This isn’t as bad as it seems. Reveka could use this $9,000 loss to reduce her taxable income, thus reducing her tax bill.
Let’s assume that Reveka can offset the $9,000 against her taxable income, bringing her tax bill down by $3,000. Now her out-of-pocket costs are only $6,000.
Given her ultimate goal of long-term capital growth, Reveka's comfortable making a $6,000 loss each year.
This is an example of negative gearing. It’s a more complicated investment strategy, certainly.
Before you decide which strategy's best for you, talk to a professional. A financial advisers or accountant is a good place to start.