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.