If you’re looking to invest in real estate, one of the first decisions you’ll need to make is whether you’re going to negatively gear or not. It’s best to do your research and make sure you’re going to get the most out of your investment.
How does positive cash flow work?
This is the traditional way of making money from your investment properties. Basically, you just add up all your expenses (things like interest, maintenance, rates and insurance), and if the rent you’re receiving for the property is more than you’re spending on it, you’re generating positive cash flow.
Advantages of positive cash flow
Having a positive cash flow means you’re likely to be making a profit from day one. With a higher income, you can start putting money aside for another deposit – and continue to build your portfolio that way. Or, you might use the extra cash to pay down the principal on your mortgage. Either way, you’ll be in a better financial position for the future.
Disadvantages of positive cash flow
The main disadvantage of generating a positive cash flow is that because you're receiving extra income, you'll have to pay more tax. Read our positive cash flow case study to find out more about how this works.
How yield affects cash flow
You can determine your yield by taking your gross annual rent, and dividing it by your investment property’s purchase price (it’s calculated as a percentage).
Australia’s property prices are at an all-time high (relative to rents), which means yields are low for many investors.
As a general rule, the higher your yield, the more likely you are to have a property that’s in the positive. But don’t leave it to chance – as an investor, it's crucial to crunch the numbers before buying.
What’s negative gearing?
When a property is negatively geared, it means the cost of owning it is more than the income it generates. Because this strategy returns a loss, it can seem risky – but there are other benefits that can add up in your favour overall. For example, you can deduct the loss from your taxable income.
Advantages of negative gearing
While you’re making a loss, your property’s capital value is (hopefully) growing. Negatively geared investors are banking on their overall loss being offset by their property's potential capital appreciation. Keep in mind, there may be tax implications (like capital gains tax) that you’ll need to factor in if or when you sell.
Saving tax shouldn't be the only reason for choosing an investment strategy, but it’s definitely worth factoring in as you weigh up the options.
Disadvantages of negative gearing
You’ll need to have enough cash flow to cover your losses until tax time comes around each year. Running negatively geared investment properties can also make it harder to build your portfolio, since your extra cash will be tied up.
If you’re more highly geared (more deeply in debt) you'll be vulnerable to rate rises too. To find out more about how it all works, read through our negative gearing case study.
Choosing to negatively gear
Before you negatively gear a property, make sure you can afford the ongoing out-of-pocket expenses. If rates go up, you can’t offset the added expense by simply increasing your rent – and you don’t want to be forced to sell your investment property before your capital grows.
Speak to an expert
It’s always a good idea to run your plans by an accountant or financial adviser before settling on an investment strategy.
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The information contained in this article is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, financial and taxation advice before acting on any information in this article.