When you are thinking of investing in real estate, there are several things to be kept in mind. One of the biggest and most important things is to decide whether you want to invest through negative gearing or not. This is a major decision as it directly affects the return on your investment. In the real estate investment game, the term “gearing” means the borrowing of capital to buy a real estate property.
What is Positive Cash Flow?
This is the orthodox method of earning profits on your investment. Simply put, if the rent you are receiving on your property is higher than all the costs (maintenance, mortgage repayment, and insurance) you are spending on the property, then you are generating a positive cash flow.
In this method, the investor enjoys all the advantages of having an additional cash flow in his revenue stream. Although the investor might have to face comparatively higher taxes as compared to someone who is negatively gearing their property.
Investors who are investing in a property to earn a positive cash flow have the luxury to save up for their next investment and consequently expand their property portfolio. If they do not want to do that, they can choose to use the returns on their investments to pay down the principal on their mortgage.
Another major benefit of continuing with such properties is that investors are less likely prone to selling their property under duress as the property pays for itself. The higher profit ratios help investors to improve their serviceability.
Even after all that, investors are advised to be cautious of being very focused on cash flow properties. One of the biggest flaws of positive cash flow properties is that, such properties do not grow in value that much.
What are the Advantages of Positive Cash Flow?
One of the biggest benefits of positive cash flow is that you are likely to make a profit from the very first day. The higher income will allow you all the flexibility to continue to create a formidable portfolio. You can use the money to pay down the principal on your mortgage or maybe invest in your other passion projects. No matter what you decide, you will be in a better financial state than before.
What are the Disadvantages of Positive Cash Flow?
The greatest disadvantage of positive cash flow is pretty obvious! Since you are earning more, you will have to pay higher taxes. Moreover, positive cash flows are usually achievable with properties in the regional areas that do not have capital growth.
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What is Negative Gearing?
Negative gearing is the opposite of positive cash flow. Instead of enjoying a higher rent from day one, you invest your surplus amount to support your property. In short, a property is negatively gearing when the investor’s expenditure is higher than the rent collected from the property.
One would ask why would anyone bear the loss on their property on purpose, right? But it is a pretty common practice. Investors invest in such properties with the confidence that the property will be worth it after calculating its capital growth in the future. Investors hope to offset their loss by their property’s appreciation.
For example, an investor buys a property, a house, for $400,000 that will appreciate within a few years by a ratio of 10 percent. With this rate of appreciation, you might be paying $25,000 in interests while earning $19,200 in rent. You can easily offset your $5,800 loss from the $40,000 you earn from the property appreciation.
Furthermore, if the interest rate does not rise at an unprecedented rate and the market exhibits strong growth, investors can make up for their losses over time.
Moreover, a loss on the investment means that investors will have to pay fewer taxes on their proceeds from other sources of income. It has been seen that in some cases the tax savings can exceed the loss borne by negatively geared properties.
All these things might seem enticing, but an investor might have to keep this in mind that to make a profit, one must find other sources of income while their property appreciates.
What are the Advantages of Negative Gearing?
While you are bearing a loss, your property is (hopefully) appreciating. Negatively geared property is basing their profits on the hopes of offsetting their total loss by the property’s capability to appreciate. Investors do have to keep in mind all the tax implications that are attached to this method when selling like capital gains tax.
Moreover, if you want to save yourself from taxes like capital gains tax, then you can hold on to the property and build up quite a reasonable equity. This can be a valuable resource when it comes to investing in other properties.
Saving tax should not be the only reason for you to invest in a negatively geared property. But it is still a factor worth considering.
What are the Disadvantages of Negative Gearing?
First, you will need enough capital to cover your losses and keep on investing in the property until it is time to sell. Owning a negatively geared property can make it harder for investors to build a portfolio, as all your extra cash will be invested in your property.
Another drawback of negative gearing is that if you are in deeper debt than usual then you are likely to be a lot more vulnerable to rate fluctuations.
Frequently Asked Questions!
1. Why would I invest in something that is losing money?
Investing in a negatively geared property might seem like an unsound choice on the surface, but its benefits greatly outweigh its drawbacks. First, the potential increases in capital growth in the short/long run is what the investor is looking at. Finally, apart from huge growth prospects, the tax benefits on such properties can be huge.
2. Why wouldn’t I always invest in positively geared properties?
Positively geared properties might seem a safe choice at first, but upon further investigation, you will notice that neither the growth nor the appreciation value is worth the investment.
3. Which type of property should I buy?
It all depends on your financial standing. If you believe you can bear the hardships of buying a negatively geared property and it aligns with your goals, you could consider making a move. If not, then you could explore positively geared properties.
Crunching the Numbers with Investment Property Feasibility Tool
To make matters easier for investors we’ve created an Investment Property Feasibility Tool that lets you compare up to 5 properties at the same time to help you identify and pick the best investment property that fits with your investment goals, investment strategies (positive cashflow or negative gearing), and financial capacity.
The example numbers above show how negatively geared properties are more beneficial in the long run when compared to positively geared properties.
Conclusion
There are a few key messages that we would like to deliver here. When investing in real estate, you are either looking for growth or you are trying to make an earning out of it. Whether these investments are positively geared or negatively geared is a separate topic altogether. The best advice we believe we can give you is not to after every glittery and shiny thing you find in the market. When buying a property, we believe proper research and calculation is the key to your success. We would also like to add that it is absolutely possible to have a good cash flow and capital growth simultaneously, by using proper researching tools like SuburbsFinder.
Our fully customisable tool will help you in choosing which areas have both Good Capital Growth and Positive Cash Flow. It lets you narrow down 15,000+ suburbs by combining all 40 data points as filters. It also lets you compare suburbs historical & current performance. And once you identified the best location our tool also lets you do feasibility studies on 5 properties all at the same time. Save time, budget, and cover the full cycle of your investment property research workflow
So, if you think what we’ve built will drastically decrease your time researching for the best location and finding the right property based on your goals and financial situation, why don’t you sign up for free and give it a try.
It is the most comprehensive location report of all 15,000+ suburbs in Australia – with linked state, suburb, and postcode. It’s the perfect tool for property investors looking to buy a property to rent out rooms individually to have a positively geared portfolio.
