What is the difference between Positive Gearing and Cashflow?
Positive Gearing and Cashflow – ‘Know when to go with the flow.’
All positive cash flow properties are positively geared but not all positively geared properties are cash flow positive.
Yes, it might sound a bit complex but it is well worth taking a moment to understand it.
Choosing an investment strategy can be difficult. Choosing between positive gearing and cashflow can often be harder. As an investor a lack of cash flow can leave you in limbo. Making you unable to move forward to build up your portfolio.
I often hear from clients that they want a positive cashflow property, and for many investors who have spare savings. Combined with today’s low interest rates, this is quite simple to achieve. We simply put additional cash in as a deposit to reduce the costs of owning the property. Which brings them down to a level where the income exceeds the expenses.
A positively geared property is often what a client really wants. Many don’t want to use any of their spare cash even if they have some. What this means is that they actually want to make a profit. That is once they have got their rent in and paid their expenses out. Naturally at this point, it is likely that they are now going to have to pay some tax too. But at the end of the day, they don’t want to have to put any money from their own pocket in to subsidise the property in any way.
It is more about using these strategies for your own financial gain if you have the flexibility to do so.
So let’s look at a couple of examples of positive gearing and cashflow:
Based on a positively geared property — which generates more income than expenses before and after tax.
- You purchase an investment property and each month it brings in $1,000 in rent and you pay $700 in property expenses. At the end of the month, there’s $300 in cash spare ($3600 before-tax that year). After-tax, based on a marginal rate of, say, 47 per cent, not including Medicare levy or surcharge, you still have more than $150 per month in loose change.
Compare that to the scenario of a positive cash flow property — which generates a loss before-tax but more income than expenses after-tax.
- In this instance, your investment brings in $1,000 in rent each month but your property expenses are $1200. Before tax you’re down $2400 a year but once you claim, say, $10K in depreciation, based on an assumed rate of 30 per cent, your total loss for the year (on paper) is actually $12,400. Given you are entitled to claim back total expenses [at 30 per cent], you’d receive a refund of $3,720. In effect, you paid out $2,400 but got back $3,720 — a profit of $1,320 after-tax that year.
In this instance, your investment brings in $1,000 in rent each month but your property expenses are $1,200.
Of course, the level of equity or deposit put into an investment property purchase can affect the total annual cost of owning real estate.
Is there really a difference between positive gearing and cashflow?
Apart from the opportunity costs of any equity or cash you put down as a deposit. Taxation is where the opportunities differ. A positively geared property is one that delivers a positive cash flow after-tax but a positive cash flow property must generate a LOSS before-tax and a positive cash flow after-tax.
Put simply both strategies generate income, but the decision of what works really comes down to which one best benefits your circumstance: before-tax or after-tax.
That’s why it is important to consider your investment objectives. That is, you may have the cash sitting around in your bank account to buy a property outright. But if you borrow using equity in your home, you can increase the cost of ownership by the amount of interest the bank charges. Or you may prefer to borrow the full amount. Even if you don’t need to, it will increase the face value of the cost of ownership to maximise tax deductions and decrease overall costs.
To put that in perspective, it’s essential to understand that investment properties can be expected to earn either a good rental return or capital growth. Better still, both capital growth and a great rental return. If you are still trying to make sense between positive gearing and cashflow, then consider the following.
For more information, ASIC publish and handy guide to Investing and Tax.
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