Many clients ask about "cash flow positive" properties, but rarely do people ask about "positively geared" properties. The 2 definitions are very similar but there is one stark difference.
What is gearing?
To explain the difference we must first understand what "gearing" is. Put simply... "the term ‘gearing’ in property simply refers to borrowing money to increase the amount of capital to invest, or to leverage so as to make purchases more feasible."
There are 3 types of gearing - negative, neutral and positive.
An investor, based on their goals, portfolio and personal financial situation, needs to determine the best type of gearing for each investment purchase. This decision will also likely change during an investor's journey; for example if you are young and on a very good income you may be happy to apply a negatively geared approach - you have the excess cash to make up the shortfall but are also looking for high capital growth assets early in your investment journey. Later in life, however, let's say you have children and your income drops, it could be wise to purchase a positive or neutrally geared property.
What is a positively geared property?
Technically speaking, a positive geared property is where the net income from the property is greater than all the expenses - these expenses include interest on the borrowed money, management fees, rates, insurance and maintenance etc. The result is a taxable gain and the critical point here is that this is a pre-tax positive gain.
For example:
- You purchase an investment property for $500,000.
- You have a 90% LVR and you borrow $450,000 on an Interest Only loan at 5%. This means your interest payments are $22,500 per year.
- Your other expenses are $5,500 per year, therefore your total expenses are $28,000.
- You obtain a rental income of $600 per week, giving you a total income of $31,200.
- This property is positively geared by $3,200 per annum (pre-tax).
What is a cash-flow positive property?
Positive cash flow property is property that generates a loss (expenses are higher than income) before tax, but then after tax deductions (depreciation is the main one here) and refunds are taken into account your income is greater than your expenses.
For example, let's use the property above:
- Let's say though your rental income is only $520/week, meaning you have an annual income of $27,040.
- This is a loss of $960 for the year.
- You can claim $5,000 in tax deductible depreciation.
- This means your total loss for the property is $5,960. At 30% tax you get a refund of $1,788.
- Your income therefore becomes $1,788 + rental income of $27,040 = $28,828, meaning your property is positive cash flow (after-tax) by $828.
What is best for you?
There is no right or wrong answer. The best option all depends on you - your goals and financial position, and where you are at in your investment journey.
An experienced Investment Buyer's Agent will ensure that they drill down into the WHY behind your investment purchase and tailor a strategy to suit your situation. This could even be negative gearing, which we will discuss in another article.
Always remember to seek advice and link your investment strategy to your goals - this is the fundamental rule in investing. Stray from this and you risk not delivering on your goals.
DISCLAIMER - please note that Niva Property are not authorised tax accountants and the above information cannot be relied upon as taxation or financial advice. Seek guidance and advice from your Accountant when it comes to taxation law as it relates to your personal financial situation and any investments you wish to make.
