So, why one would prefer negative gearing?
A negatively geared property is typically a compromise on cash flow in favour of capital growth. Here, the goal is primarily to "wait" for the property to grow in value and then sell it at a profit later. Until then, you have to bear the costs of owning the investment property.
Benefits
✅ Reduce Tax Payable
Whenever a property is negatively geared, any shortfall you incur can be claimed as a tax loss, reducing your tax liabilities.
✅ Focus on Long-Term Capital Growth
Selling the property at the end of a property cycle, usually for 7 to 10 years, should lead to a good return on investment. The return should outweigh any losses you incurred in the past if you purchased the right property at the right time.
Drawbacks
🚫 Tighter Cash Flow
You can rarely bear an increase in costs, so you may feel that your cash flow is a bit too tight and, if the worst scenario comes, you may be forced to sell before you realise any capital growth returns.
🚫 Lowered Borrowing Power
When you have less cash available in your pocket, your ability to borrow money for further property investments may be compromised.
On the other hand, what exactly is positive gearing?
A positively geared property is commonly referred to as a cash flow property. Here, the property generates an immediate return, so you can start making money from the moment you own it.
Benefits
✅Available Cash On Hand
Having more cash in your pocket enables you to lead a better life or pay off your investment loan quickly. In addition, it provides an additional buffer in case your financial situation changes.
✅Increased Borrowing and Purchasing Power
When you have more cash available in your pocket, chances are, it will be a lot easier for your loans to be approved to further invest in more properties. In addition, this could be used to grow your investment portfolio.
✅Less Debt
Whether new or in their pre-retirement phase, an investor may not want to be burdened by too much debt, so adopting a cash flow positive strategy tends to be a better option from that perspective.
✅ Non-Reliant On Capital Growth
The positive cash flow benefit is that you can start making money right away, rather than relying on appreciation of the property price to generate income.
Drawbacks:
🚫 Additional Costs
Maintenance and repair costs can strain the cash flow on a property used as a rental house.
🚫 Reliant On Economic Factors
To keep the income flowing, you rely on favourable economic factors such as low-interest rates, low vacancy rates, and even high employment numbers.
🚫 Tax
Your rental income will be taxed by the Australian Taxation Office (ATO).
🚫 Slow Rise In Capital
Positively geared investment properties typically are located in regional areas, so any gains will have to wait since growth rates are generally lower here than in the city. Thus, you may have difficulty accessing equity to fund future property investments.
Case Study: Building Wealth by Chasing Capital Growth
Jasper wants to invest $500,000, understanding that the total current return is 12 per cent. However, he is not sure if he should prefer:
• Property A, promising 8 per cent capital growth and 4 per cent cash flow, or
• Property B, promising 4 per cent capital growth and 8 per cent cash flow.
He calculated the estimated value and rental income and computed that at the end of year 25, Property A would be valued at $3,424,238, giving a gross rent of $126,824 in year 25. Whereas Property B would be valued at $1,332,918, and the gross rent collected would be $102.532.