Positive gearing or positive cash flow investment properties — what is the difference?

Some investors look to increase or supplement their income or cash flow by investing in property. There are two basic approaches to investing in property that can derive an increase in income to the investor. This article will provide insight into the difference between positive geared and positive cash flow properties and how it can affect the investor.

Both positively geared and positive cash flow properties will contribute to enhancing or increasing the net income of the investor. However, a positively geared property will provide a pre-tax profit, meaning that the investor will generate an income independent of tax offsets. Whereas a cash flow positive property will generate a profit after tax offsets are considered.

There is often confusion with terms and definitions for investing in property, however it doesn’t take long to grasp a broader understanding when investing in property. Let’s start with the scenario of a positively geared property and what this means for the investor.

A positively geared property will generate revenue greater than the property expenses prior to tax offsets. In more detail, the rental income will exceed the operating costs of the property. The operating costs of the property include but are not limited to property management fees, insurance, rates, water and sewerage, body corporate (if applicable) and maintenance. For simplicity, the following example will use some basic figures to provide further explanation.

In this example the investment property generates $500 per week in gross rental income. If this property had a zero per cent vacancy, the property would generate an annual income of $26,000. If we take into consideration the expenses associated with this property, which include a property management fee of 8% (excluding GST), letting fee equivalent to one weeks rent, rates, water and sewerage of $2,500 p/a and building, contents and landlord insurance of $1,200 p/a. The total property expenses (rounded up) equal to $125 per week or $6,488 p/a. In summary, this property is positively geared by increasing your income by $375 per week or approximately $19,512 per year.

In most cases, investors will leverage their money to acquire an investment property, which involves a loan or mortgage at differing loan to value ratios. If we were to introduce another property expense to the equation, such as interest payable on an interest only loan on the aforementioned property example. In this example, the loan repayments would need to be less than $375 per week or $19,512 per year for the property to remain positively geared. That would be the equivalent of a loan balance of $464,571 at an interest rate of 4.2%.

You might have noticed that the aforementioned example didn’t take into account any tax offset considerations. That is because a positively geared property will continue to increase the investor’s income without any tax offset considerations. This is the main difference when comparing positively geared and positive cash flow properties.

A cash flow positive property will increase your income, however it requires tax offsets to do so. Using the same example above with the same rental income of $26,000 p/a and expenses of $6,488 p/a and increasing the loan to a balance of $500,000 with an interest rate increase to 5%. This equates to an interest expense of $480 per week or $25,000 p/a. The total property expenses now equal $31,488, which equates to a $5,488 deficit to the gross rental income of $26,000. With this increased loan amount and interest rate, the property you would be required to contribute $5,188 p/a to service the investment in a pre-tax setting.

You might be thinking, how can this property provide a positive cash flow if I’m required to contribute $5,188 p/a? The answer is through tax offsets. There are number variables that can change the total tax offsets generated by an investment property, such as individual taxable income and depreciation. For simplicity, the property generates a tax offset of $8,000 p/a, meaning that this property will reduced your tax bill by $8,000 p/a.

The application of the $8,000 p/a tax offset will essentially reduce the property’s operating expenses to $23,488 p/a. This is a simple way of thinking about tax offsets, however is more complex when applied in a tax statement. This property will still generate a rental income of $26,000 and now have net operating expenses of $23,488. This means that for the investor, the property is now cash flow positive by $2,512 p/a or approximately $48 per week.

Please note that these figures are basic in nature and do not take into consideration any variables that would normally alter the outcome. A detailed breakdown of the performance of a property would require further information. This article is information only and shouldn’t be considered as advice.