# Positively Geared vs. Positive Cashflow



## young-gun (30 November 2012)

I just wanted to get people's opinion on what you think is the better way to set up an investment property. Ultimately the idea would be to pay a property off in full and have a few hundred a week in income. So for example:

If you had $100,000 ready to go, and thought it was time to get into the market for an IP. Would you consider it a better option to use the whole 100k as a deposit, and positively gear the property (say worth 300-350k). Or would some consider it a better option to split it and buy two properties with a 50k deposit each, and ensure they are cashflow positive?

The main difference that I could see is that you would obviously have smaller repayments in the first scenario, allowing you to pay the loan down much faster, while still claiming depreciation etc, which in turn would lessen the amount of interest you are paying in the long run, and gaining equity faster for your next property.

However the second example exposes you to 2 properties that are putting cash in your hand each week, and you are able to pay off more than the required amount of each loan each week.

Would the latter scenario only be a better, more viable option in a property bull market? As your leverage allows you to see capital growth on 2 properties instead of one. And the former scenario better in a stagnant/falling market?


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## kid hustlr (30 November 2012)

YG can you explain what you perceive the difference to be between postive cashflow and postive gearing?

To me they are the same thing (they both put money in your pocket at the end of the year).

It sounds like you are asking 'how much debt should you take on'?


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## young-gun (30 November 2012)

kid hustlr said:


> YG can you explain what you perceive the difference to be between postive cashflow and postive gearing?
> 
> To me they are the same thing (they both put money in your pocket at the end of the year).
> 
> It sounds like you are asking 'how much debt should you take on'?




Sorry. The 2 are similar but different.

Positive gearing - you actually receive more money in your hand thatn you pay in expenses EG the total yearly cost of holding and maintaining property is 24,000, the total rent received is 25,000. therefore you make 1k for the year, and would have to pay tax on that.

Cashflow positive - you actually make a loss on the property, however the tax that you receive back via deductions actually exceeds your yearly costs. EG total income from the property 22,000. Total expenditures, 25,000. You then deduct depreciation and costs etc which allows you to claim back 4,000 in tax which puts 1,000 IN your pocket, and you are not reuired to pay tax on this money.

I know the examples aren't the greatest but I don't have time to do a full blown in detailed example. As you can see, if you were making 100k a year for example, you would pay probably $400 in tax on the first example. Whereas you don't pay any in the second, and have more cashflow.


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## kid hustlr (30 November 2012)

OK that's how I see it as well.

effectively a prop which is is slightly neg geared can be pos cashflow once you get your tax return. depreciation is a good example of how this is achieved.

will give  a full reply later today after hearing some other input


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## young-gun (30 November 2012)

kid hustlr said:


> OK that's how I see it as well.
> 
> effectively a prop which is is slightly neg geared can be pos cashflow once you get your tax return. depreciation is a good example of how this is achieved.




That's right but just to clarify it wouldn't be classified as negative gearing, as negative gearing is when you actually make a realised loss each week even after tax is claimed. whether it be -$10 or -$60 it's not a good thing, and leaves no room for higher interest rates or unexpected costs.

Anyway I am just curious to hear different opinions on the current market and how some would approach it given the example.


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## matty77 (30 November 2012)

I would buy one house and put as much as I can that is left over into an offset account against the loan of that house, maybe you have $70,000 left in cash after the deposit has been used. Run it in the offset and pay down the house of the next few years. 

In about 2 years time you can look at pulling more out of the offset and buying another property if you are close to being positively geared - depends really on how quickly you intend to pay down the debt. Ideally you want to try and keep it negatively geared by pulling the cash out of the offset one the loan payment gets down. You would need to speak to a good accountant to get those numbers about right to maximize your tax return etc.

People forget about the tax advantages of an offset account, it does mean you can manipulate your loan amount fairly easily without many of the consequences like tying up your cash.

Im not sure if thats what you were asking though.


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## tech/a (30 November 2012)

For me it is.

If there is clear capital growth then Ill buy multiple properties with minimum deposit.
Where there is no growth or negative growth I want to hold as much equity in the property as I can.
So I sell off some and hold those with best return. (Financial partners like this)

Im then loaded with equity if an when capital appreciation or demand governed opportunities arise.
(financial partners like this).

Cashflow and servicability in harder times is king.


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## young-gun (30 November 2012)

matty77 said:


> I would buy one house and put as much as I can that is left over into an offset account against the loan of that house, maybe you have $70,000 left in cash after the deposit has been used. Run it in the offset and pay down the house of the next few years.
> 
> In about 2 years time you can look at pulling more out of the offset and buying another property if you are close to being positively geared - depends really on how quickly you intend to pay down the debt. Ideally you want to try and keep it negatively geared by pulling the cash out of the offset one the loan payment gets down. You would need to speak to a good accountant to get those numbers about right to maximize your tax return etc.
> 
> ...




Wouldn't an offset account be the equivalent to a redraw facility? except that to withdraw against the equity you have its roughly a $25 fee?

and yes it's basically what I was asking. Was just curious to hear opinions on whether people would prefer having the equity, and a cash flow position slightly lower than having else equity in multiple properties but potentially acquiring more cashflow. I guess eventually your property is going to wind up being positively geared (ie you paying tax on your rental income) anyway, so there may only be a couple of years if that where it is of any real benefit.

I do like the idea of altering how much 'equity'(if you can call it that) you appear to have in a property via your offset account. Would make things easier to maximise tax returns as you say.


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## young-gun (30 November 2012)

tech/a said:


> For me it is.
> 
> If there is clear capital growth then Ill buy multiple properties with minimum deposit.
> Where there is no growth or negative growth I want to hold as much equity in the property as I can.
> ...




I remember you saying a couple months back you had condensed your holdings down. So are you saying in the above situation you would prefer to own a larger portion of a 350k house, as opposed to 2 properties around the same value that also have a good cashflow.


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## kid hustlr (30 November 2012)

the offset account gives benefits in regards to taxation.

if i buy an apartment, live in it, then 3 years later move out and move into a new principal place of residence and want to keep the apartment as an investment, an offset account becomes very important


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## tech/a (30 November 2012)

young-gun said:


> I remember you saying a couple months back you had condensed your holdings down. So are you saying in the above situation you would prefer to own a larger portion of a 350k house, as opposed to 2 properties around the same value that also have a good cashflow.




Right now at this very point in time that would be a more difficult call than a year ago.
Prices have stabilized a little.
But the safest thing to do in my opinion is to have the smallest exposure to down side risk.
But if there is an opportunity to find a sustained or even a temporary spike in capital value 
Eg a new freeway or train to an area or a distressed sale ---- then it's worth considering the second option
In my view.


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## skc (30 November 2012)

young-gun said:


> Wouldn't an offset account be the equivalent to a redraw facility? except that to withdraw against the equity you have its roughly a $25 fee?




Totally different from tax perspective.

Say you buy an investment property and took on a $300k loan. The full interest (say 6% = $18k p.a.) is tax deductible.

If you put a spare $50k in the offset, the bank only charges you interest on $250k (~$15k p.a. @ 6%). Next year, you want to buy a car with that $50k in the offset. Your investment property loan goes back to $300k and again full $18k interest is tax deductible.

If you put you spare $50k to actually pay off the loan, yes the bank only charges you $15k interest on $250k. But next year, when you redraw $50k to buy that car, the interest on that $50k is no longer tax deductible against the investment property. It is actually a loan for your car. On the other hand, if you redraw the $50k to invest in shares, then it is tax deductible against the share investment. 

That's my understanding of an offset account.



young-gun said:


> I remember you saying a couple months back you had condensed your holdings down. So are you saying in the above situation you would prefer to own a larger portion of a 350k house, as opposed to 2 properties around the same value that also have a good cashflow.




It is really a leverage question, isn't it? Do you want to leverage $100k into $350k or $100k into $700k? 

It all depends on how well / not well you would manage the downside scenarios.


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## young-gun (1 December 2012)

skc said:


> Totally different from tax perspective.
> 
> Say you buy an investment property and took on a $300k loan. The full interest (say 6% = $18k p.a.) is tax deductible.
> 
> ...




Got ya.




> It is really a leverage question, isn't it? Do you want to leverage $100k into $350k or $100k into $700k?
> 
> It all depends on how well / not well you would manage the downside scenarios.




it's not so much the leverage I was concerned with, more the cashflow outcome. If you were to place 100k into a 350k house(with an offset account or whatever it may be) and you were $100 ahead each week but pay tax of say 30$ aweek on that.

Or you buy 2 houses with 50k down on each, and they are cashflow positive(as defined above) by $50 a week. You then have $100 a week tax free as opposed to $70. What I am asking I guess is would this $30 a week be considered a big deal, and would it lead to a bigger portfolio faster? or would the $30 a week be negligible and not really be that big of a deal in the long term for a property portfolio?

I guess over time, if you had 5 or 6 properties, that $30 a week turns into $180 a week....and you would also have exposure to more properties in different areas, all of which are supporting themselves anyway.


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## KurwaJegoMac (1 December 2012)

What's important to keep in mind is that leverage is a double edged sword. Two properties will make more than one property in an ideal scenario where interest rates remain steady/decline, you can maintain payments and have consistent capital growth. What I think you should be asking yourself is not positive gearing vs positive cashflow, but rather what is your downside risk and which option ( 2v 1 property) you can handle.

For example for both properties, consider whether your purchase can survive the following:

- an increase in interest rates: long term aussie average is about 7% - so can you afford to maintain positive cashflow across two properties in a scenario where interest rates are 9-10%

- what happens if capital gains are flat for the next 5 years?

- what happens if prices continue to fall? How much will it take for you to hit negative equity and will you be able to cover the margin call or risk foreclosure?

- do you have enough of a cash/equity buffer to cover unexpected scenarios? E.g. Loss of employment, medical emergency, car breaks down, etc

This is not a comprehensive list but i think they're some of the key questions you need to work out. You don't want to put yourself in a situation where you have no equity/cash buffer to handle downside situations - then you'll be forced to sell on someone else's terms: bye bye stamp duty costs so there's $40,000 down the drain already + any capital loss. 

Being 95% LVR on two properties can definitely work but it takes very little to be wiped out. There are times to do it and times when it's too risky. This is your first purchase I believe - remember you can always buy one property now and draw down that equity later to buy another. No need to rush straight into two - especially in this climate. 

Hope that helps!


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## kid hustlr (1 December 2012)

I think the point you are making is irrelevant/nit picking YG.

I don't think you should making big investment decisions based on a slight difference in taxation outcomes.

Based on your current situation, decide how much risk you are willing to take on and then make *the best investment decision possible*. Its basically weighing up opportunity cost.

Whether its slightly cashflow positive or not is only one piece of the pie, how will the property perform in the future? can you add value to it? do you have the skills to do so? how will you be influenced if there is a downturn in the property market? what if you lose your job?

In answer to your question, I shove everything I have into my offset account. When I think there is an investment opportunity which can beat the 8% pre tax or whatever it is needed to beat the offset account then I'll adjust accordingly.

edit: a lot of what KJ said


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## young-gun (1 December 2012)

kid hustlr said:


> I think the point you are making is irrelevant/nit picking YG.
> 
> I don't think you should making big investment decisions based on a slight difference in taxation outcomes.
> 
> ...




Thing is I am happy with my ability to do everything else. I am confident in my ability to pick the right house, in the right suburb, in the right state, for all the right reasons. I am confident that I know how to allow for worst case scenarios and cover myself in all events. The reason I started the thread was purely to understand what others thought about the 2 scenarios, and to see if there was any major advantage of one over the other.

General consensus seems to be that it doesn't matter to many, so perhaps it's not something I need to concern myself with. The fact is one makes more money than the other, albeit marginally. I guess like a few have said the only thing really to consider is the amount of risk taken. @ proeprties with less equity is quite risky in this environment.

I guess the risk involved with leveraging into 2 properties when there is no real sign of strong capital growth might be pointless, and best just to pay down one house and then use that to leverage when the time comes. I won't be purchasing for at least another 12 months anyway, still gotta see how things pan out not just in our backyard but around the globe, and may not even enter into residential, just like to cover all bases and hear others opinions
Our risk will be low when going into investments anyway, we're renting for peanuts, and have no debt.


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## kid hustlr (1 December 2012)

young-gun said:


> Thing is I am happy with my ability to do everything else. I am confident in my ability to pick the right house, in the right suburb, in the right state, for all the right reasons. I am confident that I know how to allow for worst case scenarios and cover myself in all events. The reason I started the thread was purely to understand what others thought about the 2 scenarios, and to see if there was any major advantage of one over the other.
> 
> General consensus seems to be that it doesn't matter to many, so perhaps it's not something I need to concern myself with. The fact is one makes more money than the other, albeit marginally. I guess like a few have said the only thing really to consider is the amount of risk taken. @ proeprties with less equity is quite risky in this environment.
> 
> ...




I like it.

Sounds like I'm only 6 months ahead of you 'in life' for what its worth.

The smartest property man I know doesn't own his place. He just subdivides blocks for a living, keeps his cash clean and moves onto the next one building his fortune along the way.

To me its all about developing a skill/trade which can beat the 'opportunity cost' of the money sitting in the offset account. In a boom market it doesn't matter because any leveraged property will produce 15%+ p.a. In a more realistic world you need to get good at making your money work for you.

Climbing the corporate ladder is one option to making millions I guess but it wasn't the option for me.


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