NEGATIVE GEARING (Equity Growth) vs POSITIVE GEARING (Cashflow) - which is superior??

[Bud Fox]

i jumped on this forum today for the first time and a ran a couple of searches on cash flow vs capital growth (ie. positive gearing vs negative gearing), the endless debate..

This is an area that interests me greatly. After reading through many threads on the topic, there are people who put down some very valid arguments, from both sides of the coin.

There are also many posters that ask for supporting analysis or empirical evidence, to substantiate either side of the debate. I struggled to find any in these forums. Correct me if I am mistaken.

Before posting , i took it upon myself to run a search on the net for any basic analysis (in the form of excel worksheets) that have already been created on this topic, fortunately for me there was some. (no point re-inventing the wheel..)

its fairly basic stuff but at least it provides some food for thought

I can appreciate that the argument for positive or negative gearing comes down to personal preference, (ie. what is your risk tolerance / profile, do you prefer two in the hand or one in the bush, are you young, near retirement, do you prefer additional ordinary income or are you after capital growth for equity leveraging purposes, do you earn 300K p.a hence getting a bigger tax break or do you earn 30K p.a and pay little in tax so negative gearing becomes less of a priority to you.. etc etc). All valid points to consider.

Lets say we put all of these considerations aside and we just focus on the quantitative aspects (just the raw numbers as they never lie), I would be interested to know what the results are.

And lets assume that 'all things are equal' (ie. peoples risk profile, people salaries and hence tax rate, peoples' time they had to invest), what would the results be???

I have heard many of this forum argue "i will take positive gearing any day over negative gearing because why would someone want to make a loss??" but there is much more to consider - as many of you already know.

- If you are inclined to be positively geared because of falling asset prices, what's to say that purchasing a positively geared property wont fall at a greater rate than a negatively geared property?

- What happens if banks 'mark-to-market' every year instead of retaining property's book value?? And as a result, your positively geared asset is now 50K lower in value than the negatively geared one? The only offset being the the additional 10K p.a in rent, but the net different is still 40K in this example. So which one is better?

- What about if we are in an increasing asset market and you have bought a positively geared place in country Bendigo (Victoria) that has a foretasted compounded capital growth rate of 3% p.a and is positively geared, but had you bought that Victorian style apartment on the outskirts of Melbourne's CBD, you would be enjoying a 9% p.a compounded capital growth rate - all else being equal.

So lets put aside the qualitative variables (ie. risk profile, stage of life you are at, old, young, have family, or just personal choice). Lets focus instead on the quantitative only, as mentioned already. The point of this exercise is that we need to consider all the quantitative variables, some of which have just been mentioned.

I am personally of the view that negative gearing is much more powerful than positive, this is simply my view. However, i am always open to learning if one can support it with some evidence to the contrary. Even some general information that I can further explore to form a more informed view (admittedly I do not know as much about a positively geared IP strategy as I do about a negatively geared one)

This is a very important discussion, because it could make a difference between having say $10m in equity after a 30 year period or a $3m in equity after the same time period, for example.

So this is good analysis for people starting out and assessing their options in property investment.

I have attached a spreadsheet, analyzing the 2 strategies, and i would be interested to hear what values we should be using to make a call on which method is superior (quantitatively) that will give one confidence in which one to chose.

i would be very interested in hearing what values people would use to work out which strategy is better, in their opinion. This also important because a change in rental yield or capital growth can swing one ahead of the other.

Looking forward to some discussion on the topic.

BF

 

[Trogdor]

All comes down to the growth assumptions used!!

I favour negative gearing for now - to (ironically) provide some sleep at night factor as I know that I can attact a better calibre of tenant (i.e. stay out of lower income / regional areas).

THough I do agree that this isnt a long term proposition - when enough equity is gained I am very keen to get into the commercial space - slowly at first - as this seems to be the best of both worlds (as long as its funded from resi IP loans!)

 

[WillG]

Bud,

I can't answer your question because there are too many variables.

The only advice I can give is to not discount any strategy and form your own. Your strategy will likely be a mixture of positive and negative geared strategies. Your strategy will change as you aquire more properties.

The most important thing in investing is taking action.

Cheers

 

[Nathan]

Too many factors....

I want both...

I have come to conclusion that cashflow is king, and weather you get cashflow by holding and pos geared, or cashflow from buy and flick for profit it doesnt matter but you can make it happen.

I dont see the upside of a 20kpa cashflow negative for a future gain of 400k in 10 years time. doesnt do it for me.....

Negative gearing is a term used by slick sales sharks who make it sound alright to loose money.

i would never give away $100 for $30 in a year and potential of making $120 in 10 years, why would you do it on a larger scale and on a scale that could collapse you?

 

[jaycee]

I dont think there's that much in it..

If hypothetically talking about the same property, the difference in it being postive or negative wpould be the amount of rent earned. To be negative, it would rent for less than for it to be positive

Would there be benefit in reducing the rent of that property ?

excel doesnt work on my pc, I can view, not edit or use it.

The examples show a property which is renting for $300, growing at 5%, or a negative one, renting at $175, but growing at 8%

With these stats, negative gearing provides more at the end.

What if the figures were closer though ?
What if the negative property rented for $225/wk

How do you accurately assess the different capital growth rate for the examples ?

 

[sash]

I want both....my target is 7-10% CG and CF+ within 2 years.

But it is important to note in times like this CF+ is more important than growth....because if you get in trouble you could lose the lot.

 

[JamesGG]

I want both...

Agreed.

Never understood this 'or' concept. Let's look at 'and' instead

 

[Nathan]

Agreed.

Never understood this 'or' concept. Let's look at 'and' instead

Well put brother Like that line.

 

[josko]

Bud,

I can't answer your question because there are too many variables.

The only advice I can give is to not discount any strategy and form your own. Your strategy will likely be a mixture of positive and negative geared strategies. Your strategy will change as you aquire more properties.

The most important thing in investing is taking action.

Cheers

Couldn't have said it better myself.

It also depends on your income. If you are paying 43c in the dollar to the Taxman, like husband was...then NG is a great way to pay less and consider that your hard earned money is potentially earnng you more money.

We got to a point where we were too NG. In times like these, nathan is right and cashflow is king.

Regards Jo

 

[mja]

There is no better strategy. If one was a better strategy, then everybody would be doing it, and then it would be an ordinary strategy.

 

[Rolf Latham]

But perception is reality....................

Put the same core data in front of 100 people, and depending on their soft data output, you will get many different answers to the same question.


ta
rolf

 

[Propertunity]

Held long enough, EVERY property ultimately becomes cash flow positive.

 

[WinstonWolfe]

I have heard many of this forum argue "i will take positive gearing any day over negative gearing because why would someone want to make a loss??" but there is much more to consider - as many of you already know.

- If you are inclined to be positively geared because of falling asset prices, what's to say that purchasing a positively geared property wont fall at a greater rate than a negatively geared property?

currently it is the other way around......higher priced property (tends to be more -CF) is softening more than lower priced....and it will always be that way outside of booms. it's a number game.....

I am personally of the view that negative gearing is much more powerful than positive, this is simply my view. However, i am always open to learning if one can support it with some evidence to the contrary. Even some general information that I can further explore to form a more informed view (admittedly I do not know as much about a positively geared IP strategy as I do about a negatively geared one)

This is a very important discussion, because it could make a difference between having say $10m in equity after a 30 year period or a $3m in equity after the same time period, for example.


BF

good to see you thinking hard about this stuff BF.

If you want to make headway on this, I'd suggest you get some real data from the last 30 years.
- Don't use median house prices though. Get repeat sales on at least 6 houses in a similar suburb, or street.
- interest rates
- cpi
- tax rates
- median single earner income. (not household because that introduces confounding variation)

modeling reality will be worth the time you put into it, and you'll pick up some great excel skills in the process.


The xls you have has a trap for those who dumb down analyses. Two general truisms:

- Compare your rental yields in year 1 to year 25. That never happens in reality. Rental yields are attached to market values, via a rubber band. If you stretch market value up quickly, it isn't too long before yields follow and revert to long term mean.

- House prices will always be constrained by debt serviceability. When credit is loose relative to previous years, prices go up (because most people can't pay cash). Prices go down or flatten when credit tightens. Out of interest, plot interest rates against median property prices. But remember banks have been messing with credit LVRs, documentation, and post codes for a decade or more which weakens the correlation between prices and rates.


If you want to play property well, you'd have maximum exposure to growth when growth is high, and +cf when it is high. Unfortunately, there are barriers to doing so. namely in and out costs, and cgt.

Therefore, you need to reach an optimized compromise, or risk/reward smoothing. In investment, when dealing with the uncertainty/risk of future unknowns, then it is recommended to disperse risk by having exposure to two inversely correlated strategies. i.e. 50% cf+, 50% growth.

You might vary the % exposure to either depending on the general economic outlook. But unless you are really good, and can work out a way to minimize the in/out costs and tax, it is difficult to swing 100% between two property strategies.

Finally, there is a truism dear to my heart regarding investing.

Near money is dear money.

meaning basically that a bird in the hand is worth two in the bush.
Some make the mistake of thinking a growth strategy is not near money.
But it is. the near money comes via revaluing property and using the equity to buy more. Plus you don't get taxed on that equity before you can leverage off it.

But for most of us -CF strategy has a low ceiling because of debt serviceability.

So in the early days of investment journey, and when growth is poor, it is better to focus on a +CF strategy.

So remember, both strategies aim to increase return on investment early. It is just that -CF does it via equity, +CF via after tax income.

I'd also suggest you study up on internal rate of return. It helps combine net equity and cf, and compare investment decisions with different cash flow histories.

If you PM me, I might share some xls with you.

 

[Bud Fox]

jaycee, i dont know the answer to your questions, all those figures are arbitrary and purely for the purposes of the example, but they are certainly relevant. I think I will do what Winston suggested and backtest -ve vs +ve IP property model on some real data. Guess there wont be much room for conjecture then.

With regards to what you said re similar CG rates and neg geared property being $225 in rent, based on that, the positively geared strategy blows neg geared one out of the water - over time

Positively Geared
Rent per week $300
House appreciation (on CPI) 7%
25yr return $624,609.24
ROI 3123.05%


Negatively Geared
Rent per week $225
House appreciation (on CPI) 7%
25yr return $503,680.37
ROI 2518.40%

Winston, great email and all very true. Admittedly my excel spreadsheet on this topic is very simplistic and there are so many more considerations to take into account. I will PM and will be keen to share some xls

James, spot on, you have got me thinking about the 'and' as opposed to the 'or'. All my IP are all -vely geared (may alittle too much for this environment) and its probably time to start thinking about the +ve strategy. Has definately got me thikning

To everyone else, just thought I would share how superior this site compared to one other major aussie property forum, wont mention its name but it too has 10's of thousands of members (is that obvious?). The reaosn I say that is because I posted a very similar question/topic and got over 100 hits in 2 weeks and but not one damn reply. No one wanted to shed any light on the topic. Now Ive canned that forum, packed up my bags and come here. Very glad I did, looks like there are quite a few i can learn from here.

Looking forward to the IP chat and awkward online banter.

BF

 

[rugrat]

Too many factors....

I want both...

I have come to conclusion that cashflow is king, and weather you get cashflow by holding and pos geared, or cashflow from buy and flick for profit it doesnt matter but you can make it happen.

I dont see the upside of a 20kpa cashflow negative for a future gain of 400k in 10 years time. doesnt do it for me.....

Negative gearing is a term used by slick sales sharks who make it sound alright to loose money.

i would never give away $100 for $30 in a year and potential of making $120 in 10 years, why would you do it on a larger scale and on a scale that could collapse you?

Completely agree with this sentiment.

 

[Ms Jade]

...With regards to what you said re similar CG rates and neg geared property being $225 in rent, based on that, the positively geared strategy blows neg geared one out of the water - over time

Positively Geared
Rent per week $300
House appreciation (on CPI) 7%
25yr return $624,609.24
ROI 3123.05%


Negatively Geared
Rent per week $225
House appreciation (on CPI) 7%
25yr return $503,680.37
ROI 2518.40%


BF

This confuses me a bit because it now looks like the same property. Great example of how maximising rent greatly increases returns over time (no surprise there). I don't know that, as a rule, these + & - cashflow properties are sitting next to each other, thus selling for the same price with the same CG. It's more likely that they have quite different characteristics so it would be better to compare 2 actual properties or property types.

 

[WinstonWolfe]

BF, here's a comparison of low and high growth over 10 years.

As I mentioned above, the spreadsheet you used has a flawed method, in that it grows house value at a higher rate than rent over a long period of time. This doesn't happen in real life.

Some points:

- I've used the same rates and cpi for both scenarios.

- I have used excel solver to find the breakeven point for Year 10 net equity.

- In the green section, note Net Present Value is higher for the low growth scenario, even though net equity is the same. Higher NPV occurs when cash flows are higher in the earlier years. You should become familiar with NPV which is related to internal rate of return. Getting higher cash flow and equity earlier means you are able to leverage into other property earlier. So just looking at a net equity position years down the track doesn't tell the whole story.

 

[BayView]

In Margaret Lomas' books she makes comparisons between the two strategies such as you've done, and in the end there was little difference; not enough for it to be adecisive victory either way.

In the end, both strategies meant you were far wealthier than the "cash in the Bank" brigade by a loong way.

In my opinion, you should always strive to have both.

And, not just this; you also want to maximise every other possible thing you can.

The depreciation, the position, the quality of the property, the rental demand area, selecting the properties in the lower half of price range to maximise tenant pool and buyer pool, add value prospects, etc.

To consciously go for only neg geared in the hope of a huge cap growth is very risky and not required. You may not get the huge cap growth.

I know a doctor (from the ICU days) who wanted to buy a block of land in Kew for $700k, near where he lived. No rent, no deductions; pure out of pocket cash. He could afford the repayments.

I asked him why he would do something so dumb. He wasn't going to be building on it for several years as well.

I then asked him; "Why not put the same money into a couple of properties that will return a very good rent and still allow you to minimise a lot of your considerable tax bill?"

After his initial reaction of being very offended, he said; "Kew will always have very good cap growth."

This is like saying red will come up more than black. Sometimes it doesn't.

On top of everything else, neg gearing keeps you tied to your job to service the properties while you wait for the growth.

That's not what I want out of this.

I want to accelerate my path to no longer having to work. Go for cashflow and growth. Simple.

Either one on its own will slow you down.

 

[WinstonWolfe]

On top of everything else, neg geqaring keeps you tied to your job to service the properties while you wait for the growth.
.

And there's the rub........it is all about risk/reward, and in times like this when unemployment risk is higher, it would be a precarious position to be levered to the eyeballs chasing high growth with low yield. What has the SS mantra been for the last 12 mths? pay down debt? but I suppose that was before rates fell.

Incidentally, doctors have a reputation for being crap investors....they let their confidence in one field fool themselves into believing there's nothing they can learn in other fields. If they looked at some historical data for the last 30 years, they might find capital gains + rent in Kew are lower than cg + rent in Elsternwick.

Nevertheless, some elites prefer to minimize contact with people in a class underneath their's, even if it costs them. I rarely found old money that was dynamic and innovative in anything. They seem more concerned with cocooning themselves off from the hoy poloy, and that means a lot of them don't see opportunities as they present.

This same arrogance and elitism imho is what will bring down GM and Wall St banks, and gave Bill Gates the break over IBM.

 

[Witzl]

Some very wise words from some experienced investors here

I'm happy to read this, because without really having a strategy for either cashflow or growth... we (fiancee and I) have achieved a portfolio including a bit of everything.

We picked our purchases looking at ALL factors
- cashflow
- ease of finding tennants
- add value prospects
- potential depreciation
- capital growth
- good location
- desirable property
etc etc.

Since we are just starting out, are fairly young, and dont have massive incomes to service a negative cashflow portfolio... we picked properties that would have MINIMAL impact on our lives (in terms of cashflow), but offer maximum potential for future benefits. We now have two IPs and a PPOR - the cashflow on the IPs is just $8000 a year negative before tax benefits... and the PPOR repayments are similar to what we have been paying in rent - so its quite a comfortable portfolio to hold cashflow wise, with good prospects of future growth (total worth >$1million)

I should add that when picking the PPOR, we picked one that would best serve as an IP *if* we had to reduce our lifestyle costs due to losing job, etc... or if we wanted to upgrade PPOR in the future.


I agree that in these times, you should be looking for cashflow AND growth