Negative Gearing vs Capital Growth – which makes for better property investing?
- Haynes Wileman
- Oct 7, 2020
- 3 min read
Updated: Nov 11, 2020
When it comes to property investment you’ll often hear two conflicting philosophies advocated.
Some suggest you should invest in property to achieve positive cash flow – that’s when rental returns are higher than your mortgage repayments and expenses leaving money in your pocket each month.
Others suggest you should invest for capital growth looking for an increase in the value of your property.
This second strategy usually leads to negative cash flow (negative gearing) in the early years because properties with higher capital growth usually come with lower rental returns.
But there is a third element to investment that many commentators forget to mention and that is risk.
Considering cash flow, capital growth and risk, when investing in residential property you can only typically have two out of the three.
If you want a property investment that is low-risk and has a high cash flow you will have to forgo high capital growth.
If you are looking for a low-risk investment that has strong capital growth, you will usually have to forgo high rental returns (cash flow).
There’s no doubt in my mind that if I had to choose between cash flow and capital growth, I would invest for capital growth every time.
Of course, in an ideal world we’d all like to buy properties that have all three elements and while this combination is possible, it’s far from the norm.
You can achieve all of these by purchasing properties in high growth areas and then adding value by renovating them or redeveloping them into townhouses.
The extra rent and the taxation benefit you achieve can give high-growth properties with high yields.
Since many beginning investors look for cash flow positive properties let’s take a look at the negative gearing vs positive gearing debate.
Of course, negative gearing has been a much-debated and discussed aspect of property investing for many decades, with a number of reforms, changes and proposals related to this tax mechanism over the years.
Negative gearing vs positive gearing – which is better?
As frustrating as this might be to read, the truth about positive versus negative gearing is: there is no “better” strategy.
Whether a negative or positive investment strategy will work for you depends on your unique and personal situation.
Ultimately, different investment plans require different strategies based on any one person’s income, tax position and goals.
We could find a very good quality property investment opportunity priced at $700,000 with a rental return of $500.
This might suit Investor A extremely well, based on his personal income tax rate, savings, risk profile and goals.
However Investor B – who has a different budget, different investment timeline and different risk profile – might find this particular property to be completely unsuitable.
Does this mean that our $700,000 property is a “bad” investment? Absolutely not!
What it means is that every individual property investor in Australia needs to make their investing decisions based on their own unique circumstances and goals.
Taking our above example, this $700,000 property may be sitting on a large corner block that is ripe for development.
Investor A wishes to own it for a few years whilst they aggressively pay down the mortgage, at which point they plan to split and subdivide the block, selling the land component off.
At this stage, they will use the proceeds of the land sale to pay off the existing home.
They now own an investment property free and clear with no debt against it.
This is going to help to fund their retirement from the workforce in five years’ time.
This is a great strategy and would be very suitable for a number of people.
It could also be the completely wrong approach for a different type of investor.
This is why we always suggest that rather than trying to decide whether to look for a positive or negative investment property, a much better strategy for property investors to employ is to understand what their end game is (as well as their risk profile).
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