Investing for positive cash flow
(also known as positive gearing) means buying an investment property that has a
high enough rental return in order to cover all holding expenses and still have
some cash left over.
This is easier said than done.
In most capital cities, rental
yields average around 5%. Therefore if you are paying 7% on your mortgage and
1% for other expenses (such as insurances, council fees, body corporation fees etc.)
you are making a 5% minus 8% equals -3% cash loss. That is negative cash flow
and you have to put in your own money every month to hold onto that property.
Given enough time, most investment
properties become positive cash flow after a number of years which creates a
passive income stream for the rest of your life. This should always be the long
term goal unless you use a strategy such as flipping to make your money.
Why
Favor Positive Cash flow Over Negative Gearing?
If you buy a positive cash flow property, you are receiving money in the hand from the very first month. Yes, you probably will have to pay tax on that income, but it is still cash in your hand to save or invest further!
Negative gearing involves making a
cash loss (and therefore draining your bank account on an ongoing basis) in the
hope that the capital gain in the future will outweigh the money being spent in
the present. This can be a good strategy if the capital gains eventuate, but if
they don’t, you may end up with a bad investment.
A lot of people have the
misconception that by losing money on a property and utilizing negative
gearing, they are reducing their tax bill. This is true (in countries where
negative gearing is an option) but there is no point in reducing your tax bill
if at the end of the day you are still spending money! Don’t focus on reducing
tax, focusing on making money with a good investment.
Opportunities
to Buy Positive Cash flow Property
There may not always be good
opportunities to buy cash flow positive, but here are some things to consider.
Property
Cycle Timing
In a growing property market, or a
market that has surged in prices recently, positive cash flow property will be
harder to find. The reason for this is the price of the property has increased
yet the rental return may have stayed roughly the same or increased only a little.
In a declining market, however,
property prices may be stagnant or dropping a little (hopefully not too much!)
and more people are favoring renting than buying due to uncertainty in the
economy. This puts pressure on rental prices as there is more competition for
the available rental stock.
Therefore rents are increasing
whilst prices are decreasing which increases rental yields. This is probably
the best time to find positive cash flow properties.
Regional
Areas or Boom Towns
Areas where the populations are
smaller and have plenty of land for future expansion generally have lower
property prices than the capital cities. The rents may also be lower, except if
there is an abnormal demand for rental properties versus owner occupied
properties. This can create a situation where rental yields are significantly
higher than capital cities.
Be wary of investing in “one
industry towns” where the town relies on one or two major industries to support
its population as this is riskier. But if you can find a regional town that has
a good variety of industry, lower property prices and higher rental returns,
this can be as good if not better than buying a property in a capital city.
Tax
Advantages Impact Cash Flow
Depending on circumstances and local
regulations, depreciation of your investment property can be claimed as a tax
deduction. This can often turn a negative cash flow property into a positive
cash flow property as it is a non-cash deduction (meaning you are not spending
any money on an ongoing basis to receive the deduction).
Depreciation is where the cost of
the building and its fittings are depreciated over time much like a business
claims depreciation on equipment, computers and physical assets which do
decline in value.
Balancing
Capital Gain and Cash flow
Overall, if you can find a property
that has positive cash flow, even if it is minute, and has potential for
reasonable capital gain in the future then this is a good property to invest
in. It may be harder to find these types of properties, but they provide
immediate returns as well as future gains.
