The Positively Geared Truth
It used to be that negative gearing was the in-vogue investment strategy. I can remember people looking at us strangely and thinking it mildly humorous when we found and endorsed the potential of positive gearing back in early 2000 … but who’s laughing now? We’ve enjoyed lots of overseas holidays including several trips to Greece and the USA as well touring Europe … In fact we’ve visited 29 different countries since we started investing in property almost 14 years ago 🙂
These days people are much more educated and you probably understand the benefits of having an investment that doesn’t negatively impact your lifestyle, while you build your wealth through property. However, there’s still a lot of myths and misunderstandings out there … so let’s go over the key issues and questions that I hear, and hopefully that will help you understand things more clearly, so you can build your own positive property portfolio …
1. Do They Really Exist?
If you’re a savvy investor looking for a cash flow positive property you’re probably finding it difficult to find anything reasonable unless it’s in a Mining resource area – and even then you are no doubt concerned about the high entry cost and / or higher vacancy rates that many of those regions are suffering at the moment. Even if you take mining out of the equation, the answer is YES, positive properties do exist- and with the current low interest rates across Australia they are actually easier to find … if you know what you’re looking for, not just where to look!
2. They’re So Hard to Find!?!
I hear this feedback all too often. Investors get excited about the potential and rush off expecting to get online and find the right property within minutes, hours, days or weeks. However these properties don’t just ‘show up’. You need to know what you’re looking for and even then it can take a while to find anything suitable. The same happens to home owners looking for a new house, but they’re usually more persistent because of their strong emotion around that purchase. Investors often give up, or at this stage decide to use a Buyers’ Agent to help them source a property which could save them time and energy. However, before you delegate this aspect of your investing journey, there are some issues you need to check on first before you commit to this taking this route…
Delegate – Don’t Abdicate.
Although it may seem easy to just find a Buyers’ Agent and let them handle everything, you still need to delegate this aspect responsibly. In fact, most good Buyers Agents will agree that the more information and specifics you give them for their shopping list, the easier for them – and the better for you. They need you to be specific about your needs so that they can help you more effectively. Of course, the best thing could be for you to find the property yourself, but if you do decide to use a Buyers’ Agent, make sure they’re reputable, effective and are licensed in the area you’ve chosen to invest in.
Therefore it’s best to work out the location/s you think best to invest in for your personal strategy and goals. For example if you’re wanting to find a property that you’ll manage or want to renovate personally, then make sure it’s within reasonable travelling distance for you. Once you have a short list of Agents, use your contacts and online research to find feedback and evidence of their track record. Ask them for past customer referrals and contact the people directly to ask relevant questions that help you get evidence of their capabilities and credentials.
3. Can I Expect to Live off the Rental Income?
Unless you’re paying cash or borrowing a smaller amount of the property value, you’re not normally going to get rich living off the net rental return. When John and I left our employment about a decade ago we had about 45 rentals which were quite highly geared, which meant that our net rental income from our positively geared properties still wasn’t sufficient for the lifestyle (and holidays!!) we wanted. As a wise man (I think it was Geoff Doidge of the Reno Kings) once said ‘Cashflow pays the bills, but Capital Gains make you wealthy’.
What you can expect from positively geared property is that you can build your portfolio without negatively impacting your lifestyle. Imagine if you lost your job and you had negatively geared properties … how would you pay the shortfall without selling them? And if you have to sell, it may not be the best time in the market to do so. Whereas if you have a positive property portfolio, you shouldn’t have to sell them until you’re ready, because they’re paying for themselves. Let’s face it, it’s a bit of a paradox if you want to retire from work early, but have to work longer and harder to cover your negatively geared properties!
4. Can I get Capital Growth and Cash Flow in the Same Property?
In a word – YES !! That doesn’t mean of course that every positively cash flow property will provide capital growth. You still have to choose wisely and there are a number of factors to be considered when you’re buying any property for investment. We have purchased a number of positively geared properties over the years. Many have been blocks of units and sometimes they’ve been in Regional areas. As an example, we purchased 8 Units on 1 Title in Bundaberg, North Queensland. We paid $320,000 for the property and it started with over 10% gross yield… which is about double the ‘average’ yield an investor expects. We sold that property last year (not the best time to sell) and still achieved a sale price of $850,000. Considering we borrowed the entire amount for the purchase (using equity from other property too) and it paid for itself during the time we held it, the $500,000 profit after 10 years was a fantastic bonus!
On the other hand, we purchased a property specifically for ‘capital growth’ which we’d chosen to also reduce our taxable income through Depreciation. It would have still been ‘cash flow positive’ if our taxable income had been higher but this one sadly is negatively geared for us. Unfortunately that property has only increased by about $50,000 in the last 10 years and we paid nearly $500,000 for that one alone! It’s probably the only property I’d love to live in … but with rental income of over $700 pw, it’s not logical to move into it so it doesn’t benefit us either emotionally or financially.
So look for a property with Capital Growth potential as well as Cashflow… because they do exist – it’s just that some people can’t see them 🙂
5. What Should I Look for as a Positive Cash Flow Property
You’ll find lots of people and places these days advertising positive cash flow properties – but that doesn’t mean they will be positive for you! That doesn’t mean they’re being dishonest – however it does mean they are using a range of different assumptions in their calculations. It’s crucial to your cash flow to check what those assumptions are, and whether they are true for you!
Sadly, there are some spruikers who I believe, are quite intentionally misleading. Warning bells go off for me when someone includes potential capital gain with the rental income, and quotes that as the overall return on investment. For example if they ‘assume 7% pa capital gain, and 3%pa yield they may advertise a property as having 10% return. WARNING!! It’s a dangerous assumption to rely on capital growth as ‘income’ when looking at the return on your investment. This sort of promotion has often been used to persuade uneducated mum and dad’s investors to hock their home to purchase an overpriced, negatively geared property.
Always Do Your Own Analysis
Statistic, Assumptions and Guesstimeates can be your undoing so don’t abdicate this crucial step in checking to make sure a property is Cash Flow Positive for you personally. You’ll find in magazines and online that many properties are advertised as ‘Cash Flow Positive’. The assumptions, like many ‘statistics’ can be skewed to give a property a positive light. As a savvy investor you need to understand the different aspects that make up the general return of a property and the personal return of it too.
When you look at the numbers of a property to assess its cash flow potential, there will be 3 different areas to look at:
A. General Expenses. These are expenses you can find out specificaly and factor in to your calculations with confidence. For example: Rates and Taxes / Strata or Body Corp Fees / Insurance / Property Management expenses / Depreciation
B. Estimates and Guesstimates. These are expenses you may not be able to ascertain exactly when you’re analysing a property, but you can try and reasonably estimate ongoing costs such as: Maintenance / Water usage / Utilities and perhaps Cleaning (particularly for rent by the room strategies) / Gardening /
C. Your Personal Financial Position. This is an important part of your analysis and can mean all the difference to a property being negative or positive cash flow. The property I used as an example earlier is negative for me, but would be positive cash flow for many others. In your ‘Personal’ position you’ll be considering costs such as: Loan Amount & Interest / Ownership Structure and Marginal Tax Rate. Plus of course if you’re doing your own property management and maintenance this will positively impact your cash flow, even though it could negatively impact your time of course 🙂
6. How Do I Analyse a Property Properly?
Although my first stage of analysis is basically a quick ‘back of envelope’ calculation to checks the gross yield, I’d always recommend using a good piece of software to fully analyse the figures before signing on any dotted line!
If you’re a whiz at spreadsheets you could make up your own calculator and incorporate all the expenses I mentioned above. You’d also need to include Stamp Duty for the relevant State you’d want to purchase in, consider Lenders costs and know how to include your personal tax rate calculations.
Personally I use and recommend PIA Software. It’s written by investors (Jan and Ian Somers) and I’ve found it very easy to use to work out the expected cash flow (positive or negative) for a property on it’s own, or as it fits within an existing portfolio you may have. It has built in Stamp Duty Calculators for all the States (and New Zealand) as well as tax rates so it’s function rich. Plus it’s got a lot of other benefits, including some great reports that Lenders or other Investors would be impressed with when you are looking to get help securing funds for your next property purchase.
There are of course lots of other options out there – just do your research and make sure they include everything you need for an un-biased analysis. Click this link if you’re interested in PIA Software.
7. Add Value to Reap Rewards
As mentioned previously, buying Cash Flow property isn’t just about buying income. it’s about making capital gains too. So when you’re looking for a potential property, make sure you consider how you can add value too. Look at what you can do as cheaply as possible to make the property more attractive so that you can get a better return and increase your equity.
There could be one or more opportunities such as:
Sub-Division – could you reasonably expect to sub-divide now or in the foreseeable future to improve the value?
Development – could you add more dwellings on the current lot, perhaps a GrannyFlat or other second dwelling to increase the income and add value?
Quick Reno – would a clean and paint throughout add value and make the property more presentable for higher paying tenants? Perhaps just adding such tenant benefits as air conditioning, carport or shed, security features or furniture could improve the income too.
Remember, the biggest benefit will be in the shorter term manufactured equity through value adding, or longer term more organic growth, so keep all that in mind when you’re property shopping!
8. Why Would Anyone Sell a Positively Geared Property?
As with any property sale there can be a multitude of reasons why an investor or owner would sell their property – even if it’s producing cash flow for them. We’ve picked up some good positive deals, sometimes from older investors who just want to reduce their holdings and have some good capital growth already to realise. We’ve also purchased property being sold due to a relationship breakdown, and another where the owner had been managing his units, but wanted to go touring around Australia instead.
There are also those cases where a property for one person is negatively geared, but for another it would be positive. For example, where Depreciation benefits increase the cash flow (after Tax) for a high income earner but don’t help a low tax payer. Or perhaps where an Investor has mortgaged the property too highly, or at too high an interest rate, and isn’t in a position to refinance.
In my personal experience we sell some of our positive properties too – usually when it’s time for another holiday adventure or another business venture!!
In our case we’ve also found that many of our properties become due (or overdue!) for Renovation. If we loved renovating and wanted to travel to the properties and manage the reno projects ourselves, we’d be very excited by the potential to improve the value and the income. Unfortunately for us, that’s not something we get excited about … in fact for us it’s quite a chore…. especially when we have so many properties (around 37 Rentals at the moment!) Fortunately for others of course, there are some properties that are cash flow positive for many investors to snap up!
But don’t take my word for it – or anyone elses! Do your own research and analysis…
Buy Wisely – Buy Well – and Prosper through Property 🙂
FYI – Click Hereto link to our properties which are currently for sale if you want to check them out and do your own analysis. As you’ll see by the webpage that John drafted with these properties – Renovation definitely isn’t his forte! So feel free to contact him for more details 🙂
PS. Once we’ve sold enough for our next needs, we’ll take the link off, so if it doesn’t work later, you know why now!