With the growth in the number of Australians becoming property investors in recent years, whether as a result of starting a self-managed super fund (SMSF) or as one element of a sound financial plan, there is a real need for people to understand more about the mechanics of investing in property.
Understanding your investment property’s cash flow is one vital area of property investing you need to know about so you can build a successful property investment portfolio, should you wish to use property as part of your financial plan.
Hamish Ferguson is Vision’s Newcastle partner and he deals with many clients who are investing in property, often for the first time. He finds that investment properties will usually fit into one of three cash flow categories. Importantly, Hamish says, throughout the lifetime you hold your investment property, the category it reflects may also change.
Negatively geared properties are where the property doesn’t generate enough income to cover all of the property’s expenses, and the property investor may be eligible for a tax deduction because of the losses incurred as a result of holding the property. Hamish warns though, that negative gearing is best suited for high-income earners who have the ability to cover the excess expenses their investment property is generating. It makes sense for high-income investors because of the possible tax deduction of the investment property’s losses.
With positively geared properties, the investor may still be able to access a tax-lowering rebate, however, when the rebate is applied, the property changes from generating losses to surpluses. In this category, the investment property expenses are still higher than the property’s rental income. After tax, however, the property’s income works out to be greater than its expenses because of what you get back from the government. “This type of investment property contrasts with a negatively geared property,” says Hamish, “where, even after tax breaks are applied, the property will still be costing more than it makes in rental income.”
Positive Cash Flow
“A positive cash flow investment property doesn’t even need the help of a tax rebate”, says Hamish. “With this kind of property, regardless of whether or not there is a tax rebate available, the property is structured so there will be more income than expenses. It is possible to deliberately create these conditions. For example, if you received a $400,000 inheritance and you purchased a $500,000 property, you would probably have positive cash flow from day one. This might also be true if you bought a brand new home with high depreciation.”
Hamish urges people to make an appointment to speak with their financial advisor to go through their options when it comes to adding an investment property to their financial plan. Even relatively simple things, like choosing the right loan for your investment property, can have a big impact on your property’s cash flow. “For example, you may wish to use an interest-only loan instead of a traditional principle and interest loan. As you will only be paying interest on the loan, your expenses will be lower, helping the property to become a positive cash flow investment.”
Researching all of the options available to you and receiving excellent advice from a knowledgeable professional is your best insurance against any problems you may encounter as you embrace investing in property as part of your financial plan.