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 Favour 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 utilising 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 favouring 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 it’s 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.
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