Hi All,
Having recently started looking at IP's, I've spoken to several people regarding my options and what the best results would be, including property specialists (still reading the books!), and my mortgage broker. With all the options presented before me, I'm starting to get disillusioned and hesitating about my final choice, mainly because:
*Buying for negative gearing/tax purposes, and eventual capital growth, means I'll still have to make up for the difference between the rent and the IO loan, and at the end of the financial year I'll still get less back than what I've given – by ways of interest and other expenses/costs – during the entire year. To make up for that loss, however, I'd eventually have to sell the property (once it achieves substantial capital growth), and still pay CGT, which really defeats the purpose of owning property for the long-term, as one day I'd have to sell it to make up for my losses;
*Concentrating more on +CF IP's generally means I'll have to look for an IP in a not-so-flash area, but the rent of which will still cover my loan. This means me going into a higher income tax bracket, being taxed more, and with the prospect of higher interest rates within the next 12-18 months, there's a good chance the IP might even turn to -CF (and still not grow as much in value as what another -CF IP might in a better area).
Just wondering what all you gurus out there think and what suggestions you'd make to a beginner such as myself. Funding several negatively geared IP's won't get me far in terms of the amount of properties I could buy in the future, whereas a +CF IP will increase my earnings and capacity to purchase more, and perhaps sooner. This too, however, can still go pear-shaped.
Thanks.
Hi there Ms Trump,
You have posted a very good question, and one that many people chew over when they first start thinking about investing in property.
I am a total advocate of positive cash flow. Obviously capital growth is very important as well. But to be able to hold the properties long enough, you have to be solvent, IE. be able to afford to service the debt over a long enough period of time to benefit from the growth in Value.
You need to be able to build a sustainable portfolio with a mix of CF positive properties, as well as some properties better located for capital growth. The idea is to purchase, what I like to call a 'cashflow base', then as you build up a portfolio of say 3-4 CF + properties, that give you a cash surplus. You can then purchase a High capital growth property (that will need topping up of course) but the surplus from your CF+ base will do this. (You keep repeating this as many times as you want)
By building a 'balanced portfolio' you have a sustainable model where you get the benefits of both positive cash flow and capital growth. And remember that just because you are getting +CF from a property doesn't mean you are not going to get any Capital growth. Some of the cash positive properties I purchased in New Zealand back in 02/03 have actually tripled in value since.
When I started investing in property I had an extremely average income, and not a lot of capital to play with either. I was single so couldn't benefit from a partners income for debt servicing. However by purchasing very well, and gaining more equity in each deal than I was using up (for the deposit) on each purchase, I was able to substantially improve my equity position with each new purchase.
Also by purchasing properties with strong yields to begin with, this made it easier to qualify for more mortgages moving forward for even more purchases.
When building your portfolio, it is a continual balancing act between equity (Loan to value ratio) and yields (debt service ratio) to keep the balance.
Also another little tip, on buying the cash-flow first, even if you are on a higher income. You may not always have your high income, particularly in the current climate. Also when banks look at your income to allow for debt servicing, they generally only take 35% of personal income to put towards their debt service calculations, whereas they generally take 75-85% of any rental income into account for the same debt service calculations – From this you can easily see that your rental income very quickly becomes far more powerful for qualifying for further mortgages.
I hope this has helped shed some light on the question in subject. Of course we cover all of this stuff in far greater detail, along with everything else in our e-Coaching online property mentoring program
I think you would have to be crazy to buy a property in an inferior area with little growth prospects. There would be no point, in my opinion, even if you were making positive cashflow.
These days good properties in Sydney or other capital cities would be close to cashflow positive – some even positive. Rents will grow as well, so if there is a loss in the early years this will certainly help as will the capital gains.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Terry,
Of all the investors that i have seen get into trouble and go to the wall over the last 18 months (and the list is long), it has been mostly the investors that ignored the cash flow side of things, and went soley after the capital gain or speculative type deals.
Those of us that had good sound sustainable and balanced portfolios are still here and are now able to take advantage of some of the very good buying opportunities we have been seeing more recently.
As i mentioned in the above long post, you need to have the cashflow to be solvent long enough to realise the capital gain.
Please note: I am not referring here and above to someone who wishes to purchase only 1 investment property, but someone who wishes to build a large portfolio of properties.
Cheers.
Sorry to be so critical but what do you want out of an investment? What is the purpose of investing if at the end of the day you have not made a 'profit' whether it be a capital gain or a good rate of return on your investment? Paying tax is a side effect. I consider that if I am paying tax then I am still making money (or I will have to find a few more non-cash deductions).
Risk is inherent with investments. You will need to consider whether property is an investment suited to your profile.You will need to consider if investing is for you or whether you would be better in other vehicles like super, managed funds or in bonds/term deposits. Consider that you should have a balanced portfolio ie not just property as that goes against all the fundamentals of not having excessive exposure to one type of investment.
It may be worth you while to sit down with a financial planner to determine your goals and to map out the pathway to achieve your goals.
@ Kiwi Property Guy – thank you! You've certainly shed some light on what I may end up doing in the future, and your suggestions had seriously crossed my mind – buy +CF first, and as that portfolio builds up, start concentrating more on areas with greater capital growth potential. That's not to say, though, that +CF IP's in "worse off" areas haven't grown significantly in capital value over the last 5-6 years. Some have doubled in value.
I know it's completely wrong to buy an IP just for tax purposes, as at the end of the day you're just funding a loss over an entire year. And then at the end of it, you still don't get 100% of it back. I'd have to sell to cover my losses, but as I said before, why sell when you're buying a property for a long-term investment to begin with? I'll certainly need a CEO-type salary to fund a few negatively geared properties, and still have money to live on
@ Scott No Mates – I'm definitely looking at IP's. I'm very cautious when it comes to taking risks re: investments, but do realise you need to jump into it sometimes to reap the rewards in due course. You're certainly right about the tax aspect of it, though, although I want the best of all worlds –> +CF IP's, + capital growth, and very little tax
There are cf+ deals to be had in Sydney & major regionals like Newcastle. (which I mention only because I am familiar with it. I am sure there are others like it). I don't believe you have to go out into the counrty to buy sub-optimal property with low CG prospects to get good yield.
You need to think a bit laterally. You can rent by the room to students near a University for example or buy a house with a small flat attached. Both these kinds of property we buy a lot for ourselves (as investors) and for clients. That way you get the best of both worlds CG & yield.Yes there sure are currently some excellent opportunities to purchase quality properties, which if bought well can offer some pretty good yields. We just contracted two such properties yesterday.
Have actually just come back from inspecting one of them, and we are amazed how good this property is, and the fact that it is one of the best capital growth areas in the City, and it will be positive cash-flow pre-tax
Hi Ms Trump,
Pretty much the number one question that everyone asks, and "experts" often back a philsophy and then stick with this line as the best (and only sensible way forward).
On a pure numbers basis, a high capital growth, low rental yield will over time perform better than a low capital growth, high rental yield property. But cash flow is critical and I remember a quote someone said to me " the negative geared strategy will ultimately make you wealthier if you don't go broke along the way!"
I started with a mid range position and then went more on the capital growth focus.
As people are noting with the current rents and interest rates you can achieve the best of both worlds at the moment, but just remember that things WILL change so build this into your thinking and strategy
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