What is the right investment strategy for me?
Do you need rent to cover your mortgage payments, or are you looking for tax benefits?
Often, buzz-words like 'negative-gearing' and 'cash flow strategy' are thrown around without an understanding of what they mean. Now that you've made the decision to invest, the next question should be for what reasons?
The investment strategy you choose should depend on several factors, the most common being the length of time you plan on having the investment property, how much capital you are willing to initially put down on the property and your other financial investments and goals.
Capital Growth
All property investors are looking for their property to grow in value over time and generate capital growth. As the value grows over time, investors will increase their equity as their loan balance will be falling while the property value is going up. How much property is anticipated to grow largely depends on the type of property you purchase and where it is located. For this reason it’s important to research the growth of comparable properties in the areas you are looking to buy.
Is a positive or negative cashflow right for me?
There are two types of cash flow strategies and it’s important you understand them both and plan your investment property purchase around one of them. Regardless of the cash flow strategy you choose, there are tax deductions you’re eligible to claim regarding expenses for your property and depreciation.
Positive Cash Flow (Rental Income) - this is where you earn more money from your property than your expenses More simply, when you collect more rental income than your repayments and other expenses. This type of strategy is common when interest rates are lower and rental vacancy rates are low and with buyers who have lower loan-to-value ratios (LVR) and have smaller repayments.
Typical strategies for positive cash flow:- buying a property with a high cash deposit
- buying in an area that is extremely popular with low vacancy rates
- using loan features such as an offset account or interest only payments
- Depreciation claims
An example
Jason is a fly-in-fly-out worker and has saved $200,000 for a home loan deposit over the past years. He recently decided he wants to invest in property instead of buying so he bought an inner-city 1 bedroom apartment for $500,000. After paying $25,000 in costs associated with purchasing a property, Jason had a $375,000 loan which he elected to pay off at 4.64% for the next 30 years. Jason’s monthly expenses included $1,639 in loan repayments and $500 in other bills.
Because Jason bought in a popular area he was able to rent out his property straight away for $2,500 per month. Each month Jason’s property generates $361 of positive cash flow ($2,500 - $1,639 - $500). Over 12 months Jason would earn $4,332.
In a single year Jason would have an investment yield of 2.16%
Negative Cash Flow (Negative Gearing) - A property investment with negative cash flow simply means the expenses of the property are greater than the income the property generates. Many investors choose to negatively gear their properties so they can take advantage of tax benefits that allow them to offset their losses against taxes paid from other sources, such as a salary.
Typical strategies for negative cash flow include:- Borrowing closer to the property value
- Loan repayments that include principal and interest
- Shorter loan terms (25 years or less)
- A PAYG employee who wants to reduce their taxable income
Negative Gearing Explained
Negative gearing is a common strategy for investors who want to offset the taxes they pay from other sources against the losses they incur owning an investment property.
Negative gearing is only beneficial if you are paying tax and is not recommended for many property owners such as retirees. For negative gearing to work effectively it is highly advisable to have a mortgage broker property structure your loan.
An example
Lauren owns a one-bedroom investment property in a regional area of Queensland. She collects $1,300 a month in rent and her loan repayments are $1,500 a month and she incurs $300 a month in other costs. Each month she has to cover the $500 shortfall in cash flow from the investment. At the end of the year, Lauren has lost a total of $6,000 from her investment and claims the total on her tax return alongside her $100,000 a year salary. This reduces her taxable income to $94,000.
Mixed strategies for property portfolios
Some investors use a mixture of both negative and positive geared properties in their portfolios so that the shortfalls of one can cover the other.