Why Cash-Flow Positive Property Is Essential To Building Your Property Portfolio

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1 Why Cash-Flow Positive Property Is Essential To Building Your Property Portfolio

2 Contents 1. Letter from the CEO: 3 2. Introduction 4 3. What are cash flow positive properties? 5 4. Why it s important to consider a cash flow positive strategy 8 5. Cash Flow Positive strategy under current market conditions A balanced portfolio is crucial to building wealth Locating cash flow positive properties Conclusion 16 Why Cash-Flow Positive Property Is Essential / 2

3 1. Letter from the CEO Dear Reader, We are delighted to provide you with a free copy of this Special Report ebook. Investing in property is a wealth strategy open to everybody, not just the affluent. The benefits of doing so are immense and life changing- wealth creates options, and with options comes a variety of choices which can ease the burden of everyday living, and help us to realise our dreams sooner. With the many strategies and opinions out there, it can be confusing to tell the right from the wrong, the high risk from the low risk- this often leads to procrastination and sometimes, poor investment choices. This report will shed some light on the benefits of cash flow positive property, and why it is important to consider when detailing a wealth strategy. After reading this report, you will gain insightful knowledge which AllianceCorp can then build upon, in a bid to help you become a successful property investor. We have many great services to offer, which will help turn your visions of wealth into a reality. They include: Buyer s advocacy services to target the best investment property Property Coaches to develop your property wealth plan Renovation services to add value Property management services Feel free to contact us and make an appointment Regards, Jason Paetow Why Cash-Flow Positive Property Is Essential / 3

4 2. Introduction At the core of property investment, there are two basic strategies for long-term success. Experts in the industry (who propose that the way in which you create success through property investment is down to your current circumstances) support both strategies as ultimately, both strategies lead to the creation of wealth. The two basic strategies are: 1. Aiming primarily at capital growth (even if it means that properties have to be negatively geared) 2. Aiming primarily at maintaining positive cash flow Both property investment strategies are proven, and can co-exist as part of the one property portfolio. While the strategies are fact, the choice between the two is personal. Investors should take into account their current circumstances, market conditions and their investment profile. It s not advisable to take the sudden word of a supposed property guru, and you should also err on the side of caution when it comes to hot tips and supposed investment trends. Go with what works and go with what s proven. You should reduce your risks and don t elevate them unnecessarily. Each of these two strategies reveals their benefits during different phases of the economic cycle. Strategy one, Capital Growth, is easier to demonstrate in a rapidly rising market than during a market period of stagnation or depreciation. Conversely, the attraction of having a self-paying property is clear during economic periods for strategy two, Cash Flow Positive, where capital growth is but a distant dream for investors; it is because of this, that many investors are starting to take a serious look at the possible benefits of implementing a cash flow positive strategy. The purpose of this ebook is to help you understand some of the issues involved in a Cash Flow Positive strategy. We will provide you with background information on the strategy, including its pros and cons, and highlight the importance of locating the right property which can allow for a positive cash flow, and thus, a great wealth creation strategy. Why Cash-Flow Positive Property Is Essential / 4

5 3. What are cash flow positive properties? Property investment lingo can be intimidating to the new investor, and all too often those using the terminology fail to adequately explain what they mean. To make life easier, and bring you up to speed, we are going to take some time to carefully explain what a positive cash flow strategy is. The first distinction to make is that a Cash Flow Positive property is not the same as a positively geared property. A positively geared property is a property where direct rental income covers all of the direct costs (including the full monthly mortgage payment) associated with it. Finding these properties can be difficult, and traditionally they have been associated with regional mining towns during booms - so right now may not be the best time to go looking for them. Positive gearing can, of course, be achieved by laying down a very large deposit on a property. A positive cash flow property is different from a positively geared property, in that all of your direct costs are not covered by the rental payments, meaning you may show a negative cash flow on paper. This negative cash flow can be turned positive, by tax refunds that you receive by claiming expenses and depreciation. This refund can be substantial since you are allowed to claim all reasonable expenses, and an amount of loss of value for the building, fittings, fixtures and furniture. For every dollar lost due to depreciation, you can claim back an amount equal to your marginal tax rate (approximately 30-40%). This tax refund/payment can help ensure that your property does have a positive cash flow, when you balance your books at the end of the financial year. Working out if an individual property will fall into the Cash Flow Positive tax bracket, will depend on a range of variables. It is important to take a close look at the numbers before making a final decision- there are a range of software programs on the market which can help you with this. Why Cash-Flow Positive Property Is Essential / 5

6 Important variables to consider are: Purchase price and rental yield The higher the potential rental yield is, the more likely it is that your property will fall into the Cash Flow Positive bracket. Interest rates The higher the interest rate, the higher the cost of property which in turn reduces the likelihood of achieving a positive cash flow. Conversely, the lower the interest rate, the less the property will cost you and thus, the more likely it is that your property can achieve a positive cash flow. Depreciation tax benefits The more you can claim for depreciation, the better it is for your positive cash flow. As a general rule, this means that new or nearly new properties offer better cash flow prospects, since the rates at which you can claim depreciation are higher than for longer, established properties. Operating expenses Expenses, such as rates and body corporate fees, can vary between properties and may have a significant impact on your final cash flow position. Maintenance costs High maintenance costs, usually associated with older properties, can have a detrimental effect on your positive cash flow, which serves as another reason to go for newer properties which usually have lower maintenance costs. If you have a bit of money left over each month after you have crunched all of the numbers for each of these variables, then you have a Cash Flow Positive property! Why Cash-Flow Positive Property Is Essential / 6

7 The following example will help to illustrate the concept further: Example of a cash flow positive property: INVESTMENT ANALYSIS PROJECTIONS OVER 10 YEARS End of year yr 2yr 3yr 5yr 10yr Property Value $400, , , , , ,558 Purchase Costs $20,310 Investments $0 Loan Amount $421, , , , , ,321 Equity $-21,321-1,321 19,679 41,729 89, ,237 Capital Growth Rate 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% Inflation Rate (CPI) 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% Gross Rent (pw) $550 28,028 29,149 30,315 32,789 39,893 Cash Deductions Interest (I/O) 6.00% 25,279 25,279 25,279 25,279 25,279 Rental Expenses 13.36% 3,822 3,975 4,134 4,471 5,440 Pre-Tax Cash Flow $0-1, ,039 9,174 Non Cash Deductions Deprec. Of building 2.50% 2,500 2,500 2,500 2,500 2,500 Deprec. Of fittings $30,000 4,000 3,467 3,004 2,257 1,103 Loan Costs $1, Total Deductions 35,803 35,423 35,120 34,709 34,322 Tax Credit (single) $100,000 3,227 2,604 1, ,312 After-Tax Cash Flow $0 2,154 2,499 2,896 3,836 6,862 Rate of Return (IRR) Your cost / (income) per week Pre Tax equivalent (41) (48) (56) (74) The above example shows a positive cash flow of approximately $41 per week- for a property that falls within the Cash Flow Positive bracket to begin with. It s important to note that it is also possible for a property to move into this bracket, after a certain period of time (which may lead to increased rents and/or lower interest rates). Why Cash-Flow Positive Property Is Essential / 7

8 4. Why it s important to consider a Cash Flow Positive strategy Some of the great advantages that come with buying a cash flow positive (CFP) property include the following Cash flow properties mean you don t have to constantly come up with extra cash in order to cover your outgoings. This means peace of mind, and a worry and hassle-free investment. Using a negative gearing strategy, where you have to pay in some funds to cover the shortfall, means your portfolio expansion is limited by the amount of extra cash you can raise to meet additional expenses. By following a positive cash flow strategy, your expansion will only be limited by the amount of equity you have available. Money generated from a positive cash flow property can be put back into the property via extra mortgage payments. Usually, this leads to increased equity in the property, resulting in added potential for further expansion. The main disadvantage to a Cash Flow Positive strategy is that properties within this bracket are usually not the same properties, which perform, well in long term capital growth. The reason for this is that Cash Flow Positive properties are often located in more stable markets (i.e. regional centres) that don t result in the high spikes often witnessed in other areas of the property market. Ultimately, choosing a Cash Flow Positive strategy often means (but not always), choosing between a regular income, and long-term capital growth. One of the most common problems is serviceability. Serviceability becomes an issue when the banks refuse to lend you any further funds, due to you and your investment portfolio not generating enough income to support further lending. On average most families that have equity in their home can comfortably afford two three negatively geared investment properties, but beyond that unless they focus on cash flow positive properties they will not be able to grow their portfolios. Why Cash-Flow Positive Property Is Essential / 8

9 Example: John and Grace Peters John and Grace are reaching retirement and while they have already made a start on their property portfolio, they realise that they still require more properties in the future to fund their retirement. Combined Income $110,000 Rental income on three investment properties $50,000 Monthly repayments on current mortgage $6,500 and investment properties Peter approaches the bank for a $400,000 loan to purchase another negatively geared investment property. As you can see above, when entering the rental yield of 4% which is approximately $16,000 to the $60,000 they were already receiving from the other three investment properties, the bank is still only prepared to lend $247,000. Why Cash-Flow Positive Property Is Essential / 9

10 Peter approaches the same bank for a $400,000 loan but this time, they present figures on a positively geared property. The positively geared property is generating rental yield of 9% which is equivalent to approximately $36,000 per annum. With the increased income the bank will lend $413,000 which is enough to continue building their property portfolio. People who are looking to build wealth can t forget that in order to build wealth, you need to invest which usually involves borrowing funds. If you invest in strategies that are low yielding, you will eventually have a serviceability problem and therefore can no longer borrow to invest. It is important to invest in growth assets but not at the expense of not being able to grow your portfolio. Why Cash-Flow Positive Property Is Essential / 10

11 5. Cash Flow Positive strategy under current market conditions There are several factors which when combined, show that a Cash Flow Positive strategy makes a strong argument for implementation. These factors are: Historically low interest rates: The low interest rates at the moment are likely to be the lowest we will ever see. The lower costs mean a higher likelihood that a property can be cash flow positive. This situation can be locked in for several years, by selecting an appropriate fixed rate mortgage Strong rental demand: There is a strong rental demand in most of Australia s urban centres- the decline in new building projects means that this trend is likely to continue. With an increased demand, and limited supply of rental properties, comes an increase in rent and thus, the possibility of positive cash flow. Slow property market: With property prices stagnating, or even falling in some locations, it s likely that you won t have to pay more than necessary for an investment property, which results in a positive impact on your bottom line. A savings in purchase price does wonders for your chances at achieving a Cash Flow Positive property. All of the above factors mean that the current market conditions present an ideal opportunity to use a Cash Flow Positive strategy. Some investors on variable rate mortgages may even find that due to the interest rate fluctuations, they are moving into the Cash Flow Positive bracket without even intending to. If the current conditions persuade investors towards investigating the benefits of a Cash Flow Positive strategy, then it is likely that most of them will stick to this strategy as a means of growing their portfolios. Why Cash-Flow Positive Property Is Essential / 11

12 6. Why a balanced portfolio is crucial to building wealth While this report focuses on cash flow positive property, it is important to understand the fundamental reason as to why many properties are cash flow positive and what impact this has on your portfolio. When we consider the returns generated by a property, we must take into account the income or yield that can be generated by the property, but also the capital appreciation through growth. The reason as to why many cash flow positive properties have higher yields is because they may be in a location where there is not a high demand for properties, or where increasing supply is greater than demand. When this happens there is no competition to buy the properties which results in very low growth. These types of properties are generally located in regional areas. If the properties have very little growth over time, it is not to say that the rental yields won t increase due to demand in the area. Because the yield is calculated as a percentage of the value of the property and may grow at a faster rate than the property, this is how higher yields are generated. While the yield may look appealing, we must take it into account how a high yielding property with lower growth may impact our wealth creation. Why Cash-Flow Positive Property Is Essential / 12

13 Growth verses Yield As you can see above, Investor A focused on a high growth property with a low yield, and investor B focused on a cash flow positive property with a high yield. Over a ten year period, investor A s property is now valued at approximately $1m while investor B s property is only worth $651,000, which is a significant difference. This illustrates that it is wise to build a portfolio that has both high yielding properties and high growth properties. If your high yielding properties have very little growth, where are you going to generate the equity required to cover your deposit and establishment costs to buy more properties in the future? Why Cash-Flow Positive Property Is Essential / 13

14 7. Locating positive cash flow properties Rest assured, there are many investors who actively seek properties with positive cash flow potential. You are not alone, and as such, it will take time to find the right property which falls into the Cash Flow Positive bracket. Research the best opportunities, so that you can make the right decision. To help with this research, the following elements should be closely analysed: What s your present position? Time to analyse! Before considering an individual property purchase, it is crucial that you have a clear idea about your overall financial position, tax position, risk profile and the level of debt with which you are comfortable. Taking a closer look at these factors and seeking both financial and tax advice where necessary should give you a better idea of the type of property most suitable for you, and the confidence required to deal with a level of debt you are comfortable with. Do your homework: Finding the right Cash Flow Positive property for your circumstances will take quite a bit of research to begin with. This is a good thing, however, as it allows you to learn more about the market and more about what you should be aiming for in the future. The following suggestions should help you with the research process: Investigate and analyse the property statistics for the area(s) that you are interested in. For help, your state s Real Estate Institute should be able to provide this information. Pay close attention to the average rental returns for different areas. The higher the better! When it comes to research, especially property research, the internet is your best friend. Property listing websites provide great insight into both asking prices and possible rental returns. In addition, you can conduct research into the area, in terms of infrastructure, transport, attractions and more, using Google Earth s mapping service. Once you have found an area of interest, you Why Cash-Flow Positive Property Is Essential / 14

15 should speak with real estate agents who specialise in that area in order to understand its pros and cons better. They can advise you about local issues and developments that may have an impact on the area (i.e. a new shopping centre opening up, or a new university being built). Speak to property managers. Property managers have a wealth of information that can prove priceless- they have all the insider knowledge on rental demands and average rents, as most of them are in contact with both tenants and landlords on a day-to-day basis. Target a specific tenant profile: It is of the utmost importance that you do your best to understand the demographic group that would benefit the most from the kind of property you are considering. Therefore, it s a great idea to do some research on your ideal tenant- for example, what would they look for in a property? What type of transport would they use? By monitoring the media and talking with real estate agents, property managers and other investors, you can keep abreast of this valuable information. Having this information available will help you to choose exactly the right property and to prepare it in a way that will appeal to the needs of the tenant profile you are targeting. Renovate: Renovating in order to improve the decor, functionality or pleasantness of the property can have a dramatic impact on a tenant s choice of property. If you fall well below the competition, you are going to have a hard time renting it out. But it s not just about getting the tenant - with a renovation you can justify a rental increase which can push your property into the Cash Flow Positive bracket. Consider blocks of units: A small block of units will deliver better rates of return consistently, than simply a single unit. This option may be worthwhile if you can raise the capital, and are willing to take on the increased administrative burden of managing several units, as opposed to just one. Make low offers: The lower the purchase price of a property, the more likely you are to achieve a positive cash flow. It could be worthwhile to make several low offers, if you have the time and have your eye set on various properties, as there is always a small chance that one will be accepted due to seller desperation. This would leave you in good standing to achieve a positive cash flow. Investigate the idea of subdividing existing properties: If you can get the right permissions and have the capital to do so, then subdividing can be a lucrative option on the path to cash flow success. Properties, which lend themselves favorably to this concept, include: Large houses (e.g. old Queenslanders ) where you can free up space and build separate living areas and bathrooms, to accommodate two separate family units. Houses on very large blocks, where it would be possible to build a granny flat. Old motels and hotels that can be transformed into permanent rental accommodation. Investigate occupation needs: A method for increasing rental income by a significant margin can be to cater towards specific niche needs. Specific niche needs may include fully furnished apartments for urban professionals, or separate rooms designed for students. Although this type of approach may result in more labour, the potential pay-off could make it a worthwhile option. Why Cash-Flow Positive Property Is Essential / 15

16 8. Conclusion It is no secret that times are tough during this period in the economic cycle. Tailoring your property investment strategies to adjust successfully to the market conditions is the right course of action, so that you can make the best of the presented opportunities and give yourself the optimal chance of growing your property portfolio well into the future. Selecting a Cash Flow Positive investment strategy in one way of achieving your goals of wealth and prosperity- it is for this reason that we encourage you to investigate the associated benefits and opportunities that come with such a lucrative strategy. We sincerely hope that this guide has served as an informative and helpful introduction to the Cash Flow Positive strategy. We wish you only the best in all your future investment Why Cash-Flow Positive Property Is Essential / 16

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