13 STRATEGY INSIGHTS INTO POSITIVE CASH FLOW PROPERTY

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1 13 STRATEGY INSIGHTS INTO POSITIVE CASH FLOW PROPERTY Financial education for all Australians

2 13 Strategy Insights into Positive Cash Flow Property This page is left blank intentionally. Financial education for all Australians 1

3 13 Strategy Insights into Positive Cash Flow Property No Advice Warning This ebook contains general information only. This ebook has been written by Wealth Adviser Financial Education (Wealth Adviser); the educational division of Spring Financial Group (a licensed Financial Advice firm, AFSL ). The information in this ebook is general information only and has been prepared without taking into account your personal objectives, financial situation or needs. You should therefore consider any ideas in this ebook in light of your personal objectives, financial situation or needs before acting on them. You may wish to consult a licensed financial adviser to do this (in fact we recommend that you do). Information in this ebook is no substitute for financial advice. If you are considering acquiring a financial product you should obtain a Product Disclosure Statement and consider its contents before making any decisions. Wealth Adviser and its affiliates assume no responsibility for any actions you take independently, without seeking professional advice from a licensed financial adviser. Spring Financial Group (ABN ) 2016 This publication is protected by copyright. Subject to the conditions prescribed under the Copyright Act 1968 (Cth), no part of it may be reproduced, adapted, stored in a retrieval system, transmitted or communicated by any means; or otherwise used with without prior express permission. Enquiries for permission to use or reproduce this publication or any part of it must be addressed to Spring Financial Group by to info@springfg.com. Financial education for all Australians 2

4 Letter from Wealth Adviser 13 Strategy Insights into Positive Cash Flow Property Dear Reader The goal of Wealth Adviser is to ensure that concise, informative financial education is available to everyone at no cost. Our books and seminars seek to inform people of not only the benefits but also the potential risks and pitfalls of various strategies and investments. With this aim in mind, we are delighted to provide you with a free copy of this ebook. We live in interesting (and somewhat difficult) times where making good, informed, long term investment decisions can be quite hard. People are simply looking for someone they can trust who can help and guide them with their financial and investment decision making. Finding that person is not easy. We hope that some part of what you read in this educational ebook is beneficial and of service to you. From there, once you have a general understanding of options available to you, we believe that it is important for you to seek personal advice that is appropriate to your situation. You should find a trusted adviser and work with them. It is worth saying that good information, although valuable, is no substitute for experience and professional guidance. And that no matter what specific strategy, product or transaction you are considering, it will always be interconnected to several other aspects of your personal and financial life. Being aware of these connections is the hallmark of a good, considered transaction and strategy. We look forward to meeting you at some point, to introduce ourselves and what we do. Best regards Wealth Adviser Financial education for all Australians 3

5 Contents 13 Strategy Insights into Positive Cash Flow Property No Advice Warning... 2 Letter from Wealth Adviser... 3 Introduction... 5 What do we mean by positive cash flow properties?... 6 Why you may consider a positive cash flow strategy... 8 Why a positive cash flow strategy can make sense in certain market conditions... 8 Finding positive cash flow properties... 9 Conclusion Readers Notes The Value of Financial Advice What makes Spring Financial Group different? Financial education for all Australians 4

6 Introduction Anyone who has ever taken the time to investigate property investment would be aware that there are two basic strategies embraced for long term success. The two 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 The reality is that the two strategies can co-exist. The choice that you make should depend on your personal circumstances, market conditions and your investment profile. The benefits of the different strategies are most clearly demonstrated during different phases of the economic cycle. The benefits of a Capital Growth Strategy are much easier to demonstrate in a rapidly rising market than during a time when prices are stagnant or falling. Conversely, the Positive Cash Flow Strategy is very appealing when capital growth is stagnant, as the properties pay their own way. The purpose of this ebook is to help you understand some of the issues surrounding the building of a positive cash flow property portfolio. This will be done by giving some background information on the strategy before going on to discuss some of its pros and cons. Obviously, a vital part of any successful positive cash flow strategy is to find properties that can deliver this kind of cash flow. This guide will conclude with some tips on how to source positive properties. 13 Strategy Insights into Positive Cash Flow Property Financial education for all Australians 5

7 What do we mean by positive cash flow properties? A positive cash flow property is an investment that earns more than it costs to own, taking into account the effect of taxation. Positive cash flow property is property that may generate a loss (more expenses than income) before tax, but then after tax deductions and refunds are taken into account your income is greater than your expenses. As the direct costs of a positive cash flow property may not be covered by rental payments, this means that you may still show a negative cash flow on paper. This negative cash flow is then turned positive by tax refunds that you receive from claiming for expenses and depreciation on the property. This refund can be substantial since you are allowed to claim all reasonable expenses and an amount of loss of value for the building, fixtures, fittings and the furniture. For every dollar lost in depreciation you can claim back an amount equal to your marginal tax rate. This payment from the tax man can ensure that your property does indeed have a positive cash flow when you balance your books at the end of the financial year. What is the difference between a positive cash flow property and a positively geared property? A common misconception is that a positive cash flow property is the same as a positively geared property. This is not necessarily the case. A positively geared property is one where the direct rental income covers all of the direct costs (including the full mortgage payment) associated with it, ignoring the taxation benefits associated with the gearing. Finding properties like this can be extremely difficult. Positive cash flow on a property typically occurs when rents are high and interest rates are low, or after you ve owned a property long enough that you ve made a significant dent in your principal. This can be achieved also by putting down a very large deposit on a property. 13 Strategy Insights into Positive Cash Flow Property Calculating whether an individual property will fit into the cash flow positive bracket is based on a range of variables and you will certainly have to do a bit of number crunching before making the final decision (there are some software programs available that can help you with this). Some of the things that you will have to consider are: Purchase price and rental yield - The higher the achievable rental yield the more likely it is that the property will be in positive cash flow territory. Interest rates - The higher the rate the more the property will cost you and the less likely you will be to achieve a positive cash flow and vice versa. Depreciation (tax) benefits - The more you can claim for depreciation the rosier your cash flow position will be. This means, as a rule of thumb, that new or nearly new, properties offer better cash flow prospects since the rates at which you can claim depreciation would be higher than for longer established properties. Operating expenses - Expenses, such as rates and body corporate fees, can differ widely from property to property and could have a significant impact on your final cash flow position. Maintenance costs - The negative effect that high maintenance costs can have on your cash flow position is another reason why it is generally easier to achieve positive cash flow with a newer property. Marginal tax rate - The higher your tax rate the greater the tax benefit you will receive to increase the total cash flow from the property. However, property is a desirable wealth creation strategy regardless of these variances. If you have a bit of money left over every month after you have crunched all of these numbers, then you have a positive cash flow property! Financial education for all Australians 6

8 13 Strategy Insights into Positive Cash Flow Property The following case study will help to illustrate the concept further: Let s assume you purchase a property for $500,000, borrowing the full amount and the purchase costs. This is on an interest only mortgage at 4.99% per annum. You pay $25,700 per annum interest repayments and around $5,000 in other expenses. Rental income received is $500 per week; $26,000 for the year. As the rental income of $26,000 is less than the total expenses of $30,700, a loss of $4,700 results. However, at tax time the loss on paper includes the $4,700 cash flow loss and the deprecation of $15,000, resulting in a $19,700 loss on paper for the year. Assuming a 39% tax rate you would be entitled to a $7,683 tax refund on this loss. Your income, or total cash flow received from the property now becomes $33,683, which is greater than your expenses of $30,700. Thus after tax your property becomes cash flow positive. This represents a positive cash flow of around $2,983 p.a. or $57 per week. Assumptions Purchase Price $500,000 Borrowings Interest Rent Other Expenses (e.g. strata fees, insurance, rates) $515,000 (Purchase price plus costs) 4.99% / $25,700 p $500 per week/ $26,000 p.a. $5,000 p.a. Cash Flow Cash flow situation Taxation Impact Taxation implications Final Cash Flow Position Final cash flow position Rent: $26,000 - Interest: $25,700 Expenses: $5,000 = Cash flow loss: <$4,700> Tax loss: <$4,700> + Depreciation: <$15,000> = Total tax loss: <$19,700> Tax 39%: $7,683 Rent: $26,000 - Interest: $25,700 - Expenses: $5,000 + Tax refund: $7,683 Net cash flow: $2,983 p.a. The example above represents a scenario where the property is in cash flow positive territory from the outset. However, it should be noted that it is also possible for a property to move into this category after some time on your books (e.g. through increased rents and/or lower interest rates). Depreciation $15,000 p.a. Financial education for all Australians 7

9 Why you may consider a positive cash flow strategy Some of the advantages of buying a positive cash flow property include the following: Investing in a positive cash flow property means that you will not have to constantly come up with extra cash in order to meet your outgoings. If you follow a negative gearing strategy (where you will have to contribute some of your funds), the expansion of your portfolio will be limited by the amount of extra cash that you can raise (to meet additional expenses). Funds generated from a positive cash flow property can be directed as extra mortgage payments or an offset account. This should lead to increased equity in the property. This can be used to expand your property portfolio. The main disadvantage to a positive cash flow strategy is that properties that lend themselves to this approach are often not stellar performers when it comes to long term capital growth. This is because many positive cash flow properties are located in smaller markets (e.g. regional centres). Therefore, choosing a positive cash flow strategy could often mean that you will have to make the trade-off between a regular income and long term capital growth. 13 Strategy Insights into Positive Cash Flow Property Why a positive cash flow strategy can make sense in certain market conditions The convergence of several factors means that a positive cash flow strategy may make sense under some market conditions. These factors are: Low interest rates - Low interest rates mean that financing costs are low. This lowering of costs obviously increases the likelihood of a property being cash flow positive. This situation can be locked in for a few years by choosing an appropriate fixed rate mortgage. Strong rental demand - Rental demand in most of Australia s urban centres is strong. With increased demand come increased rents and, again, the possibility of a positive cash flow. Slow property market - If property prices are stagnating a positive cash flow strategy may be appropriate. All of the above means that market conditions can be a factor in considering such a strategy. Some investors on variable rate mortgages may even find that they are moving into positive territory without even actively pursuing a positive cash flow strategy. Financial education for all Australians 8

10 13 Strategy Insights into Positive Cash Flow Property Finding positive cash flow properties There are many investors who are actively looking for properties with positive cash flow potential. Therefore, you should not assume that such properties will simply fall into your lap, should you decide to follow this strategy. It will, instead, be necessary to do a bit of solid research into the best opportunities. Some possible routes toward positive territory include the following: Analyse your present position - Before think about purchasing an individual property you should have clarity about your overall financial position, your risk profile, your tax position and how comfortable you are with debt. Thinking a bit about these issues, and getting appropriate financial and tax advice where necessary, will help you to enter the market with a much better idea of what you should be looking for as well as the level of debt with which you would be comfortable. Do your homework - It is likely that it will take quite a bit of research in order to find the right positive cash flow property for your circumstances. The following suggestions should help you with the research process: Take care to investigate the property statistics for the area(s) that you are interested in (your state s Real Estate Institute should be able to provide this information). Pay specific attention to the average rental returns for different areas. The higher the better of course! The internet is a fantastic resource for doing property research. You can use property listing websites to get a firm indication of both asking prices and possible rental returns. You can also do a great deal of field work (e.g. checking out infrastructure, transport links etc.) by using a mapping service like Google Earth. Seek out property managers. The average property manager in the area that you are targeting will be dealing with landlords and tenants on a daily basis and should be a goldmine of information on issues like rental demand and average rents. Once you have zoned in on a specific area, it would be a good idea to talk to a number of real estate agents who specialise in that area. This should greatly improve your understanding of local issues and developments that could have an impact on the property market you are interested in (e.g. a new university campus that is in the pipeline). Target a specific tenant profile - It is extremely important that you do your best to understand the profile of the demographic group that would benefit the most from the kind of property that you are considering. You should therefore do some research on your ideal tenant (e.g. what do they look for in a property? What kind of transport do they use?) This kind of research can be done by monitoring the media and also by having discussions with estate agents, property managers and other investors. Having this information at hand 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 - A renovation leading to a more functional and cosmetically appealing property and could the only difference between yours and similar properties. This could also be sufficient reason to charge a higher level of rent that will move you into positive cash flow territory. Consider specific demographics/ occupational demands - It is possible to significantly increase your rental income by offering accommodation suited to specific niche populations (e.g. furnished apartments for urban professionals and separate rooms for students). It is quite likely that this kind of targeted approach will be more labour intensive but the possible pay-off should make it worthwhile. Financial education for all Australians 9

11 Conclusion Tailoring your investment strategies to make the most of the market conditions that come with these times would make perfect sense and will also place your property portfolio on the path to future growth. Choosing a positive cash flow strategy is one way of achieving these goals and we would encourage you to investigate the benefits and opportunities associated with this strategy. It is our sincere hope that this guide served as an informative and helpful introduction to the subject. We hope that the information presented in this ebook gets you thinking about some of the issues that you will have to pay attention to in planning your next steps and more importantly your financial future. It would be impossible, however, to present a complete guide to all your financial planning needs in a document as brief as this. We urge you to continue your explorations by making use of some of the other resources and ebooks available on wealthadvsier.com.au. We also invite you to meet with us for an obligation free introductory meeting. Details of all our national offices are at the back of this ebook. 13 Strategy Insights into Positive Cash Flow Property Financial education for all Australians 10

12 Readers Notes 13 Strategy Insights into Positive Cash Flow Property Financial education for all Australians 11

13 Readers Notes 13 Strategy Insights into Positive Cash Flow Property Financial education for all Australians 12

14 13 Strategy Insights into Positive Cash Flow Property The Value of Financial Advice Professional financial advice is one of the most valuable services you can engage in. It is a must for anyone serious about improving their chances of achieving financial independence. Financial Independence is a point in life when you are no longer dependent on work, government or family for your income. It is a point where you are generally debt free and have sufficient investments and income to look after yourself. A Financial Adviser is a professional who brings together a wide array of skills, experience and disciplines to develop and execute a financial strategy to help clients achieve their goals and objectives on their journey towards financial independence. A Financial Plan is a written document that articulates your goals and outlines a steady path towards your financial independence. A financial plan may address this by assisting you to: protect your family plan for retirement secure your house monitor your saving and spending determine the right combination of assets meet your investment goals legally reduce your tax achieve peace of mind keep you on track. At Spring Financial Group our mission is to bring a fresh approach to financial services in Australia. Please contact Spring Financial Group to organise an initial obligation-free meeting to see how you can take a positive step towards a written financial plan for your future. To Make an Appointment please click on this link or go to either of our websites: The steps are: An initial obligation-free meeting 2. A thorough investigation of your personal circumstances, goals and objectives 3. A review of strategy and options by our Advisory Panel, including: Finance Tax & Accounting Superannuation Equities & Securities Property Estate Panning Risk Management 4. Preparation and presentation of a financial plan to suit your individual circumstances 5. Implementation of your Financial Plan 6. Review of your Financial Plan. Financial education for all Australians 13

15 13 Strategy Insights into Positive Cash Flow Property What makes Spring Financial Group different? Wealth Adviser is the educational division of Spring Financial Group, a publicly listed full financial services organisation that operates its own Australian Financial Services License. Spring Financial Group is not owned by a bank or large institution that dictate products and strategies for our clients, allowing us to offer services that best suit your requirements and circumstances. Our advisers are educated and experienced in Financial Planning, specialising in advanced investment strategies for wealth accumulators. We are unique in that we also provide deep expertise in sourcing and investing in direct residential investment property - so you will not be offered managed funds as the only investment solution. We provide a balanced approach to investing between property and shares; plus considerable expertise in Self-Managed Superannuation Funds and wealth creation. We are a fully integrated firm; consisting of: Spring FG Wealth - Financial Planning Spring FG Accounting - Accounting and tax Spring FG Finance - Mortgage broking and structuring advice Spring FG Realty - Investment Property advice Spring Equities - Shares and trading advice Wealth Adviser - free financial educational ebooks. We operate a primarily fee-for-service based advice model. Let us help you to meet your financial goals and objectives by contacting one of our experienced Advisers or send an to: info@springfg.com Financial education for all Australians 14

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