Could a positive cashflow property be the right strategy for me?

Hello Everyone,

I am thinking about venturing into property investment in Australia and I am confused about what property investment strategy to adopt. I am a 30 Y.O single male and make 80K from my day job. I have 360K owing on my PPOR in Melbourne (townhouse) that I bought 2 years ago and have it 100% offset (inheritance). I also have a property in development stage overseas which should come online in 3-4 years. There are no loans on this so it will be CF+ when ready and rented. The reason I am thinking about entering the property market is to diversify from Stocks and other asset classes and to create an additional source of income (in the near future) and for later part of my life.

The advise I have gotten so far is to pay down my PPOR debt and use the equity to buy my 1st IP in a growth area (I can only borrow upto $325K). This property would be negatively geared and I would be around $800 out of pocket per month after all deductions etc. I will use the equity built up in my property after 2-3 years to buy my next one. I will own around 2-3 properties in total by this strategy. Is this a sound strategy?

Or should I, look for a cashflow positive property and use the cashflow generated + equity growth + part of my cash in offset to fund my next CF+ property and aquire more of such properties. I am in my PPOR in the near short term, but its not necessarily my forever home, so I can turn it into an IP and move for work interstate or overseas if needed. Thus I am not paying my PPOR off.

Any comments are highly appreciated as I am really confused about what to do. Thanks.

 

Gday @ad1t welcome. You will get loads of opinions here but first and foremost the answer to your question depends on your goals. What is property supposed to do for you? In what timeframe? Map out your desired future (I know we don't have a crystal ball but just what you would like to see pan out) and look at how you are using your time, what kind of income you are generating and how and when you want to live off a property portfolio. This will make the desired portfolio clearer - map out an ideal end scenario, then work backwards and divide the goals up into years etc. Have fun with it!

 

It is a really tough question and one that is hard to predict but you can do some scenario modelling to help work out where your risk profile lies.

You are looking at 2 very general ideas and the reality is that it will come down to individual sites as to which one might work for you. There are members on here which use both strategies to balance each other so there might be no single right answer for you.

Generally cash flow positive properties are usually hampered in their capital growth prospects. This is a big generalisation and one to take with a grain of salt.

Cashflow examples :
1. a regional cheapie might be good for cashflow but sh1thouse for capital growth
2. a house with granny flat in metropolitan suburbs good cash flow and more likely to have CG as not regional
3. inner city dwelling that is air bnb
4. dwelling near university that can be rented out by the room

All are very very different from each other and each have different risk profiles

If the aim of IP #1 is to generate funds to purchase IP #2 then you weigh up
1. how much actual cash a CF property can produce and how long will that take to add up to a deposit for #2
2. how much growth could a CG property produce and how long will that take to add up to a deposit for #2

 

@ad1t, in answer to your question, No

 

Hi Rolf,

I have used a property investment advisory service. Based on the end goals that i gave them (retiring at my current income level from my portfolio by the time I am 60), this was their recommendation.

 

Thanks for the response and the kind welcome BuyersAgent. My main goal to model the portfolio was retiring at my current income level from my portfolio by the time I am 60. After the model came out and seeing the negative cashflow for a prolonged period of time, I started wondering if i should change it to a positive cashflow strategy. Further reading about positive vs negative was just more confusing and I thought I will see what most investors think on this forum. I will keep studying this further and hopefully can get the clear picture for my property investment journey. I am excited to begin this new chapter.

 

were they recommending a new property?

 

Thank you for the examples and scenario Wesminster. This will definitely help me find my answer

 

No. I just paid for the independent strategy advice. Their recommendation at this stage is just based on target rental yield and growth in order to meet my end goal.

 

think about rents over time. They are whatever the market dictates today. Over time the market/demographics/demand/supply etc plus inflation pushes rents up. Most negatively geared properties become positive eventually. the question for every individual investor is when. How big of a weekly loss and for how many years can you handle to obtain a percieved or estimated gain? Capital gains are also subject to market forces and are (in my view) a lower risk bet than the casino but still speculation. The best rule of thumb I use is to look at your goals pick properties that fit them (ie short term gain for sale if you need money or want to pay off non deductible debt, long term cash flow, immediate cash flow etc are others) and then choose properties fitting your criteria in markets where the supply and demand equation is stacked in your favour.

 

Thanks Kierank. Any main reason that it's no?

 

Thanks heaps BuyersAgent. I will definitely consider these points.

 

good.

80k in 30 yrs should be very achievable with the start you have made. If you had 4 properties netting 20k each this would hit the target. Or more cheaper ones or fewer blue chips. How you get there is up to you, many of my clients do a bit of cash flow, a bit of renovations/small development and a bit of holding through cycles to generate equity over time. You have a lot of time so definitely learn about acceleration strategies don't just buy something new off the plan or off the shelf you will probably pay too much and slow the plan down.

 

Thanks.

 

You are 30 and you have a 30 year investment time horizon.

IMHO, you will be better off buying IPs with 6% growth/3% yield than IPs with 6% yield/3% growth. Put the numbers in Excel and look at the outcome at 25 years and 30 years. You may be surprised.

My strategy was/is:

1. Always to buy property for growth with as much land as possible and never sell (hence, in trusts). I love property because of leverage (our LVR is 46% of our property portfolio and we are retired). I never bought property for income.

2. Buy shares (domestic and international), initially for growth but transition focus to income/dividends when in retirement. As these shares were going to fund our retirement, we bought them in a SMSF for protection and only ever used cash. I don't believe in borrowing in Super; hence I would never buy property in a SMSF. I know this is conservative but ...

3. Keep sufficient funds in cash to keep the wolves away from the door, no matter what **** happens in the world. I know this is conservative but ... All our cash is in Offset accounts so, in my eyes, we are getting 4+% after tax on these funds.

This has been our strategy for 25+ years. I am not saying it will work for you but it has worked for us.

I note with interest that some on PC are now selling down their property portfolios to fund their retirement as they have realised that net income from IPs is not great.

We are self-funded retirees (have been for 7 years), the 4% mandatory pension more than covers our living and travel needs, we are still buying property if a great deal comes our way (settled on one last month and another in April 2016, both negatively geared and the shortfall covered by our excess pension).

But you need to work out what is right for you and you are the only one that can do that. Others like me can give you our 2c worth but only you know your life .

 

I would have thought that if you paid down the PPOR in full, your borrowing capacity may well be quite a bit more than 325K. Although you aren't making any repayments at the moment because of the offset balance, from a borrowing capacity perspective lenders will still consider that you owe 325K of non income producing, non deductible debt, and that has a real impact on your borrowing capacity. By moving the money out of the offset and instead using it to repay the PPOR debt in full, lenders will consider you to owe $0 ... and that's where the borrowing capacity improvement comes from.

Using 8 x income as a rough guide for borrowing capacity, under the circumstances noted above you may well then be able to borrow 650K or thereabouts... although you would need to have a broker confirm that before getting too excited.

Let's assume for a moment that 650K or thereabouts was possible, you could then draw equity from the unencumbered PPOR to fund deposits + stamp duty + a little bit of cash buffer for possibly 2 x 300K(ish) purchases . Unlike using the funds from your offset, if you were to use this approach the deposits would be deductible as the funds would be for investment use. So you'd have maximised your borrowing power and you'd have maximised the tax effectiveness of your loan structure using this approach.

If you then chose to purchase 2 x CF+ properties, the surplus funds from the properties could be used to make extra repayments against the 2 splits secured by your PPOR, in order to pay down the PPOR splits as quickly as possible, returning you to a position where the PPOR was unencumbered again within a few years...

And it's possible that in a few years time, having paid down the INV splits secured by your PPOR, and with some wage inflation and rental inflation, your borrowing capacity may allow for another purchase at that time... if that played out that way, you could then use the 3 x surplus incomes ( from the 3 x CF+ INV properties) to pay down the 1 x INV split against your PPOR quite quickly, returning your PPOR to unencumbered once again.

You have to consider the new credit environment very carefully. Take your own case as a great example. 325K of debt ( yes, I know its offset but its still considered 325K of debt) and an 80K income means you can only borrow 325K now... pre APRA you may well have been able to borrow $1 Million or thereabouts to use towards INV purchases. You arent the only one in this situation. Consider how many other median income earners will face the same limited borrowing capacity moving forward. Consider how many future borowers are median income earners... I would suggest the majority are. Then consider just how much growth anyone can reasonably expect under such circumstances if most current and future borrowers simply cant borrow the amounts they used to. Under those circumstances can price cycles from the past be repeated? Can the assumed growth being discussed by others on this thread be relied upon to occur? Is an assumption of 6 or 7 or 8% compounding growth really very realistic? No one really knows, but the borrowing capacity changes make it difficult to see those sorts of results happening. One might even say the lending changes make it almost impossible mathematically simply because the debt to income multiples have been halved for most borrowers. And then consider whether even if you got that level of growth, can you manage the holding costs based on 3 or 4 % yields, when the loans revert to P&I?

These are all the things to consider.... but its why I believe a dividend reinvestment approach , where you purchase cash cows and reinvest the surplus towards debt reduction , will serve median income earners very well moving forward.

With a 30 year time frame to work with, the power of compounding dividend reinvestment could be very powerful for you and could see you own several properties outright before retirement, with a healthy passive income generated. It's not fast. Its not glamorous. Its not sexy...but it is effective.

 

I don't completely understand the question. Do you mean what % target yield and growth assumptions? For IP1 in 2018 5% growth 5.5% yield. Overseas property coming online in 3-4 years. IP2 in 2021 5.5% growth and 5% yield

 

Hope it wasnt too much......
A few weeks on Property Chat educating yourself (with your own goals in mind) may have yeilded better results

In part i agree with the above posts
The idea is to pay down your PPOR as this is non deductable funds.
Where as an Investment Property is a deductible expenditure.
So for most people it is a juggling act, pay down your PPOR as quickly as you can and use the equity to buy an IP, unfortunately it is rare to purchase a cash flow + IP, so the purchasing and ongoing costs can stall your repayments on your PPOR for a year or several

IMO the sooner you buy an IP the better, as then you will have two property's growing for you (if purchased well)(or it is like saving a deposit, the longer it takes the more you need)

Due Diligence is what it all come down to