Definition of positively geared

Discussion in 'Investment Strategy' started by Mogul, 8th Dec, 2017.

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  1. Mogul

    Mogul Active Member

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    What is the general consensus in working out if a property purchase is positively geared?

    Is it based on 80% LVR home loan IO costs + all ongoing ( water/rates etc) = cash flow positive?

    Because with a 50% deposit, and a low interest rate, practically any property can be positively geared..even a bad purchase..

    The property I am looking at will put $65 in my pocket per month based on 80% LVR @ IO 4.19% interest rate...after all costs.. does this mean its a good buy?
     
  2. neK

    neK Well-Known Member

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    Rental income > expenses + Interest x (purchase price + stamp duty + legal + Reno)
     
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  3. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    Positive geared is when after all the financials related to the property are considered, you have to pay some tax on the ongoing income.

    Putting down a large cash deposit is one way of helping a property becoming positive geared.
     
    Last edited: 8th Dec, 2017
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  4. neK

    neK Well-Known Member

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    Exactly. So it really comes down how much you want to fool yourself and others
     
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  5. Sackie

    Sackie Well-Known Member

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    There are a few factors which constitute a good buy. Rental yield is one consideration but its certainty not the only one and many people fall into the '$10 profit a week' trap, and then miss out on 10s or 100s of thousands in CG over the next cycle. I've seen people do it just this last Sydney cycle. When they calculate how much they lost... its very painful.
     
    Last edited: 8th Dec, 2017
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  6. Trainee

    Trainee Well-Known Member

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    If it doesnt go up in price, can you retire on $65a month?
     
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  7. Anthony Brew

    Anthony Brew Well-Known Member

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    Positively geared does not equal cash flow positive.
    ______________________________

    1. Gearing (this is not what you are looking for I believe)

    Firstly figure out the gross rental income.
    Then take off about 30% for costs

    or calculate each of these and subtract it
    - repairs & maintenance
    - vacancy period
    - council rates
    - water rates
    - strata cost
    - ongoing property management cost
    - advertising cost
    - cleaning cost
    - letting fee
    - building insurance
    - landlord insurance

    You are left with net yield.

    Some say to compare this to the loan repayments. So
    If this covers the loan, it is positively geared.
    If it is short, it is negatively geared.

    Others say to compare this to the loan repayments on the cost of borrowing 100% of the purchase, and I would agree with this.
    ______________________________

    2. Cash flow (I believe this is what you are after)

    Do the same above, but
    1. Only account for the money you borrow, not 100% of the price; and
    2. Account for tax and depreciation

    If the gearing is positive from part 1, then you already have a CF+ property (even more after depreciation).
    If the gearing is negative, reduce your negative cash flow by your marginal tax rate, and then add on depreciation.

    A property can be negatively geared but positive cash flow if it has depreciation benefits that cover the net yield after accounting for the tax deduction at your marginal tax rate.
    ______________________________

    If you have correctly accounted for all costs and you have a surplus cash flow at 80% borrowing, I think this is pretty good regarding the cash flow part of selecting a property.

    However, the actual location and property are far more important.
    I would rather have a property that loses 3k/year in cash flow (reducing 0.5k/yr as rent increases over time) and that goes up in value 30k/yr because it is a sought after location than a property that gains 1k/yr in cash flow and goes up in value only $15k/yr.
    Point is - be careful not to ignore the importance of capital gains when look at the cash flow.
     
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  8. euro73

    euro73 Well-Known Member Business Member

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    Also be careful not to assume previous growth cycles will be repeated in the future. Every growth cycle talked about on these forums occurred in an expansionary credit environment. We are now in a regulated credit environment . Its unlikely old cycles will repeat themselves. Its more likely new cycles will evolve. ie - they will happen slower. Potentially much slower.

    So also be very careful to consider your ability to hold the asset while you wait for the fabled pot of capital growth at the end of the rainbow. If it doesnt come in 6,7,8 years...but instead takes 13,14,15 years... can you hold?

    And even if you can, will that mean every spare dollar going towards holding rather than paying down your PPOR mortgage?

    If you dissect such an approach, it is clearly a strategy that places an awful lot of faith in the assumption that previous cycles will repeat... because it relies on growth alone to work - which seems a risky assumption when we KNOW everyone's borrowing power has been reduced and we KNOW borrowing power has a direct impact on peoples ability to pay higher prices.

    Now, provided you can afford the holding costs at P&I repayment levels, thats all good. You can take that punt. But for many ( well, most I would argue) especially those starting out with sizeable debt, and even more especially those with non deductible debt and who want to be able to add and hold multiple properties, cash flow considerations simply have to become more critical for 2 reasons

    1. the ability to retire non deductible debt more aggressively during the I/O term, building you a buffer. It may not be huge, but owing less on your PPOR is owing less on your PPOR...
    2. the ability to hold the INV property when P&I repayments arrive. Having CF+ doesnt insulate you against P&I, but it does dramatically improve your chances of holding if you have less PPOR debt and if you have less of a gap to cover on the investment debt. For example, holding a 4% yielding property if rates are 6% or 7% P&I and you havent paid down any PPOR debt is harder than holding a 6% yielding property if rates are 6% or 7% P&I where you've paid off some PPOR P&I debt...

    In a nutshell; because cycles are likely to take longer to evolve now, you will need to hold for longer. And this almost guarantees you will have to hold under P&I conditions at some point. Consider whether extra yield helps or hinders that situation. It doesnt mean go and buy anything thats CF+... but it does mean that you need to account for more than a model that just "assumes" growth... what's plan B if the growth doesnt come ?

    Too many posters on these forums still imply through their comments that growth will just keep coming. They ( more often than not) just arent getting the seriousness of the APRA servicing calc changes... so they continue to argue that the same cake can still be baked using different ingredients. It cant. So we come full circle to the question... what if growth doesnt come as fast as it has in past cycles , or doesnt come at all? How will you hold under those circumstances?

    All Im saying is... cash flow redirected for debt reduction has real value both offensively ( during the I/O years) and defensively ( later during the P&I years) and is something to think about...
     
    Last edited: 9th Dec, 2017
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  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    No it doesn't mean it is a good buy. That is something separate to consider.
    What about the other 25% you haven't factors in.
     
  10. DaveM

    DaveM Well-Known Member

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    You wont retire or pay down PPOR debt on $65 a month, you need capital growth. Dont focus on cashflow to the detriment of all else, its a myopic view. If you are negative cashflow of $3k pa but picking up 50-100k on the growth side, calculate your ROI on that.
     
  11. Beano

    Beano Well-Known Member

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    I would say option one is positively geared
    I would also include an allowance for carpet replacement, bathroom/kitchen refurbishment and any cost to maintain the rental.
     
  12. MTR

    MTR Well-Known Member

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    You may find this interesting??

    Grow Capital First

    If you can create cash flow and capital then you have found the gravy train, there are ways but it will require more active investing.

    The best yield to date that I worked on in Australia was a deal in Tassie/Hobart at 6.38% but this was gross yield not net.... massive difference. I would take 30% off calcs
    Only looked at Tassie because it is currently experiencing best growth in Australia.

    I did not buy in Tassie/Hobart only cos I can get better results in US, have growth and cash flow. Not saying you should what I do, just saying with more research you can work through the process.

    It could even be an add value exercise ie develop at rear.... Looks like you have a nice chunk of cash.
    Don't rush, easiest options are not necessarily going to be the best long term.....take your time, $65 wont cut it. I don't think managed apart or shares are the answer in this market?? just my opinion

    Dig deeper, research posts on PC, start chasing different deals, get outside the comfort zone. Everyone hits the wall at one time or another, means you need to tweak your strategy.

    MTR:)
     
  13. kierank

    kierank Well-Known Member

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    Is this before or after tax? I will assume before.

    As a matter of principle, I would rather buy an IP that takes $65 out of my pocket per month (and get a tax refund) than buy an IP that puts $65 in my pocket per month (and increase my income tax).

    Also, I would rather buy an IP that gives me capital growth of $65 per month (tax free until/if I sell) than buy an IP that puts $65 in my pocket per month (and increase my income tax).

    Others are bound to disagree but that’s OK as there is no one way to cook this Xmas cake :D.
     
  14. FrivolousPanda

    FrivolousPanda Well-Known Member

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    I'd like to understand how this could be good. Given 2 assets which have the same capital growth, why would one prefer to have a $65 loss to get less than $65 back in a tax refund compare to getting $65 and paying less than $65 in taxes.
     
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  15. kierank

    kierank Well-Known Member

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    They wouldn’t have the same growth. Which is better:

    A. 6% growth, 3% income OR
    B. 3% growth, 6% income

    I prefer A; I wouldn’t buy B.
     
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  16. bob shovel

    bob shovel Well-Known Member

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    It's all about mindset. Be positive and then rake in the goodness ;) ie rent
     
  17. FrivolousPanda

    FrivolousPanda Well-Known Member

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    This I follow. Your statement didn't include assets having different growth rates which is critical.

    Also I agree with you there are significant benefits with tax to growth the portfolio value and personally think it's the best approach for me. However one limitation is the person needs to have sufficient cash flow to hold the asset if the asset creates a negative cash flow so the investor may have no other choice.
     
  18. Trainee

    Trainee Well-Known Member

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    If the person has so little spare cashflow, maybe property isnt for them.
     
  19. Beano

    Beano Well-Known Member

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    How can you tell in advance what the capital gain will be ?
    I have brought many properties ...all positive cash flow ...and cannot figure which will perform the best in the future
    Some of my highest yielding properties have had the best CG
    While some of lowest yields have also had the lowest CG
     
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  20. kierank

    kierank Well-Known Member

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    I have always used businesses to generate cashflow. I accept whatever income I can get from IPs but would never build a strategy where this income was the foundation.

    Owning businesses gives one a far stronger foundation.
     
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