Positive Cash Flow Property - am I getting this right?

Hi All,

So I have two investment properties (previously my PPORs) and am in a position to purchase another investment but first decided I should educate myself properly on property investing (I know something I should have done long ago). I always considered that as long as the property was at least paying the interest/expenses then that was great, and anything that I had to contribute to pay off the principal was fine.

So I am reading the Investment books, forums and analysing my current investments and potentials trying to work out how to move forward…….

Property 1 - almost makes me break even for the loan repayment, but I still have to pay tax on the principal payment so it is costing me. CG has likely peaked.

Property 2 - covers the interest/expenses and about 1/2 of the principal and I am paying the rest out of my own pocket. Unlikely to have any CG.

So both my properties have positively geared, do I understand that correctly?

And as I see it the only way to get actual positive cash flow from my properties is to throw a considerable lump sum now at them so that the rent results in enough remaining cash to cover the tax bill as well. But long term as the depreciation reduces and the tax bill increases it is not sustainable, so then they would have to sell or have the money again coming out of my own pocket (which might be worth the difference considering selling costs). So am I getting this right?

So about my next investment property, if my sydney property which is a low loan with great rent can not even result in cash in my bank, I am not sure how anything else could actually do it these days (that is avoiding risky mining towns)?! So I wonder if people would generally just happy to be paying the holding costs themselves or if this is a big no no??

Thanks for any advice!

 

Hi there

Welcome to the forum and well done on getting 2 IPs already.

An IP is said to be CF+ if after all expenses including interest, rates, strata, insurance etc. you still have money left over in your pocket. Some IPs can be CF+ before tax and some can cost you to hold but the -ve gearing puts you into CF+. Paying a big lump sum to reduce debt isn't considered CF+. You should assume you borrow money for the full purchase and all expenses. Hope that helps and I'm happy to be corrected.

I'm not sure what you mean by paying tax on the principal? Are your loans Principal and Interest? Most investors structure their loans to be Interest Only to manage cashflow better, pay off non-deductible debt first or increase -ve gearing benefits.

 

Principal repayments are not accounted for when calculating whether or not a property is cash flow positive.

It is generally advised to set up your loans as interest only with 100% offset.

Based on my understanding of your post both your properties would be cash flow positive

 

thanks! its correct both properties are not on interest only (both fixed term as they were my PPOR), one is about to come out though so thats another option soon…..I did speak to my bank about it already and I am still confused as to how interest only works if you are keeping the property for long term, I understood it was beneficial for short term holds not long term??

 

I would strongly recommend talking to a mortgage broker near where you live before you do anything further with your bank.

Sounds like the way you have structured your loans is not ideal. Its better to talk to an independent broker rather than going directly to your bank. A broker would consider your specific situation and offer unbiased advise that suits your needs.

 

The 'lum sum' that you may throw at a property to reduce its debt and increase cash flow a little will have a significant opportunity cost of not reinvesting that lump sum into other ips.

What you dont want to do is increase your cash flow by $20 a week but losing 5% growth on another ip you may be able to buy with the lump sum. You will lose a lot this way imo. 5% growth on a 400k ip , you'll be potentially losing $20,000 in growth.

 

I'll reiterate that you would likely be better off to have an interest only loan with an offset account. P&I repayments can use a lot of your cash flow which might be better directed at other things. Furthermore you could be missing out on future tax benefits by paying down the principal. There are times when P&I makes sense for investment lending, but rarely when you're starting out.

Interest only doesn't appear to make much sense in the short term, but consider the long term prospects, say 30 years. Whilst it's hard to say what property values will be in 2045, we do know what they were back in 1985. A property might have cost $40,000 back then and it's worth $1M today. You probably wouldn't care about a loan you took 30 years ago today, but imagine what you could have done in the meantime with the extra cash flow?

Generally a property is considered positive cash flow when all the holding costs (interest, maintenance, rates, management, etc) are less than the income. Personally I don't like to include the tax benefits in the equation but they are valid as well.

Keep in mind that you usually don't see immediate returns from property investment. Yes it is possible that an IP will put some money in your pocket from day 1 but it's extremely rare. People on this and other forums tend to focus on cash flow but frankly very few are actually buying truly cash flow positive property. The real benefit in property investment often occurs years after you purchase it. One day you wake up, realise that not only is the property putting money in your pocket, but it's also increased massively in value.

 

Completely agree.

 

Hi Breeamy, with investment loans on interest only, the costs are tax deductible. In one of these situations it may seem counter-intuitive at first, because it seems like it's a "never never" loan, like it will never be paid off if you're only paying interest. When the property increases in value, you can use that equity (and any extra money from the rent that you have put into the offset) to use for another IP. Then that is also deductible.

 

Okay thanks everyone, so my investment properties are planned to be long term hold properties and I am fine with no positive cash flow in my hand and the small holding for my two current properties, but reanalysed based on interest only loan, if I kept the sydney IP until the term of the loan (300K, 25 years) me paying the tax on the principal payment will end up with 85k out of my pocket, leaving a $215k profit from discharged loan + any further CG. But if I continued interest only for 25 years the full 300k is still owed and I only make 130k in cash flow profit after tax…..so this is why I don't see the benefit to it unless you are planning on not retaining that property for the long term??

Next stop broker…..

 

A really rough way of thinking about it;

Lets say you are paying for property 1 $1,000 - $500 interest and $500 principle (clearly this is not happening). The same thing with property two so total amount being deducted each month is $2,000 and each assets is valued at 500k each (keeping it simple). So today total assest $1M and you have 800k loan (80%LVR).

Lets also pretend a house doubles every 10 years so in 30 years the 500k properties are now worth ~$4M each or total asset is $8M.

If you paid off the loan on each during that time you (and did nothing else) have $8M.

However

If you went out and got another 2 properties today worth 500k (4x 500k) so now you are still paying the same amount per month being 2k per month, however this is all interest only. So today you have $2M in property 1.6M in loans (400k x 4).

Not calculating the tax savings but in 30 years you will have $16M (4x4M) in assets however you will still have your original loan amount of 1.6M so if you sold one of these houses you will have $14.4M.

I would rather have $14.4M than $8M as another 10 years from this point you would be comparing ~$29M to $16M and $58M vs $32M.

Please note I am using only rough examples as i am not calculating rents, tax, deprecation, or stamp duty etc etc and I am not a financial planner.

Your broker will be able to give you a better run down draw what is happening.

 

Good news is if you're paying P&I and fixed period is about to come up, you can most likely restructure things to improve your cashflow, safety and serviceability.

As others have said, talk to a great broker (if you struggle to find someone excellent due to being in a regional centre, there are plenty of excellent brokers here who can work remotely via phone/email/skype etc) and they can help you on your way

Oh and well done for deciding to learn more. You're in the right place and the learning will pay great dividends.

 

Great thanks for the advice everyone, I have a booked appt with a local financial planner and broker this week ….although I am cautious as they probably don't have enough property experience so will let you know how I go!

 

Good stuff. Finance broker should be able to help you a lot if their good. Wouldn't waste my time with the FP though. Some will influence/confuse you with their own 'agenda' if your not careful imo.

 

Hi, a financial planner will be unlikely to help you. A broker would be more useful in explaining loan structured.
I still don't understand what you mean by paying tax on the principal. In your example you state you will pay $85K so I assume you mean that's the amount you would pay down. If you don't pay that down you haven't lost it, if you have interest only and continue to pay the same amount but put the money in the offset it achieves the same result but you have the flexibility to use the money in any way you want.
Do you have a PPOR? If do you would be better off directing the extra money to that mon deductible loan.
This forum is a great place to answer questions as they arise.

 

Let us know how you go with the financial planner. I am willing to wager the advice will be to diversify away from residential property, (all your eggs are in one basket) most likely into managed funds, and to set up some insurance and or SMSF. Nothing wrong with this advice per se, but important to realize this is how a financial planner usually is remunerated.

 

More great advice, after my initial discussion on the phone with the FP this is exactly why I thought they might not be appropriate (mentioned diversifying, SMSF and managed funds)…..will not waste my time then on this one

 

If only the roulette wheel was so easy to predict

 

Yes I meant 85k paying down the principal and tax payable on the cash flow (remember my loans were initially set up as they were my PPOR so principal and interest, and no offset account unfortunately) :-( I don't have another PPOR as I just moved from the one that turned into my second investment and I don't need to look into purchasing PPOR for another 1-2 years so this is why I want to focus on building up my investment portfolio now while I have the chance.

 

If you're looking to buy another PPOR in the future, it's really important that you're structured correctly for tax purposes.
For this reason you need to stop paying P&I and get yourself a loan with an offset, otherwise you'll be throwing away thousands of dollars a year in tax deductions, plus you'll have a much larger non-deductible debt than necessary once you do buy a PPOR.

Find out if your broker understand the tax side - some are great, others a terrible and will cost you a fortune, so maybe ask for recommendations rather than going pot-luck at your local Mortgage choice/Aussie etc, ask lots of questions and make sure they understand how to structure you correctly.