All who invest in real estate should do so to produce a capital gain… in my opinion, anyway! As different properties will perform differently and we all possess uniquely different situations, that must be considered before we can responsibly invest, it is imperative to understand “The Long Term Impact Of Negative Vs. Positive Geared Property!”

• Rental income from property forms part of your taxable income in the year it is earned.
• Rental property expenses; such as mortgage interest, property manager’s fees, rates & body corporate fees, repairs &  maintenance and so on, become cash deductions in that tax year.
• A positively geared property is one where combined total expenses are less than the rental income the property earns.
• Where rental income falls short of the total expenses associated with the property, that property is negatively geared.
• It is this ‘loss’ that reduces a person’s tax liability.
• Depreciation is referred to as a non-cash deduction. While is not paid from your cash flow you still get the benefit from a reduced tax obligation.
• Where a property’s rental income plus the tax savings an investor receives total more than the combined property expenses… the property is cash flow positive.
• That means you can have a negatively geared property with negative cash flow… or a negatively geared property with positive cash flow.

At mrd we believe a property investor’s primary goal or objective ought to be the pursuit of capital growth; subject to that individual’s ability to afford to hold the property with negative cash flow.

Today I will demonstrate for you specific examples of each…

Both rental income and depreciation are a means to an end; i.e. they assist you to afford the “capital-growth-friendly” property. While tax benefits are a bonus, they ought not be the reason we invest in real estate.

The Challenge:

The challenge has been sourcing positively geared properties; or at least negatively geared but with positive cash flow, that will perform well from a capital growth perspective.

Let’s Dig Deep And Look At An Example:

• Two investors and two properties; each property costing $400,000
• One investor earns $100,000 and the other earns $50,000 per annum
• One property is considered better for capital growth (Property A), but with negative cash flow; the other is positively geared (Property B)

QUESTION: Which would you be more likely to buy?

Property A

• Due to its location, Property A is a well positioned apartment, close to ongoing infrastructure spending and services
• It is expected to double (on average) about every 7 years; or 10% growth per annum
• It attracts a gross rental income of $400 a week
• In this example the property will cost someone on $100,000 about $3 a week to hold and for someone on a $50,000 taxable income, about $36 a week
• The person on $100,000 would have the property become cash flow positive (after tax) in year 2 and the person earning $50,000 in year 5

Property B

• Property B is a big house with a huge backyard. It is located on the fringe of a regional town in a new estate that has recently opened up
• It too is expected to double in value, although on an average of every 10 years, or 7.2% growth per annum
• It attracts a gross rental income of $600 a week, pre tax
• Using the same incomes; the person on $100,000 would be $103 a week better off (after tax & expenses) than he would have been with the capital growth property (Property A) and the person on $50,000, $120 a week better off

A Helpful “Rule Of Thumb”:

• There is a general rule of thumb in real estate investment that says you should expect a total of 15% return when you add the rate of capital growth to the gross rental return.
• 7 years to double (or 10% per annum) is likely to deliver an initial gross rental yield of about 5% (or $400 a week)
• 10 years to double (or 7.2% per annum) should offer a higher rental yield of 7.8% (or $600 a week)

Extrapolating These Figures Out Over A 7 Year Period:

If our property doubled in value over 7 years (i.e. Property A), then the capital gain would be $400,000 over 7 years. This equates to an average of $1,100 each and every one of those 364 weeks (52 weeks x 7 years)

WOW, both the person on $100,000 and the person on $50,000 are effectively advancing their wealth base by an average of $1,100 a week (realised over a full doubling cycle)

Suddenly the out of pocket expenses (the $3 or the $36 a week) are “inconsequential” when compared with the outcome. NB: Except where a person simply cannot afford to be out of pocket at all

Now… what if these two income earners went to a seminar or read a book that heavily promoted Positively Geared Property… or promoted house and land packages in regional areas where the rental returns are massive (such as with our example of Property B, above)

The $400,000 regional property with the higher rent and less capital appreciation will average just $770 a week over 7 years… to be worth $680,000

That’s an increase of $280,000 in the same time that Property A grew by the full $400,000

Add to that the additional income each week along the way:

1. $103/week x 52 wks x 7 years = $37,500 in additional net income (i.e. after tax etc)
2. $120/week x 52 wks x 7 years = $43,700 in additional net income (i.e. after tax etc)

Comparing Apples With Apples:

That means over the same 7 years it took Property A to double in value; Property B produced $280,000 in capital gain plus the additional net cash flow of $37,500 (for someone on $100,000) = $317,500

Divide this by 364 weeks (i.e. 52 weeks x 7 years) = $872 each week

Now compare this with Property A, which over the same timeframe added $1,100 a week to your bottom line and you can see how the higher yielding property does not better serve your objectives over the longer timeframe

This example is just over 7 years. If we doubled it and calculated the numbers over 14 years the difference would be more than double; due to the compounding effect of growth

We encourage people to buy & hold, not trade or speculate. The numbers here should help you to understand why

The difference between a property with an average 7 year doubling cycle to that of one with 10 years is staggering

The “WRONG” Type Of Investment Property Is Often Promoted:

It is my opinion that all too often companies and individuals promote the wrong type of investment property! I agree that property with positive cash flow is easier to sell… as are house and land packages in new residential estates. People just think land equals capital gain. If that were the case, however, we should all be buying farms!

I am not against investing in houses, nor am I against investing out in the suburbs… anything is better than doing nothing. There are times when a person’s unique financial position makes a property with less growth and more cash return the best choice for that person. This all serves as further evidence that you need to have the proper analysis completed ahead of you making any investment decision. It is “horses for courses” and “one size does not fit all”.

Where It Is Appropriate And Financially Responsible To Do So, Go For Growth!

Our Customer Care Program will work for you… because we understand that investing is personal. As I mentioned, it’s horses for courses… one size does not fit all. People have different incomes, numbers of dependants, commitments, risk aversion levels and so on. Our goal is to help you achieve your desired outcomes, always mindful of your unique set of circumstances.

Most of the investors and would-be investors that I speak with do not comprehend the numbers I have explained in this article. I know this because I have observed the decisions they make.

I can offer my thoughts and opinions, but not financial advice. I can only do that in a ‘one on one’ situation. Before making any investment purchase decision please carefully assess your total budgetary position and take advice from someone qualified and able to assist you; ideally someone who has already done what you want to do.

Assessing the impact an investment will have on your cash flow is as important as picking the right location and the right property type. Anything less is really just a guessing game.

Finance Structure and Cash Flow Health Check:

We have assisted many people to better structure their financial arrangements, save interest and pay off their homes quicker. If you would like us to prepare a complimentary Finance Structure and Cash Flow Health Check send your request, along with your best contact time to us.

Click here

Happy Investing,

Nick Lockhart
mrd Customer Care Program… because investing is personal

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