Many investors prefer a negative gearing strategy when purchasing an investment property. While this approach can offer short-term tax benefits*, it can reduce an investor’s ability to purchase more properties in the future. Is there another way to grow a portfolio, faster?
Building an investment property portfolio is a great way to grow your wealth. Accumulating a series of properties over your working career can provide both the foundation for an exciting retirement and some useful tax advantages*.
One of those tax advantages occurs when a property’s rental income fails to meet its operating expenses (mortgage repayments, management fees, insurances, etc.), requiring the investor (that’s you) to contribute funds to cover the shortfall.
This is called ‘negative gearing’ and is a strategy used by many Australian investors. While it can provide some relatively short-term tax savings*, there are also some disadvantages:
- You, the investor, must fork out each month to keep the property running. If you have a healthy disposable income, this can be a viable model. However if your circumstances change and you can no longer afford to contribute necessary funds, you might end up in trouble.
- Your future borrowing capacity may be reduced if lenders perceive your existing investment property payments as a liability. In other words, having to contribute each month to keep your investment(s) running may reduce your ability to secure future mortgage(s). Naturally, banks don’t want you to overborrow (and they are guided by strict lending regulations, too).
This means that, in some investment property portfolios where negative gearing is occurring, growing your portfolio can take longer because your borrowing capacity is limited. This ‘glass lending ceiling’ model gets quite a few property investors in a bind, and it’s not surprising that most Australian investors only ever acquire one property. Luckily, there is another way.
What’s passive income?
Passive income can be defined as ‘receiving a regular income from an investment, business, or property in which you are not actively involved’. You buy an asset, such as residential real estate or some stocks or bonds, which provides regular cashflow and capital growth. Passive income is a great way to fund a more relaxed lifestyle. You can enjoy more income, while physically working less.
The question is, how can a property, or a property portfolio create passive income? Of course, a very mature property portfolio with low or no gearing (ie. You have paid off most or all of the loans) will provide passive income from incoming rent. However, there are other ways a newer portfolio can provide passive income. One of these ways is called “cashflow positive” property investing.
What is a “cashflow positive” property?
In very simple terms, a cashflow positive property provides regular income to an investor because the property’s operating costs (mortgage repayments, management fees, insurance, etc.) are LESS than its rental income and tax deductions. The investor is NOT required to inject funds each month because there is no loss created by operating costs that exceed rental income and deductions. Instead, any money remaining after tax calculations etc. is passive income for the investor.
Benefits of cashflow positive property
This exciting model provides investors with a regular income while:
- Holding the property for no cost, and
- The property appreciates in value, adding to the investor’s wealth.
The surplus income created by cashflow positive properties can be used to buy more properties (to grow your portfolio) or other investments. Or converted into discretionary income for life’s pleasures.
The difference between cashflow positive property and positively geared property
It’s important to note the difference between cashflow positive property and positively geared property.
Whilst they are very similar, positively geared property occurs when the property’s operating costs (mortgage repayments, management fees, insurance, etc.) are LESS than its rental income only. Positively geared property doesn’t take into account any tax implications, whereas cashflow positive property considers tax in its calculations.
Are cashflow positive properties hard to locate?
The ingredients for a cashflow positive property can be difficult to create. You’ll probably need a significant up-front deposit coupled with low interest rates and a high rental yield to make the equation work in your favour. However, all investment properties (and investors) are different, so speak to us about the best strategy for your unique situation.
A few final notes
- Try and avoid sacrificing future capital gains in exchange for short-term positive cashflow. Capital gains are probably going to drive a significant portion of your future wealth creation. A great property has both elements interwoven together.
- Always do your own due diligence. Sometimes off-the-plan properties marketed as ‘cashflow positive’ will only provide passive income for a short period of time (during rent guarantees or via other rebates). Make sure you conduct your own calculations, with the help of a professional, to ensure that your property will remain cashflow positive.
- Seek professional advice before proceeding with any investment strategy (including this one).
Can We Help With Your Property Journey?
Of course, you don’t need to research, plan and execute these strategies. That’s what we’re here for. If you’re looking for an expert team to help with your property investment journey, request a Free 30-Minute Finance Strategy Session during which you will…
- Gain greater clarity over where you want to be in terms of owning investment properties (and how to structure your loans to get there the fastest, safest way)
- Discover how to unlock the equity in your current properties, so you can build your portfolio – and your wealth – faster (and enjoy a better lifestyle now and in retirement)
- Discover clever, no-cost ways to save money on interest, fees, and charges — immediately
- Get an up-to-date picture of the lending landscape including rates, conditions, and how to structure loans for cashflow positive investors
- Learn about our process to find you a better loan that will save you thousands.
This no-obligation session will be held with one of our experienced mortgage brokers.
Please be assured this will not be a thinly disguised sales presentation. On the contrary, you’ll receive our best strategic advice, specific to your situation, so you too can accumulate multiple properties without sacrificing your current lifestyle and accelerate your progress towards wealth.
*This article is not tax advice. Speak with your accountant for more information.
Please note, the numbers and assumptions listed in this article are for educational purposes only. Individuals should seek specific advice pertaining to their unique situation and the real estate market before making any decisions.
Trilogy Funding Two is a corporate credit representative (Representative Number 506131) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237)