Positive Cash Flow and Positive Geared Property Investment.

Positive Cash Flow describes a property that puts money in your pocket after all costs AND tax deductions, including depreciation, have been taken into account. Here is a simple (hypothetical) example of a personal investment (not SMSF):

• Purchase price: $500,000
• All cash expenses  are $27,000 per year. Cash expenses are those that I pay for with cash flow, like mortgage interest, rates, agent fees etc. 
• The rental income is $480 per week over 50 weeks of the year, or $24,000 per year
• The property is said to be negatively geared in the amount of $3,000 per year. This is before taking into consideration Non-cash deductions. Non-cash deductions are tax deductions that you can legally claim, but don’t need to fund out of your own pocket in the form of cash. A common example of non-cash deductions is depreciation of fixtures and fittings. 
• In this example the non-cash deductions total $7,000 in year 1.
• Therefore my total deductions are $34,000
• This results in tax credit of $4,102
• Overall, the after-tax cash flow of this property is positive by $1,079 per year, or $21 per week in year 1. 

Positively Geared Property refers to property that delivers a cash surplus outright, BEFORE taking into account non-cash deductions such as depreciation.Here’s a simple (hypothetical) example of a personal investment (not SMSF):

• A property is purchased for $500,000
• All expenses are $30,000 per year
• The rental income is $650 per week over 50 weeks of the year, or $32,500 per year
• This property is said to be positively geared to the tune of $2,500 per year
• (Adding applicable non-cash deductions would make the numbers even more attractive, but this property is positively geared prior to doing this).

Positively geared property sounds great in principle, but it is usually difficult to buy property that is positively geared from day 1 and that ALSO has decent capital growth prospects.

That being said, many properties BECOME positively geared over time.This is because as rents increase over time due to inflation and rises in rental demand, the income of a property investment typically increases until the property becomes positively geared.

The flip side of positive cash flow is negative cash flow

A negative cash flow property is one that costs you money to hold. In Australia, the total loss can be offset against the investor’s personal income tax liability, in what is known as negative gearing.

“Why would an investor lose money every week on a property they own?”

Some investors predict they’ll be better off overall once future capital growth is taken into account, even if it means losing money weekly on a property they own. However, negative cash flow may hurt an investor’s ability to add more property assets to their portfolio, which is one reason why 7 out of 10 investors never get past property #1.

Property values have appreciated in Australia to the point where many properties in urban areas in particular are negative cash flow.

Steady Income Stream - The most obvious benefit is the consistent stream of income generated each month. This steady cash flow provides financial stability and can be used to cover living expenses, reinvest in more properties, or save for future goals. With rising costs of living and high interest rates more and more investors are looking for extra income from their investments. Extra income to cover the rising costs of owning such investments, but also additional income to help pay down owner occupied mortgage debt. This is where investing for income can become exciting. 

Note that when investing for positive cash flow in Super the surplus income must stay within the super fund until retirement.

Wealth Building - As the property appreciates over time, your investment grows in value. Additionally, the rental income allows you to pay down the mortgage, increasing your equity in the property. Paying down debt whilst the property is growing at the same time accelerates your equity in the property much faster than relying just capital growth alone.

Risk Mitigation - Positive cash flow properties offer a cushion against market fluctuations. Even during economic downturns or periods of vacancy, the positive cash flow can help cover expenses, reducing the financial risk. Furthermore, during periods when interest rates are high these costs can be adsorbed using surplus income the property is generating.

Tax Advantages - Real estate investors can take advantage of several tax benefits, including deductions for mortgage interest, property taxes, insurance, and depreciation. These deductions can significantly reduce your taxable income, increasing your overall return on investment. Many people think that they can only claim tax deductions on negatively geared properties. The same deductions apply to Positive Cash Flow and Positively Geared properties.

When investing in a Super fund, any tax benefits belong to the Super Fund, not the individual.

Financial Flexibility - Having a reliable source of passive income provides financial flexibility. You can use the extra cash to pay down you owner occupied home loan, invest in additional properties, diversify your investment portfolio, or fund other financial goals, such as retirement or education. Just remember that when investing in Superannuation any surplus income needs to stay within the super fund until retirement.

Leverage - Real estate allows you to leverage your investment by using borrowed money (a mortgage) to purchase the property. This means you can control a more valuable asset with a relatively small initial investment, amplifying your potential returns.

Positive Cash Flow and Positive Geared Property can be a lucrative strategy for investors, but like all property investment strategies, how you execute is also critically important.

Buying the wrong type of property is worse than not investing at all.  Here are a few of the risks and traps to watch out for:

Beware of High Risk Property Types: certain property types such as serviced apartments, hotels or holiday rentals can typically show strong positive cash flow “on paper”. But beware! Often these property types don’t have strong growth fundamentals. 

There are several Property options available that deliver different levels of positive cash flow. Furthermore, these various types of Property come with different levels of complexity. So choosing the right type of property is crucial. For example, everyone is attracted to the potential income returns from NDIS property, but some people find them too complicated and prefer more "traditional" styles of property. Investing in property should never be considered a "one size fits all" strategy. This further reinforces the importance of seeking proper Property advice from someone who has the ability to investigate ALL property types.

What’s The Growth Outlook?  Additional income from an investment property is great, but we also want to see capital growth. So when sourcing a Positive Cash Flow or Positively Geared Property we do not want to see income in isolation of Growth. In fact we want to maximise Income, Growth and Tax benefits from any investment we recommend for our clients.  We scour hundreds of suburbs and thousands of properties to identify properties with strong growth fundamentals.

Watch Out For Bells And Whistles: by “bells and whistles”, I mean sweeteners such as limited time rental guarantees that make a property cash flow positive, but only as long as the rental guarantee applies.  You need to look at what the general rental market will pay after the guarantee expires.  And also question why a rental guarantee is being offered in the first place.

How Is The Positive Cashflow Derived?  Remember that positive cash flow and positively geared properties give you both cash and non-cash tax deductions. Non-cash deductions are depreciation on buildings and fixtures and fittings.  However, if the positive cash flow is derived mainly from a huge depreciation schedule, you should be wary.

Is The Depreciation Claimable? Depreciation of fixtures and fittings is only claimable if you’re the first owner of the property.  So if you buy a new property, you can claim these amounts. If you are the second or subsequent owner, you can’t claim these deductions.

What About Interest Rates? Bank interest is usually a major expense item for property investors, and if interest rates rise substantially, that may turn your positive cashflow property into a neutrally or negatively geared property.  So it is prudent to allow for interest rate increases in your modeling, as well as consider fixing your interest rate for a period of time.

Double Check Your Assumptions: financial models are only as good as the inputs and assumptions that drive them.  So if you are expecting a certain rent, conduct due diligence to ensure that rent can be achieved.  If you’re expecting growth, make sure the relevant growth drivers are evident in the suburb. We use sophisticated Cash Flow Modelling tools that allow us to analyse how the investment will perform now, but also into the future. We can even stress test those models to see how the asset will perform when those hypothetical "what iff's" occur, like loss of tennant, another rise in interest rates or even look at how long it will take to pay down the loan.

Being aware of potential risks is a natural part of any investor’s due diligence.

Don’t let the risks put you off taking action (because the cost of inaction is huge). However, make absolutely sure you do your homework in order to make high quality decisions.

Diversify - Diversifying your investments across multiple properties and/or other investments can help mitigate risks. If one asset underperforms, others in your portfolio can offset the impact. But remember what Warren Buffett is quoted as saying:

"Diversification is a protection against ignorance. It makes little sense for those who know what they're doing". 

In conclusion, if Positive Cash Flow or Positive Gearing is what you are looking for get proper advice to see which option will suit you best and also to make sure it not only delivers returns today, but also into the future.