Can Neg. Geared be Cashflow Positive?

From: Kevin Frey


Hello,

I'm two thirds through Jan Somer's book "More Wealth from Residential Property" and trying to acquire as much knowledge as possible about investment properties with the hope of "stepping out" soon and purchasing my first IP.

Jan seems to advocate the negative gearing approach in a lot of her examples. Then I find www.propertyinvesting.com which says don't touch negative gearing because it works on the assumption of growth compensating for your shortfall.

I think the guy from the above web-site advocates getting cashflow positive properties, but they would appear to be inordinately difficult to find, or are we talking country areas here? Of course, he is heavily into wraps which are by definition cash-flow positive, so could that be his reason for being "negative" towards negative gearing?

In very very simple terms it seems to me that the rental income of a property must at least equal the interest charged on the loan, and then some, for the property to be cashflow positive, wouldn't it?

But that (hence my question) got me thinking whether you can negatively gear such that the tax refund exceeds the cash loss, presumably through having a new property and claiming depreciation.

This would occur, I guess, whenever depreciation exceeds the cash loss (at the highest marginal rate at least). So if my cash expenses for the prop. are $10K per year and income is $8K per year, I face a $2k per year shortfall. But if I can claim $2K in depreciation, I claim a $4K tax deduction of which I get back virtually half ($2K), which negates my "real" cash shortfall.

Is this possible in practice?

I know depreciation is not a free lunch because the fact depreciation is allowed means wear-and-tear is real and I will inevitably have maintenance costs, but is the concept fair?

How many investors on this forum rely on negative gearing versus positive gearing?

Kevin.
 
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Reply: 1
From: Ross Sneddon


Hi Kevin

You are pretty well spot on with your interpretation of Jan's book..

If the Rental Income as Cash and the Outgoings as Cash (interest, insurance, maintenance, management etc,) are equal, then you have a neutrally geared investment.

Your example shows a shortfall of $2,000 which is able to be claimed as a tax deduction. No problems.

There are two broad forms of depreciation. You may claim the fixtures and fittings as a tax deduction under Division 40 of the Income Tax Assessment Act 1997. (You must get a Quantity Surveyors report).

You may also claim the construction cost, which is a Capital Allowance under Division 43 of the ITAA 1997)if the property was constructed after 1987. (QS Report)

Your exercise is accurate and an investment can therefore end as being slightly negatively or positively geared.

A canny buyer now needs to ask questions, do the research, get professional advice and invest in the right area to make the exercise cash flow positive or as near to it as possible. Does it make sense?

Regards

Ross Sneddon
 
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Reply: 1.1
From: Felicity W.


The last two issues of Australian Property Investor magazine have been discussing how all these numbers work. Margaret Lomas in the last issue gave examples of how a property can be negatively geared but cashflow positive. This was exactly how our first two IPs worked.
Keep smiling
Felicity :cool:
 
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Reply: 1.1.1
From: Richard Hunt


Kevin,

Absolutely its possible.

Your analysis is spot on, although you can think about the process a different way.

One way is to think about it in terms of the degree to which you can control the costs/income of the investment.

Its simply about estimating the total cash and non-cash costs that you can't control (or have less control over), rental income and then establishing a level of borrowings (which you may be better able to control) which generates the desired amount of interest expense to ensure the after-tax cashflow position you desire.

For example, estimate the costs you have less control over such as property expenses (rates, mgt fees etc) and also building & fixtures depreciation, which of course are to a large degree inherit in the IP being purchased (subject of course to any reno you may undertake).

Now its just a matter of establishing what level of borrowing is required to engineer the after-tax cashflow position you desire (assuming your equity reserves give you this degree of freedom).

Good luck!

Richard
 
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Reply: 1.1.1.1
From: Mike .


Hi Richard and Ross,

I believe you guys are relatively new on the forum so welcome and I hope you stay around for a while. I took a peek at your profiles and discovered that you are both Mortgage Brokers from Sydney. Property finance is a very big subject on this forum which is guaranteed to keep you busy if you stay with us. We look forward to your contributions in the future and thankyou in advance.

Regards, Mike
 
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Reply: 1.1.1.1.1
From: Ross Sneddon


Hi Mike

Yes Mike. I'd be happy to tune in to the site and offer comments from time to time if it can be of value to other contributors.

With around 20 years experience in property investment and mortgage finance, usually answering questions on a one on one basis, this is really something different for me.

Should anyone like to ask questions which are more personal to their own circumstances and they prefer not to become too public, I would be happy to accept emails direct to my site.

Regards

Ross Sneddon
 
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Reply: 1.1.1.1.1.1
From: Richard Hunt


Hi Mike,

I appreciate the welcome.

Whether in my capacity as a Chartered Accountant, tax specialist or mortgage broker, I have enjoyed the opportunity to contribute my experience and expertise to the forum.

I'd also like to acknowledge the superb contributions of those I've observed in my short time here to be the "vocal minority", who collectively form a formidable "brains trust" for those seeking answers and also the many others willing to share their personal experiences on a public forum -- top effort folks!

Cheers
Richard
 
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Reply: 1.1.1.1.1.1.1
From: Rick Otton


what if you were to rent your property and also give your tenant the ability to buy the property down the road, and for that option you charge him a small monthly fee.

sometimes the small fee is readily agreed to in order for tenants to have that option but life being what it is, many decide down the road not to buy your rental property.

This may be the difference between positive or negative income each month.

Rick otton
http://www.creativerealestate.com.au
 
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Reply: 1.1.1.1.1.1.1.1
From: Anonymous


I like this thinking ... outside the square.

How many people have thought about this, have implemented this ??

What sort of price do you put on it .. a weekly charge, an up-front component??

Do you count the option payment towards the final strike price? Or a portion of it?

hmmm

Rick/anyone, what in your experience works best?

Tom.
 
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