Confusion calculating cash flows for first time investor

[rednut]

Background: I have been tossing up between buying a PPOR or IP and decided on IP, unless the bargain of the century lands in my lap for a PPOR. I have a reasonable deposit (130) and reasonable income (150). I am likely to move overseas in a few years and don’t want to be burdened with funding a big mortgage whilst away. I have started to read Margaret Lomas’ stuff and I like her theories.
As such I am interested in buying cheaper IP, with a positive cash flow strategy with a plan to hold the property/ies for the medium to long term. I am happy to tolerate some negative cash flow initially assuming it will hopefully turn positive after a few years.

Problem is I am having trouble getting my head around how to calculate cash flows

1 main issue being - how do I get a realistic estimate of deductions/tax refunds.
For example - I don’t know how to estimate the construction year of the property, or the estimated construction cost - is there a simple way (or rule of thumb) for estimating this without employing a ?surveyor? At the moment I am still in the internet research stage, so employing someone is completely premature. I have used the BMT tax depreciation website, but i am guessing when it comes to estimating the construction year.

2nd issue: Most of the cash flow calculators I’ve seen only have formulas for interest only loans. Is it feasible to have a P&I loan for an IP? Eventually I want to own property outright so they are a genuine source of income for me in the future, so it makes no sense to me that the principle is not paid off, especially when it seems that the rates of capital growth may be slower over the next few years than previously. Could someone explain this? Is it not possible to have positive cash flow with a P&I loan?

Thanks in advance, and sorry if my questions seem naive!

 

[Aaron_C]

1 main issue being - how do I get a realistic estimate of deductions/tax refunds.

Depreciation varies according to the building itself. Obviously a new building will have far more depreciation than an old one. What amount? I think for an old property (that is habitable) you can easily assume something like $2,000 per year.

2nd issue: Most of the cash flow calculators I’ve seen only have formulas for interest only loans. Is it feasible to have a P&I loan for an IP?

You can have a P&I loan for an IP but it is not optimal. Firstly, P&I eats up more cashflow per month than an IO loan. Secondly, P&I means you are paying down the principal on your home loan directly, and that money cannot be redrawn at a later stage unless you apply for a loan increase or refinance. This means you are converting your liquidity into non-liquid equity which is not optimal for you. Having IO loan allows you to keep your cash for other purposes like a buffer or other investment opportunities.

 

[tgan]

Hi Rednut,
The way i work it out is as follows:
I take the annual rent and from that I deduct: interest, rates, water, mangement fees, insurance and any other outgoings the property has. If i have anything left over, then for me, its cash flow. I do not try to work out
depreciation and/or potential tax breaks-i just find this far too difficult, especially since i am self employed and my income varies and my tax is always paid as a lump sum at the end of the financial year. I regard depreciation and tax savings as a bonus and wouldnt consider buying just for these last two reasons only. Hope this helps you out.
Cheers, Teagan

 

[FelixL]

I normally ignore the depreciation/tax benefits out of cashflow calculations. They are difficult to estimate correctly so I treat them as bonus income to cover off the unexpected costs that tend to happen (eg. fixing broken door handle etc)

There is no point having P&I for investment, get an interest only loan with 100% offset account gives the best of both worlds.

So my calculation is normally

(rent * 48 * 80%) - interest = cashflow

e.g if a place is currently renting out $400, then to break even the interest need to be $400*48*0.8=$15360, at 6% interest rate this equates to a purchase price of $256000. My shortlisted property need to be around that mark before I look further

 

[rednut]

Thanks for the replies guys.
So let me get this right, I understand that IO loans improve your cash flow, but that means you are completely relying on capital growth to build equity in order to further invest. That means if capital growth is slow, you're stuffed?

 

[tobe]

Thanks for the replies guys.
So let me get this right, I understand that IO loans improve your cash flow, but that means you are completely relying on capital growth to build equity in order to further invest. That means if capital growth is slow, you're stuffed?

While you are required to make (minimum) interest only repayments, you can pay extra at any time (into the offset account), or you could choose to save in another account (what you would have paid as princial) as the deposit for your next purchase. You arent 'limiting' yourself by going interest only. You are just structuring the loan with the greatest amount of flexibility.

 

[FelixL]

for me, property investment is all about capital growth in the long term, inline or exceeding inflation, with the tenant paying the holding cost

if I am after cashflow, i will most likely go for bluechip company shares that have solid dividend track records

 

[Terry_w]

I generally estimate the land value and then you know the property value and you can estimate the 2.5% pa building depreciation. Make sure the building qualifies - built after 1985.

Fittings etc are much harder and I would generally estimate at around $10 to $15k to be depreciated. It may be much more and much less.

As for loans I would suggest an IO loan as high as you can go with the spare cash parked in the offset. You don't want to pay down the loan but keep your cash available for future private expenses. This will be more tax effective.

And keep in mind if you are working overseas you may become a non resident for tax purposes and you would have no income to offset against your property loss. This would mean no tax back....

 

[travelbug]

Thanks for the replies guys.
So let me get this right, I understand that IO loans improve your cash flow, but that means you are completely relying on capital growth to build equity in order to further invest. That means if capital growth is slow, you're stuffed?

Depends what you do with the money that you would be puting into the P&I loan.

If you are spending it- yes you will not have the increased equity. If you put it into an offset account or save it or put it into your PPOR then you will have the same equity that you would have if puting it in the P&I account BUT you will have more freedom and better access to the money.

 

[BMT Tax Depreciation]

Rednut,

If you are having difficulties calculating the age of the property there is sometimes an option available for you to order a search, for example through your local council. When looking at the age of the property for tax depreciation purposes there is an ATO recognised date in September 1987. Currently legislation states that if a residential property has been completed prior to this date it will not attract a claim on the building allowance. Throughout your research if you are not able to determine if it has been built after 1987 it might be best to base your calculations on it being built prior to 1987, this way if it turns out that is was in fact built very late 80's or early 90's the building allowance you would be entitled to claim can be seen as a bonus.

Regardless of the age of a newly purchased investment property there will always be deductions available within the property's plant and equipment items (i.e. Carpet, Blinds, Hot Water Service, Kitchen Appliance etc). These deductions will in the majority of cases warrant having a Tax Depreciation Report completed should you go ahead with the purchase.

In terms of providing an estimate to assist with your decision making, a Quantity Surveyor will be able to provide this for you (FREE of charge) as long as there is either a link to a webpage with details or photographs available.

Bradley Beer,
Managing Director - BMT Tax Depreciation

 

[BayView]

It's easy; just buy any property with a 5% yield and it's got a great yield - the agent said so.