NEGATIVE GEARING (Equity Growth) vs POSITIVE GEARING (Cashflow) - which is superior??

[Electro]

We picked our purchases looking at ALL factors
- cashflow
- ease of finding tennants
- add value prospects
- potential depreciation
- capital growth
- good location
- desirable property
etc etc.

......

I agree that in these times, you should be looking for cashflow AND growth

I think the factors you have listed here must be given thought when looking at an IP.

As for getting the best of both worlds, CF+ and CG, I think there lies the challenge. I don't thinks it's a straight forward task although predicting the future would help.

 

[Mindmaster]

I could be looking at this the wrong way but one factor I did not see mentioned was opportunity costs.

If you have an IP with high CG and negative cash flow, you have to use your disposable income to service it. This limits how many properties you can have in your portfolio which has opportunity costs.

On the other hand, if you have cash flow nuetral or positive properties, you don't need to service them so the only limits on how many IP's you can have is the number of minimum deposits you can supply and the number of cashflow properties you can find.

Or am I just being thick and missing somethign really basic here?

 

[WinstonWolfe]

Hi Mindmaster,

yes you are right in thinking the -CF serviceability wall is a real limitation.
But here's some things to think about to help cope with irs downside risk.

- get your -cf property revalued, arrange a loc, and use the loc as a facility to capitalize interest until your cash flows (job, partner's job) improve. Of course, the risk in this is the lender's valuer won't give you the value you want, or you have trouble getting a new job before you burn through your loc.

- -CF property doesn't stay that way forever. Many typical -CF properties are only in the hole by $50-100 a week, then turn +CF within 6 years.


Now following is why a portfolio building strategy is more sensitive to changes in growth than +cf.

-CF, High Growth
400k IP, 100%LVR, 5.5%int, 3.5%sustained yield, 3%cpi, 7%growth, 30%marg tax, $112 -cf in first year.

result at end of yr 1
cf -6k equity 28k net = 22k


+CF, Low Growth
400k IP, 100%LVR, 5.5%int, 7.5%sustained yield, 3%cpi, 1%growth, 30%marg tax,

it'd take 3.5 years at 7.5% yield to match that 22k
or
13.5% yield to make 22k in the first year.....which would be extremely difficult to get at any time on the economic clock.


So the message is it doesn't matter whether you raise your next IP deposit by cf or growth........but it only takes a small increase in growth to get a large increase in net wealth, whereas it takes a large increase in yield.

 

[Witzl]

The goal for me is to have BOTH the neutral cashflow AND the high growth.

I dont believe in OR boolean logic, only AND.

 

[Mindmaster]

- get your -cf property revalued, arrange a loc, and use the loc as a facility to capitalize interest until your cash flows (job, partner's job) improve. Of course, the risk in this is the lender's valuer won't give you the value you want, or you have trouble getting a new job before you burn through your loc.

- -CF property doesn't stay that way forever. Many typical -CF properties are only in the hole by $50-100 a week, then turn +CF within 6 years.

Thanks for the time and effort in your reply WW. Really helps improve my understanding.

Your comment about Loc's did not make sense to me so I had to look it up and i've just finished reading a very interesting article on line of credit or equity loans. So you use the CG to get a loc to cover the cost of interest payments on your negatively geared IP. That works but aren't you then paying more interest on a larger loan?

Looks like that building a portfolio with negatively geared properties relies on the assumption that your income will increase as your portfolio grows AND that you use enough of your income to pay off extra on your IP's so that they can become nuetral or +CF in 6 years.

Be interesting to see a graph that shows how long it takes with minimal P&I payments on a typical 300k house before it becomes +CF.

The strategy I'm working on for my self is to have the over all portfolio to be at least CF nuetral so I have a lot of learning to do on how to get +CF properties with good CG.

Thanks once again.

 

[gooram]

Looks like that building a portfolio with negatively geared properties relies on the assumption that your income will increase as your portfolio grows AND that you use enough of your income to pay off extra on your IP's so that they can become nuetral or +CF in 6 years.

Be interesting to see a graph that shows how long it takes with minimal P&I payments on a typical 300k house before it becomes +CF.

Not necessarily, typically properties will become CF+ all on their own. This is a product of rising rents while your debt stays the same. If interest rates rise or fall, of course, the goal posts shift. Also, paying down the debt with income (increasing or not) will also make the property CF+ faster, but generally your income is put to better use servicing debts for more IPs.

I guess the message is you don't need to pay off principle for a property to become CF+

 

[WinstonWolfe]

Adding to what Gooram says:

Your comment about Loc's did not make sense to me so I had to look it up and i've just finished reading a very interesting article on line of credit or equity loans. So you use the CG to get a loc to cover the cost of interest payments on your negatively geared IP. That works but aren't you then paying more interest on a larger loan?

yes you are paying more interest overall, but the idea is to use this strategy as a cash flow safety net for short to medium periods...i.e. if you lose your job, or rates go up before you can raise your rents to compensate.

I prefaced this strategy with "helping you cope with the downside risk", so it is meant as a risk managment tool. If you were faced with a cash flow crisis, and didn't realize you could do this, you would be faced with selling the property, possibly into a soft market.


Looks like that building a portfolio with negatively geared properties relies on the assumption that your income will increase as your portfolio grows AND that you use enough of your income to pay off extra on your IP's so that they can become nuetral or +CF in 6 years.

Well, at the end of the day, you can't grow a portfolio any quicker than allowed by your maximum debt serviceability. DS improves when:
- your non property income goes up (wage)
- your property income goes up (rents)
- interest rates go down
- non interest holding costs go down (self manage)
- equity goes up and you use a loc to help fund interest (for short to medium periods)

You can risk manage a drop in debt serviceability by:
- locking in rates when they look like rising, or locking 50%.
- up your rents with the market (some PMs are slack)
- reduce non interest holding costs (do your own property management and maintenance)
- increase your non property income via your main job or a second job or partner's income.
- decreasing discretionary consumption.

I am spelling all these things out because some people might have to do this stuff when rates start to rise or they lose a job. And if they're not aware of these options, they might panic sell property.

Be interesting to see a graph that shows how long it takes with minimal P&I payments on a typical 300k house before it becomes +CF.

I haven't got a P&I graph, but below is an Interest only loan.

Assumptions are on the right.
The cash injection is for in costs.
Even if you cannot borrow 100%, it is worth doing the analysis with 100%, because that will cover opportunity costs for any deposit you throw in.
It is also good practice to do the analysis covering the opportunity cost of the in costs, which this doesn't.


The strategy I'm working on for my self is to have the over all portfolio to be at least CF nuetral so I have a lot of learning to do on how to get +CF properties with good CG.

The graph shows you are cf neutral after tax from the outset in this scenario.

Thanks once again.

 

[Mindmaster]

gooram and WinstonWolfe - great posts with excellent information, thank you.

I've coppied both replies onto my PC as notes to look over and refer to later.

 

[WinstonWolfe]

Recent events with middle and higher end property has underlined a point I wanted to make regarding property bought primarily for growth.

A sustained property growth rate above median growth is highly unusual imho, and recent price movements underscore this.

High and mid priced property has softened much more than the bottom end. How much the bottom end would have collapsed without the fhog is anyone's guess.

My impression is high growth property is only high growth for short bursts (like booms), which are then followed by more severe price falls then experienced by lower end property.

For periods covering 2 cycles, my presumption is there is likely no difference in property growth rates of neg and positively geared property.
This would fit with what BV reported earlier about Margaret Lomas' analyses.

I believe high growth property is probably thought of as that because the high growth is more likely to make the news and barbecues.

this graph models what I think.

 

[HiEquity]

Recent events with middle and higher end property has underlined a point I wanted to make regarding property bought primarily for growth.

A sustained property growth rate above median growth is highly unusual imho, and recent price movements underscore this.

I agree - there is also an additional factor to consider here, which is the size of the portfolio. We all seem to agree that higher yield properties allow you exposure to a significantly larger portfolio than negative gearing. So taking that through to a logical conclusion an investor with a lower growth rate (and I haven't seen good evidence this occurs in the long term anyway...) over a larger portfolio will still get more growth in absolute terms than a high growth rate over a smaller portfolio.

I also don't believe there is much of a slower buildup of the portfolio while you wait for deposits to go again as the improved cashflow can help you create the deposits you may not get through capital growth in a (higher yield) portfolio.

Of course this all depends on the assumptions used and boils down to each investors opinion on future performance, which may or may not reflect past performance for all sorts of reasons. In my experience, the long term (10+ year) growth of higher yield property isn't materially different to the other stuff and any effect that may be there is more than compensated by having both a bigger portfolio and an improved cashflow while you wait for that capital growth.

You can safely have a much bigger portfolio if you go down the higher yield path as it's lack of cashflow that gets the vast majority of investors who crash and burn. For me that's the bottom line...

 

[WinstonWolfe]

You can safely have a much bigger portfolio if you go down the higher yield path as it's lack of cashflow that gets the vast majority of investors who crash and burn. For me that's the bottom line...

I agree with this. SAFETY is a big factor....and I don't think I have ever seen dependence on future yield stress an investor like dependence on growth.....
(unless yield is dependent on cr@p areas with cr@p tenants who do a lot of damage).

Growth after all is determined to a strong degree by lenders, MIs, and the RBA via
- their valuers
- lender's revised lending criteria.....lvr's, postcodes, etc
- rates....can't utilize a higher LOC if you don't have the sustained cash flows to service it.

It would appear TIMING is more crucial for high growth plays. Buy at the top of a boom, and you not only have lower cf's but negative equity for some time.

 

[Dbz_Vic]

Reviving a goodie Our current economic climate is one of rising or high unemployment and outlook could be said to be a little fragile depends on who you speak to. So our scenario is that we are currently looking to purchase our 3rd IP and the first 2 we have are -ve geared in Melbourne and even though we can purchase another -ve geared property in more desirable pockets of Logan City QLD for growth and future value add (Springwood, Daisy Hill, Rochedale South), or would it be wiser to purchase in Woodridge, Kingston area for cashflow at the expense of growth and risk of dodgier tenants? I know there are so many variables from the property itself to risk profiles and personal financial circumstances, but currently not sure which way to go. What is everyone doing? And for those investing in Logan do you think there is still some growth left?

 

[stumpie]

Reviving a goodie Our current economic climate is one of rising or high unemployment and outlook could be said to be a little fragile depends on who you speak to. So our scenario is that we are currently looking to purchase our 3rd IP and the first 2 we have are -ve geared in Melbourne and even though we can purchase another -ve geared property in more desirable pockets of Logan City QLD for growth and future value add (Springwood, Daisy Hill, Rochedale South), or would it be wiser to purchase in Woodridge, Kingston area for cashflow at the expense of growth and risk of dodgier tenants? I know there are so many variables from the property itself to risk profiles and personal financial circumstances, but currently not sure which way to go. What is everyone doing? And for those investing in Logan do you think there is still some growth left?

Hiya

the suburbs of Logan in Qld admittedly has a stronger rental yield some say +CF hovering around 7 or 8% the demographics for the area might warrant more maintenance than other areas which may tip you over to be in -CF. I don't hold any in this area but perhaps see_change could share his experiences. In 1 of his posts he mentioned that he has props in this area, the net returns he's had and can't remember if he has disposed of them or still holding.

 

[Tim86]

I think in times like this with lots of investor competition thinking outside the box is the best way to get capital growth and cf+

To me thinking outside the box means doing something different to what everyone else is doing.

Do what everyone else does, get what everyone else has got.

If you want something above average then you've got to do something different.

So don't follow the herd.

The herd doesn't just buy when everyone else is buying. The herd also wants an investment that's easy to manage, doesn't require much work, doesn't require much capital, doesn't want to be hands on with any maintenance/renos or management, etc...

I've gone against the herd, and although it's lots of hard work, I am seeing cf+ and capital growth.

Some people are lucky and they just buy and don't put any effort in and they see amazing capital growth and soon become cf+

But I don't like investing and hoping I'm lucky.

I factor in zero or negative growth in the property market when I invest and then I work my strategy around that. Any property market growth is just a bonus to me.