The Secret to Turning Negative Property into Positive Cash Flow
Negative properties are becoming all too common thanks to the current macroeconomic environment. Find out how you can turn the tables and earn through negative properties.
Getting positive cash flow properties has been a big part of our approach over the last couple of years. With this, we – and other property investors like us – have gotten higher yields, typically at 71% higher yields than the national average.
But we have come to a point where we can no longer escape the reality – that interest rates have risen so much. As a result, many properties that were cash flow positive are no longer that way.
There’s a potential risk that property investors looking at these properties may think that the industry is no longer good. Since a lot of us were used to high-yielding properties, many believe that a 5 to 6.5% yield that’s common these days is no longer good enough.
As a result, many investors risk putting themselves out of the market.
So if you’re among those who are now at a crossroads and are starting to doubt whether property investing is for you… you’re in good hands. In this article, we’ll talk about how to manage negative cash flow and how it differs from negative gearing.
Positive Gearing Versus Positive Cash Flow
To kick things off, let’s differentiate gearing versus cash flow.
Gearing is much more around tax.
So, positive gearing means that the taxable income of the property exceeds the taxable deductions of the property. Taxable deductions include council rates, water rates, and basically anything that can be claimed as a tax deduction against the property.
Negative gearing, on the other hand, means that your taxable income does not exceed your taxable deduction. In other words, you are operating at a loss. That negative gearing then acts as a tax deduction on your return, to which you get a tax benefit.
Cash flow is very different from gearing as it refers mainly to how profitable your property investment is.
Positive cash flow happens when the total income of your property exceeds the total outflow of the property, which may include principal repayments.
In contrast, negative cash flow means you’re paying more for the property than what you’re earning from it.
Cash Deductions Versus Non-Cash Deductions
There are many things that property investors can do to increase their cash flow and deduct against their property income. And these all boil down to cash and non-cash deductions.
Some of the basic cash deductions include the following:
- Council rates
- Property agent fees
- Leasing fees
- Repairs and maintenance
- Sundry costs (i.e. annual bank fees)
Now, a big thing that we see many investors miss out on is this scenario:
They’ve taken equity potentially out of their own home – their principal place of residence – so, that credit is split. And they’ve used that equity to fund the deposit and costs of their first investment property.
What we’ve seen so many times in new clients who come on board is that they never claimed the equity that they used to purchase the property… and therefore, they miss out on interest.
This interest could provide a deduction as high as 20% on the property’s value… or slightly even more had they used it to pay for closing costs or purchase costs, such as stamp duty solicitors fees and buyer’s agency fees.
Non-cash deductions, on the other hand, are mainly about depreciation.
A lot of people think that because a certain property is 10 or 15 years old there might not be depreciation. But that’s not often the case. If you’ve got a property that’s been built after 1984 or 1985, you could be eligible for capital works deductions.
This is the depreciation on the building itself.
Another non-cash deduction that investors miss out on is borrowing costs. These are the costs that relate to obtaining the loan, such as lenders’ mortgage insurance.
Now, most people buy with 10% deposits. If you do pay the lender’s mortgage insurance, you are not usually required to physically pay it out of cash. Instead, it gets added to the loan balance. But we can claim amortised borrowing costs over five years.
So, that’s a 20% deduction each year of the lender’s mortgage insurance that we can claim.
Turning a Negative Property Into a Positive Cash Flow Property
Now, here are some things to consider:
- Can an investor be positively geared without being positive cash flow?
- And is it possible for a negatively geared property to avoid being negative cash flow?
The short answer to both questions is yes.
The most typical case of property investors who are positively geared but feel like they have negative cash flow is when they are making principal payments to their mortgage. And in this scenario, being negative cash flow isn’t necessarily a bad thing.
Because when you are making payments towards your investment property, you are, in a way, simply deferring profits. You’re effectively saying:
“That is cash flow that I’m going to go choose to buy back equity in my asset. So, I can change my balance sheet items, which are my assets and liabilities.”
And so, you’re repurposing that cash to buy back equity.
Meanwhile, many property investors who are negatively geared end up being cash flow positive thanks to the taxable deduction they receive and the cash refund benefit they get from the Government.
These investors are pretty much getting assisted by the government to become cash flow positive. In this case, they can use these tax benefits to offset expenses that could put them in the positive cash flow territory.
Let me give you an example of how this works:
Let’s say you have a rental property that’s earning $20,000. But you’ve also got $22,000 in expenses. This puts you into negative gearing of $2,000. At the same time, your property has a non-cash deduction of a $5,000 depreciation.
So overall, you’ve got $7,000 tax deductions to claim in your tax return.
Now let’s say that your tax rate is 40%. And for argument’s sake, let’s say that it’s equivalent to 50 cents in the dollar on your $7,000 deduction. This means you would end up having a $3,500 physical cash benefit from the ATO.
And since you incurred a $2,000 cash loss, it means that at the end of the day…
You’ve just got a $1,500 cash-positive income position.
Use Tax to Your Advantage
This article has proven that you can traverse the critical phase of the property market if you know the full extent of tax deductions you are entitled to receive. It also showed that while being positively geared should be the goal… being negatively geared for the time being isn’t too bad.
Remember, being a property investor means you need to be ready to play the long game. This means you must be skilled enough to handle any risk to your portfolio and cash flow.
So, use whatever resources you have to ensure that you survive economic storms… and that you maintain a good position to grow once these storms pass.