There are three common profiles and knowing your investor profile allows you to tailor an investment plan to suit your lifestyle and risk profile. You can be a cash flow investor, Growth Investor or a mix of both.
Cash flow is determined by how you gear or leverage your property this is known as ‘Gearing’. Growth is determined by the value shaped by demand for the property. These are the two main aspects of returns and it’s necessary to understand what they are to assist in building wealth.
Gearing is the ability to leverage your return and build momentum. Meaning you can borrow money off a bank to assist in purchasing an investment property. Just like a car you need to use gears to manage the speed at which you want to invest. You may start out in a negative gear, that gives you tax benefits and eventually move to a positive gearing situation to keep momentum going.
Negative gearing: cost of the property is greater than the income generated. e.g. total cost is $2,000 per month (includes loan, council rates, real estate management fees etc) less the incoming rent $1,500/month rent received. The difference is $500 per month or $115. 38/week, which costs the investor.The benefit of negative gearing is the cash loss is offset against income from other sources, thus reducing your taxable income, and hence the amount of tax you have to pay (compared to the tax you'd pay without the investment). The effects of this cash loss are buffered or absorbed by the tax system. Because of the tax effects your loss is reduced. Simply put: the tax man and the rental income pays for your investment property!!
Neutral gearing: the property costs are equal to the income coming in. Property costs $2,000 and the income coming in is $2,000 leaving the investor with nothing out of pocket.
Positive gearing: the property costs are less than the income coming in. Property costs $1,500/month and the income coming in is $2,000 /month you are earning $500 per month from your investment.
How Negative Gearing can Help Fund Your Financial Freedom.
If negative gearing can produce high investment returns in a tax effective way, it stands to reason that it can serve as a very powerful instrument in building assets for financial freedom.
Negative gearing has traditionally been a lucrative way to build returns through high capital growth. Negative Gearing can be a viable tool in the accumulation phase provided the cash flow is there to sustain it. However it is important to note that the success of negative gearing depends on the quality of the underlying assets. In other words careful selection and accumulation of your investment properties is paramount, both in terms of the underlying return and the potential capital growth.
Is the value of the investment going up due to market forces such as supply & demand, location, the state of the economy and infrastructure in an area. This can also be simply the price someone is willing to pay for the property that can create growth.
Capital growth: means the value of the investment going up or down in value over time. This is very important to learn as it enables an investor to pick the right property that not only has good income but it is going to increase in value over time.
Major Benefit: When the property goes up in value this means you have the ability to re-borrow against the value of the property (this is called equity) and use it as a deposit for other investment property purchase to build a bigger portfolio.
Gearing & Growth - Key Points
Invest in areas with good capital growth potential - An investment property’s capital growth will more than make up for its short term cash loss, or future profits will be greater than present losses;
You only get taxed on Capital Gains once you sell or dispose of the property. Therefore you can use equity, which is tax free as long as you hold the property.
You are willing to accept wealth in the form of non-spendable capital gains (or future profits) in a short or medium term.
Non-taxed (or delayed tax) capital growth is a far more effective wealth-accumulation mechanism than income which is realised and taxed.
Contact us for a free personalised Property Accumulation Analysis to see how gearing could work for you now and in the future.
Minimising Risks & maximising Profits:
There are a number of was to minimise risk for either a cash-flow investor or Growth investor profile.
Diversification: Buy multiple properties in different states
Insurance: Protect your investment.
Have a good accountant and budget to manage cash flow.
Do your research: Know which areas will generate the best return.
Fix in the home loan to control monthly costs.
Look for market opportunities.
Don’t buy emotionally
Budgeting is one of the most important financial tools in achieving financial freedom and/or building wealth. Budgeting is not about restricting spending or cutting back it is about where you spend your money. Most people are unaware how much money is coming in and where it is going.
Level 1 Budget to Live: This is generally the person whose expenses equal their income and they live day to day. They will always be trapped in “just getting by” mode as they have no real goals or do not know how to focus their income.
Level 2 Budget to get rid of debt and eliminate unnecessary expenses: This is a person who tightens their budget to get rid of personal debt such as a car loan, credit card or monthly expenses that are unnecessary. Most people have more money than they think and can nearly always find a way to save money or eliminate an expense.
Level 3 Budget to Invest: The key is to pay yourself first… that is the first item on the budget is money set aside for investing and then all other bills come after this. It doesn’t mean you don’t pay your bills, it means that you always have a focus of investing. By investing first you build your income producing assets and those assets pay for your luxuries. Level 1 budgeters buy their luxuries first and they have to pay for them out of their wage/pocket, which is a very big difference. The goal is to get enough assets to pay for your expenses so you don’t have to work.
Investment & Deduction checklist for investment properties
Below is a checklist of typical deductions directly related to rental properties that can be claimed:
Depreciation Scheduled cost
Body Corporate Fees
Borrowing Expenses (For example, stamp duty and legal fees on mortgage)
Building depreciation (depending on date of construction)
Depreciation of fixtures and fittings (light fittings, carpets etc)
Interest on loans (including interest prepaid up to 12 months in advance) and related bank charges
Pest Control Costs
Property Agent Management Fees
Repairs and Maintenance (excluding improvements which are treated as capital and added to the cost base of the asset for capital gains tax purposes rather than being claimed as an immediate deduction)