Property Investors: When is Negative Cash Flow a Good Strategy?

  • Posted 02 Jul
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Property Investors: When is Negative Cash Flow a Good Strategy?

Exactly as it sounds, a negative cash flow property costs you more than it earns, creating a negative cash flow. This is also sometimes called “negative gearing”. It seems strange to suggest that it would ever be wise to invest in a negative cash flow property, but let’s look at some strategies where it might be appropriate.

The risk of negative cash flow

If a rental apartment brings in only $50,000 per year but costs $75,000 in mortgage repayments, taxes, and upkeep, the investor has a negative $25,000 per year cash flow.

This seems like a big risk, but not necessarily to investors who are thinking long term. While property investing is always a risk, some investors are able to turn this seemingly bad situation to their advantage.

The best place to invest in a negative cash flow property is near high-growth areas. If these areas are stable and continue to grow, the property values and mortgages in surrounding areas could climb substantially over time.

Negative gearing is a sensible strategy for investors who are trying to offset capital gains. Holding a negative cash flow property for a few years provides a significant tax break by reducing taxable income in a given year. These losses may be offset when the property is sold if values rise, though there is always a risk that they won’t.

Will this strategy work for you?

The two largest determining factors in deciding which properties to buy are your overall investment strategy and the amount of disposable income you have to spend. If you are primarily interested in pursuing capital gains, then a negative cash flow property might help offset your tax burden.

But if interest rates rise or the costs associated with the property increase for any other reason, you won’t be able to cover the costs with a rent increase. You need enough cash flow from other sources to cover out-of-pocket expenses for the length of time you intend to own the negative cash flow property.

For this reason, if you are just starting your investment business or are considering retirement, you’ll probably want to avoid negatively geared properties.

If the investment causes a strain on your budget, this puts you in a very risky situation.

Pros and cons

There are positive and negative aspects to any investment strategy. But unlike some investment approaches, negative cash flow properties typically only make sense as part of a long-term strategy. If you are waiting for a home’s value to rise due to growth in surrounding neighbourhoods, this could take years or even decades.

If you can purchase such a property and hold on to it long term, you’ll receive tax benefits in the meantime while waiting for a potential big payoff at a future date.

Tax laws around real estate investing and capital gains change regularly, so you’ll need to keep up-to-date on any proposed changes that could hurt your potential profits. Your financial advisor can help you determine if this strategy is right for you.

 

Australian Credit and Finance helps property investors obtain mortgages every day. Contact us and let our experts help you with your home loan needs right now.

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