One reason many of us decide to invest in property is to increase our wealth: however, investors vary in their expectations of the time frames that this wealth building will require. Many investors are satisfied with building their property-based wealth over a long period, and consider their property investment portfolio in terms of years. Others prefer to quickly start making money from their real estate investments.
Either way, cash flow is an important concept to consider in your real estate: because the cash can flow either way, and it’s important to understand the effects of this when considering your current and future real estate investments.
Real Estate Cash Flow: Which Way Does Yours Go?
Your real estate may produce a cash flow which is positive, negative or neutral.
Real Estate with Positive Cash Flow
A positive cash flow is one in which the income from your property exceeds all expenses (managers fees, insurance, interest, repairs and other outgoings). Of course, income tax will probably be payable on this positive cash flow. This concerns some people: paying additional tax on top of their current tax seems too high a price to pay: however, other investors see this as the ultimate strategy to leaving their employment and enjoying a more passive form of income. Sometimes a property generating a positive cash flow does not increase as much in capital gain, because many positive cash flow properties are situated in rural areas or smaller centres. This of course is not necessarily the case: all properties must be analysed based on their own unique facts and circumstances.
Real Estate with Negative Cash Flow
Many investors in Australia have a property that fits into this category: one with a negative cash flow. Real estate with a negative cash flow is costing you money to hold: essentially, you need another source of income (for most of us our job or business) in order to pay for the property. Many negative cash flow properties are in major cities, so while they lose you money for many years while you are buying the property, they may ultimately make a large capital gain (because properties in the city tend to increase in value faster and to a greater extent than those elsewhere). This is not a law set in stone, and some properties with negative cash flow do not increase in value over time.
Buying a property with a negative cash flow has been a popular investment strategy for many Australians: we call this strategy negative gearing. By losing money through an investment property, our total income for the year is lower, and therefore, we pay less tax. The money we would have used for tax is being used instead to buy a property, which hopefully will increase in value over time, and be a ‘nest-egg’ for our retirement.
Sometimes, a property that is cash flow negative can have depreciation and building write-offs (tax benefits) that can be offset against your taxable income: this can effectively turn a negative cash flow property into one that produces a net positive cash flow at the end of the financial year. Consult with your accountant on this one: careful analysis of your property in consideration of your own unique circumstances will determine whether or not this is the case for you!
Real Estate with Neutral Cash Flow
Some properties end up having a neutral cash flow outcome, where all income is equivalent to all expenses.
What will your Real Estate Cash Flow Strategy Be?
When you plan to buy a piece of real estate, its likely cash flow is something you really need to be aware of. Careful analysis of the property will tell you what cash flow you can expect from the property, before and after tax.