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Negatives attached to positive cash flow
Oct 08,2008 00:00
by
saroja
A FRIEND was excitedly telling me about her new real estate investment strategy. A FRIEND was excitedly telling me about her new real estate investment strategy. "Buy positive cash flow property -- you can't lose. Absolutely guaranteed. The tenant's already in place. No worries." For an investment of less than $179,000, on a 20 per cent deposit, my friend has picked up a house with tenant. She had calculated that the investment was entirely self-funding even after allowing property management fees, rates and interest payments. It was, however, 250km northwest of Sydney. My friend is by no means a fool, owning her Sydney home outright, but she had little in her super fund, in her 50s on modest income and looking to build a retirement income. Accordingly, she used equity in the property as additional collateral to fund the investment. "If I can repeat this exercise a few times over the next five years, I've got my nest egg all sorted," she said. There's an ongoing debate in property circles as to whether you are better off investing in positive cash flow property (which gives you a high rental yield) or negatively geared, otherwise known as negative cash flow property (which typically gives you a high capital gain). At a time of great uncertainty, when once ironclad expectations of capital appreciation are being replaced with fear, uncertainty, doubt and stubbornly high borrowing costs, it is hardly surprising therefore that the spruikers are once again sharpening their quills and putting the positive cash flow message out there. My friend's numbers are compelling: $179,000 investment, $350 a week rent, yielding a net positive cash flow into her bank account. The principal attraction to positive cash flow properties is that they provide you with an income each week. Because these properties don't cost you any money, they could be considered as fairly risk-free investments, and (in theory) there's no real limit to how many you can buy as they all put money in your pocket -- which is why my friend was so gleeful at her "discovery". Properties that produce a positive cash flow are typically found in regional centres, industrial or mining towns or country areas. The trade-off for this higher return is usually considered to be a slower growth in prices, hence a lower capital gain. When the negative-gearing case looks dubious against the backdrop of economic uncertainty, then surely positive cash flow investing is the way to go, right? Not necessarily. First of all, the people who count -- the lenders -- do not believe that such property is risk-free at all. Indeed, they often cast a leery eye across property located outside main metropolitan areas. More often than not, they will lend at lower LVR (loan-to-valuation) ratios on such locations than on city real estate. For good reason. If the region or town is reliant on, say, one industry, for example a mineral resource or an agricultural product (which is certainly the case in many cash-flow-positive areas), then employment in the town dries up, potentially leaving an investment property without a tenant. http://www.theaustralian.news.com.au/story/0,25197,2444162 |