Margaret Lomas explains why positive cash flow property investment is not a strategy and how the same property, if owned by two different investors, could deliver a totally different outcome.
Kevin: I remember talking to Margaret Lomas from Destiny Financial Solutions about this time last year. I said, “Margaret, how is cash flow? How do you see cash flow as a strategy?” and you rightly pointed this out to me.
Hi Margaret, how are you going?
Margaret: I’m going really well.
Kevin: Cash flow is not a strategy; it’s more an outcome.
Margaret: Exactly. I know when we did talk about this last year, you asked me whether or not it was possible for people to use positive cash flow as strategy for buying property, and I said to you then that the thing about positive cash flow is that it isn’t a strategy; it is simply a tax outcome. And because all property is different, then it’s a tax outcome that will also be different for each individual investor.
Let me give you an example. Let’s say you and are were going buy a property and we found a property next door to each other. We’re going to buy them to the same price, they would rent for the same amount, and fairly similar properties.
But Kevin, you’re very wealthy, and we all know how much money you earn, so you’re in that top tax bracket. And I’m a poor, struggling writer, so I don’t pay very much tax at all. I’m right in that bottom bracket.
Also, you happen to get one that has an upgraded kitchen, it’s had a brand new bathroom, so you’ve got a bunch of on‑paper deductions that I can’t get out of my property because I don’t have those kinds of deductions available.
The bottom line for both of us will be very, very different. Even though we’re getting the same purchase price and the same rent return, you may well get a positive cash flow because you’re going to get back more of your tax dollars because you pay more tax in the first place, plus, you have all that on‑paper, which you don’t pay anything out for but you get some of your tax dollars back for.
On the other hand, I haven’t paid much tax, so there’s not much to get back. I’ve got nothing on paper, so my property is likely to be negative cash flow because I didn’t have those tax dollars to plug up the gap between income and outgoings.
Kevin: It’s a very good example, Margaret.
Let me ask you this question. People who look for positive cash-flow properties, would you say they’re more risk adverse – they just don’t want to take that risk?
Margaret: Maybe. Let’s just sort of talk about how people go through that process, because people call me all the time and say, “Look, I want to buy a positive cash flow, and I only want to buy a positive cash flow.”
What that mean is they’re seeking a property that’s going to be able to give them enough money that they’re not really dipping into their own pocket. That’s really what their strategy is and that’s what they’re aiming to achieve.
Now, we need to understand, as I just said, all properties are different. There is a basis that you can start on, though. Some properties, no matter how much tax you get back, will probably still be negative if it’s got really low yield.
And if we’re in a really low interest rate environment, then that makes it hard to get positive cash flow too, because the more money you pay in interest, then the less money you’re going to have left over to meet all of your other costs.
If we’re in a low enough interest rate environment, and if we also can find areas where the rent returns aren’t too bad – say 5 to 6% in the minimum – then we could also find properties that have a decent amount of on‑paper depreciation – so they’re properties that are a little bit newer – then you have a better chance of getting a positive cash flow.
Now, the other thing that people have to understand is that first of all, it’s unusual and unlikely for you to find a positive cash flow property that’s positive cash flow from day one. When you first buy a property, remember that at that point in time your expenses are going to be as high as they’re ever going to be, and your rent is going to be as low as it’s ever going to be.
Over time, rent goes up and expenses go down because you start to repay debt. So a property that’s negative cash flow can become positive cash flow within a couple of years of buying it. That’s the first thing.
An investor should probably seek out a property that’s likely to become positive cash flow as soon as possible, because it’s already got good rental yield. But the trap that investors fall into is in looking for this positive cash flow, they often buy areas that don’t have anything else going for it.
Margaret: The important thing to understand about cash flow is cash flow might keep you in the market because it means that you are not financially burdened by a property, but unless there are other things about that area, such as the growth drivers that I always talk about, then if the property never grows, then you’re not going to achieve anything because it’s the growth in the asset that get you out of the market when you retire. You have the build up a net worth in order to be able to afford to leave the paid workforce.
Kevin: Now, you talked about growth drivers there. You and I have chatted on previous occasions, and if you only go back and search through some of the interviews that I’ve done with Margaret, we actually do touch on those key drivers.
Margaret: There’s so much information out there at the moment, yet still, we have too many of the property experts hawking the same message. They talk about things that really are relevant in terms of whether or not a property is going to perform well for you.
People still buy property emotively, as well, so they still want to buy property according to one they can get for a good price, or one that they think they can get a rental return for without having to look at what really drives growth and the importance of those growth drivers.
Kevin: Margaret, once again, thank you for your time. It’s always great talking to you.
Margaret: Thank you.