How Do You Cash Flow A Property Short Fall?

BY CHRIS GRAY, CEO, YOUR EMPIRE

When you buy an investment property in Australia and finance it with an 80% - 100% mortgage, the chances are, they’ll be a negative cash flow difference between the rent you collect and the mortgage payments and other expenses of owning it.

So how can you own one or multiple properties without that shortfall affecting your lifestyle too much?

In 2021, we had it about as good as it gets from a property cash flow perspective. Rents were around 3-4%, a mortgage was only 2-3% and so even after 1-1.5% of expenses (strata, maintenance, property management etc), many properties were cash flow neutral or very close to it. However, many people still complained and said rents had fallen from 5% to 3-4% and so they still sat on the fence and didn’t want to buy until rents bounced back. They’re now regretting that decision as they haven’t got the serviceability to get a loan.

Now we’re in 2023 and rates have jumped a massive 4% in a very short period of time, shocking virtually everyone (including the RBA) and turning our investments from cash neutral to massively negative geared. So much so that some owners and investors maybe considering selling.

When I came to Australia in the late 1990’s things were very similar. Inner city rents were around 5%, but mortgages were around 7% – 8%, meaning that a property could be costing you about 2% – 4%. That would be a whopping $20K - $40K on a $1M property before tax and depreciation, but luckily properties only cost $300-400k in those days and so it might have only cost you $5K - $15K/year which was manageable.

So, from a mindset perspective, we could all sit around saying that life is unfair, and the RBA and government have acted unfairly. Or we could take it from a positive perspective and say the current rates of 5-6% are actually the same or slightly lower than the long-term norm, and we’ve actually had it really good for a number of years. In hindsight we should have made the most of the situation and saved those extra repayments we would normally have been paying and thank god many parts of Australia got 20-30% growth in 2021 as otherwise we might have been in negative equity too. The key to successful property investing and wealth building is to be able to hold on for the long term and to try and retain a positive mindset in the meantime. The secret to cash flowing this loss over the long term really comes from being able to pull the equity out by refinancing and using that to pay the difference, rather than taking it from your limited wages.

If you refinanced at the end of the last increase when rates were still low, then ideally you would still be holding a lot of redraw or offset to help you manage that negative cash flow. But if you didn’t refinance, things could well be a lot tougher as many people can’t currently service a new mortgage with many lenders still using a 2-3% buffer on top of the 5-6% interest rates we’re already paying.

The property market and economy moves in cycles and circumstances rarely stays the same for long.

No matter what a property is costing you right now, calculate how much that would change if you got a 0.5-1% rise in rents and a 0.5-1% drop in interest rates. You might be pleasantly surprised by the difference.

Rents have been rising over the last year, especially for those that were forced to lock in big discounts during Covid. As tenancies come up for their 12-month anniversaries, this is the time to chat to your professional property manager. Those that self-manage properties or decided to go with the property manager that charged the cheapest commission may find it harder to manage any changes in the current legislation and know how to navigate tenants’ rights. For those that have investment properties in beachside suburbs, you’ll often find there could be a 20-30% difference in a lease that starts in winter compared to one that gets renewed in summer which we’re just coming into.

In August and September, the RBA held rates and there’s talk of rates dropping in 2024, so there’s a good chance you’re at the worst cash flow position right now and there’s some blue sky on the horizon.

Some banks are also dropping the 3% buffer they add into their serviceability calculators, meaning it should become easier to refinance than it was over the last 6-12 months.

Just like in my Effortless Empire book, I still think of a $1m property costing me say $10k - $20k a year but going up by $50k - $100k over the long term. If I can borrow an extra $50k from the equity, that will help me cash flow the property for 2.5 - 5 years. In some years, or if I’ve just bought it with 100% finance, it might be costing me $30-40K, but I don’t think that will last forever, especially when the property and rents have risen, and so I might take an average of $20k or a 2% break even point.

In the good old days of low doc loans, you could just tick a box to say you can afford the extra repayments, whereas these days they do want to prove that you can service it from rent and from your wages. So, if someone is on $50k, there will be a limit of how much the bank will lend them, hence that’s why it’s more a high-income earner strategy especially if you want to buy multiple inner-city properties where the rent doesn’t cover the mortgage. You don’t need to follow the strategy 100% - the main idea is to understand the often contrarian philosophies and mindsets and then adapt it to your situation. For those without a high disposable income, the strategy might be to buy further out of town where the properties are cash flow positive. They might not grow by as much, but at least they don’t drain your wages.

A strategy like this is definitely not for everyone and if you walk into a high street bank and say I want to cash flow my property losses by capitalising the interest and using my equity they’ll show you the door pretty quickly. It’s not a common mindset to have personally, but in a business it’s normal – i.e., using your balance sheet to provide working capital to fund a business in the short term. Many mortgage brokers are fairly used to this strategy with multiple property owning investors as they know that in time, properties rise and so do rents and within a property cycle that property can then turn positive cash flow.

Whether or not this strategy is for you, try and be open to different ways of thinking and then, with the aid of your professional team of advisers, choose which is the best way forward for you.