All Topics / Help Needed! / 1 Per Cent Rule?

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  • Profile photo of BjoernBjoern
    Participant
    @suoksa
    Join Date: 2015
    Post Count: 23

    Hi all,

    I’m quite new to property investment and am currently looking for a property that is positively geared. I am wondering though how this would be possible in NSW or also in other states. In the best suburbs/cities in NSW and with some luck you can find properties that give a return of 5.5-6% and you pay around 4.5% interest which gives you 1-1.5% to cover all the cost (Strata, council, water, insurance, management, operating expenses, did I miss anything?). Assuming a property worth around $300,000 (I’m currently mainly looking in rural NSW), that would give you $300,000 * 1.5% / 52 = $86 per week to cover all these cost and to generate some positive cash flow. I’m really wondering how this is possible, especially since Steve in his book mentioned his new 1%-rule according to which you want to aim for an ROI that is 1 percentage point above the mortgage, so if that rule works the above calculation should be possible.

    Is it really possible to get a property to be positively geared with a return that is only 1% (or even 2%) above the interest rate for the mortgage? Or what returns are you looking for in positively geared properties?

    Thanks a lot for your replies.

    Profile photo of TheNewGuyTheNewGuy
    Participant
    @thenewguy
    Join Date: 2014
    Post Count: 151

    In my opinion the likelihood of buying straight off a real estate / Internet and into a positively geared IP is near zero. The reasons are that other people will see them and push the price up. Maybe the real estates themselves, buyers agents who get in early through relationships, other investors etc.

    You need to be a little bit more creative or simply play the long game. Renovations is an example, buy a house and renovate it, push the rent up enough to become positively geared.

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,376

    Hi Bjoern,

    Is it really possible to get a property to be positively geared with a return that is only 1% (or even 2%) above the interest rate for the mortgage?

    I haven’t actually read/heard how Steve does that – but one thought would be that “non-cash deductions” can help cashflow. So much so, that you can own a negative-geared property and still have a positive cashflow.

    Let’s put a few rough numbers together to see how we go eh?
    3Br house older with potential for subdivision
    Purchase price $300k
    INCOME – Rent $360/wk (6% return) = $18,000 (choosing a 50 week year for contingency)

    EXPENSES – Rates $1700pa Ins $1000 Water $300pa Maintenance $1000pa = Total of $4000 expenses.
    Plus Interest on $300k at 4.5% ($13,500) = Total expenses of $17,500

    OK, we are a bit North of 1% in total expenses, but the maintenance figure is a “rubber” figure anyway. And, with Income of $18,000 you are making $10 a week (positive geared).

    But wait, there’s more …….

    Given that you are a PAYG taxpayer, and you are able to claim any losses on this property, that starts with Borrowing Costs and follows with Capital Works and Depreciation.

    Even more “rubbery figures” coming right up…. :p

    Borrowing Costs can be Tax deductions for up to 5 years from purchase. These are any costs associated with “Borrowing Money to buy an investment” and can be substantial – application fees, stamp duties on mortgages, transfer costs, LMI, mortgagee’s solicitor’s fees, valuation fees, etc. Let’s say $3000 for those (claimable at $600 per year).

    As an older house, the Capital Works cost (cost to build it) might only have been $60k when it was built 20 years ago. You can claim 2.5% of that, so $1500 each year. Any other provable Capital costs (a new carport/garage, fence, patio, renovations to structure, etc) might also be claimable. Let’s say “None right now” and settle on $1500/year.

    Then you have Depreciation – the values assigned by a Quantity Surveyor to the stove, hot water heater, dishwasher, carpets, air conditioner, and/or any other fixture in the place. These depreciate at different rates (some at 20% pa, some at 8%, etc). Again, let’s settle on a flat $1500 pa. in the first year.

    So, you have total deductions of $3600 per year. Apply them to your tax returns, and you will get back a refund at whatever your Marginal Tax Rate is. Let’s say you earn less than $50k, so your Marginal Rate is likely to be around 32.5 cents in each dollar, thus about $1000 coming back to you to offset those expenses.

    Thus that $1000 refund coming back to you WILL make your property even more cashflow +ve than expected (by an extra $20 a week, thanks to those tax deductions). As deductions in later years tail off, hopefully, rent returns will have increased to offset those losses.

    Put your own figures in there, Bjoern – the ones above are maybe about right for some situations. The way of working things out should be similar though. And if you earn more than $80,000 pa then your refund cheque will be nearer 37%.

    Keep in mind that any answer you arrive at will still be rubbery, but can be indicative of “what might be”…..

    Benny

    Profile photo of BjoernBjoern
    Participant
    @suoksa
    Join Date: 2015
    Post Count: 23

    Thanks for your answer TheNewGuy.

    So in order to have a positively geared property, what return would you typically need on top of the interest rate? Is 1% really enough to cover all the cost?

    Profile photo of BjoernBjoern
    Participant
    @suoksa
    Join Date: 2015
    Post Count: 23

    Thanks Benny, guess I underestimate the effect of deductions a bit ;)

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,376

    Hi Bjoern,

    guess I underestimate the effect of deductions a bit ;)

    They certainly help – BUT, did you notice that even with expenses of about 1.3% you were still positive geared in my example?

    So the “1% rule” looks like it can stand alone, even WITHOUT deductions. Of course, this depends on many things – it will not work in all situations. As always, the numbers say what will work for you, and what won’t !!

    Benny

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,376

    Just realised I had missed this bit :-

    you want to aim for an ROI that is 1 percentage point above the mortgage…

    OK, so let’s re-evaluate ……
    Mortgage Interest stated was 4.5%, so let’s say Rental Income is 5.5% (on a $300k IP, that is $330/wk or 16,500pa)
    Mortgage still $13,500 and expenses ran to $3000 except for Maintenance – so Total $16,500 IN and $16,500 OUT !! Neutral geared.

    The deductions can likely take care of the Maintenance AFTER deductions as per earlier example. So yes, in the example with MY numbers, it does need the deductions to get it over the line.
    Benny

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