Hedland & Newman

Six steps to creating a $100,000 per year passive Income

Income generating property is fast becoming the key wealth creation strategy of many astute investors.

Properties enjoying increased cash flow via a passive income stream offer rapid portfolio growth while enabling the investor to achieve financial freedom sooner

For many investors, one of the most successful passive income investment options is positively-geared property.

In just five to seven years, an investor could be earning more than $100,000 per annum in passive income from a positive property portfolio.

Six tips for success:

  1. Get your structure right – Speak to your accountant to find the most tax efficient structure to use to purchase your properties. Getting this right at the first stage can save you thousands. Many positive property investors have created large portfolios only to pay out huge fees down the track when they decide to change their entity structure for tax purposes.
  2. Make an informed property purchase – Education and research is key.  The town/area should provide a historical growth rate averaging 10% a year over the last five to 10 years.  A population that is trending upwards, a low rental vacancy rate, industrial growth and investment in infrastructure are all indications that demand for housing will remain strong.  Buy in low to maximize your return. Identify temporary down cycles and quiet seasonal periods which may offer opportunities to secure lower priced property. Fundamentally, the property should deliver positive cash flow of at least $400 a week into the investor pocket.
  3. Maximize Leverage – Whether you are using equity in your home or a saved deposit for your first investment property, maximize your means to grow faster.  Borrow 90% and use Lenders Mortgage Insurance (required if your deposit is less than 20%) to leverage your purchasing power and increase your flexibility. LMI is an acceptable and tax deductable method to get your portfolio started and growing. When your portfolio has generated sufficient equity you can start to buy properties with a larger deposit, without requiring LMI.
  4. Purchase again quickly – Each property strengthens your financial position. Within 12 – 18 months of making your first investment, use the equity now available in this property (which you will have created if you have invested in an area which has delivered 10%+ growth per annum) to buy a second. You may even find you have enough equity to buy a third.  Using different lenders will give you greater flexibility and borrowing power.–
  5. Regularly review your property Values–As your properties increase in value, maximize your growth potential by releasing equity from your existing portfolio to raise the required 10% – 20% deposit amount for future purchases.

    Once you have five properties in your portfolio, depending on the growth rate in the area, you will have created a positive portfolio that is paying you in excess of $100,000 profit per annum.

  6. Review your investment goals every six months – Revisit your goals and continually reassess your passive return strategy every six months to ensure your portfolio continues to maximize its return potential. Utilizing your passive income returns combined with capital growth is the key to rapidly growing your portfolio and second income stream.

Get positive about wealth creation

Last week the ATO released data from the 2010/11 tax year which showed that two thirds of Australian property investors claimed a total of $13.2 billion in losses on property during the period.

It has renewed debate over the government’s negative gearing policy which essentially rewards investors for losing money (while draining tax funds) by allowing them to claim a deduction on their interest payments and other costs associated with owning a loss-making property.

It is unlikely the government will abolish the tax benefits associated with negative gearing after the last attempt in 1985 which saw it quarantined for a period. This allegedly caused rents to surge (although there is evidence to the contrary) resulting in a swift reversal of the decision. Nonetheless, it has highlighted the need for property investors to ensure their wealth creation strategies are in fact creating wealth.

Some investors are drawn to negative gearing solely by the tax advantages, giving little consideration to the capital growth potential of the property.  Regardless of the tax benefits, while an investor holds negative property, they are losing money, putting them at financial risk.

Other investors are prepared to absorb the losses, relying on speculative capital growth to achieve a return, which will only be realized at the point of sale. By comparison, positively geared property delivers a cash return to the investor immediately, providing a passive second income stream and the opportunity to fund their lifestyle and further investments.

It the meantime, negative property investors must dig into their own pockets to supplement the shortfall in rent thereby reducing their monthly cash flow and reducing their capacity to funnel earnings into other investments. And while interest rates are currently at their lowest level in half a century, any future rate rises can impact on an investor’s ability to make payments.

A common belief held by negative gearing enthusiasts is that positively geared property does not deliver good capital growth; the resources towns of the Pilbara and central Queensland have proved otherwise.  Investors in these regions have been able to build sizeable portfolios in very short timeframes by taking advantage of the equity generated and extra income available to them to acquire more positive property.  For some, their portfolios provide enough passive income to fund their lifestyle, allowing them to shift their focus way from work and onto family, travel and other pursuits.

A negatively geared portfolio does not offer this option. If a negative property rises in value during the holding period, any equity generated can be used as a line of credit, but it cannot be drawn as an income stream to fund living expenses.

Furthermore, negative gearing benefits higher income earners (which are on higher tax rates,) the greatest. Yet, oddly, the majority of negatively geared property investors are in the middle income tax bracket.

Investors considering negative gearing should proceed with caution.  Assess your financial goals and investigate the strategies that are available to you. 

What low interest rates mean for positive property investors

In December, the Reserve Bank of Australia cut interest rates to 3 per cent following the fall in the iron ore price. It marked the fourth interest rate cut in less than a year and equals the lowest level ever set by the bank in 2009 at the height of the GFC.

The RBA said in a statement last week that while low rates have had some positive effects on the housing market – increases in building approvals, higher rental yields and improving house prices – economic growth as a whole is still below trend. It indicated that rates are likely to remain low for a while and could even drop a little further.

This is good news for positive property investors.

Interest rates have a big impact on whether a property is positively geared or not. A low interest rate results in lower interest payments. If the interest payments become less than the rental income, a negative or neutral property can become positive (assuming the rent also covers other costs associated with owning the property).

This means low rates can open up more market opportunities for positive gearing. Investors also have the other current advantage of high rents, so with thorough research you will find properties that will generate a decent passive income.

For those already invested in a positively geared property on a variable interest loan, you will be enjoying the benefits of lower interest payments and increased profit.

Unfortunately though, low interest rates will not stay low forever. Investors should take this into consideration when making an investment to ensure they can afford a drop in income when rates begin to rise again. Taking out a fixed rate loan will reduce this risk.

Low rates and high rents may also mean it becomes cheaper to buy than to rent in some areas, creating an owner occupier market and reducing demand for rentals. However, with the ongoing housing shortage in Australia and rental market going strong, any increase in homebuyers is unlikely to have a significant effect on the rental market in most areas.