How to Cash Flow a Property Shortfall

When you buy an investment property in Australia and finance it with an 80% to 100% mortgage, the chances are there will be a negative difference between the rent you collect and the mortgage payments plus 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’ve got it about as good as it gets from a property cash flow perspective.

When I came to Australia in the late 1990’s things were very different. Inner city rents were around 5%, but mortgages were around 7% to 8%, meaning that a property could be costing you about 2% to 4%. That was a whopping $20k to $40k on a $1m property before tax and depreciation, but luckily properties only cost $300k to $400k in those days and so it might have only been $5k to $10k.

Many investors are whinging about the decreasing rents these days, but it’s the difference between the rent and the mortgage that counts. Many rents are now down to 3%, but so are mortgages, if not even less and so a property might be costing you either nothing or about 1% which is only $10k on a $1m mortgage.

But what if you own, or want to own, 5 properties? That’s still $50k you’ll need to find from your wages to pay the shortfall.

The key 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.

So, I think of a property costing me say $10k to $20k a year but going up by $50k to $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 to 5 years.

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.

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.

When I wrote “The Effortless Empire” book in 2008, the examples I used were based on 4 to 5% rent and 7 to 9% mortgage.

That is… a 2 to 3% gross loss on a $500k property.

In 2017 I republished the book with the same words, but I changed the examples to $1m as I knew it was very hard to buy at $500k.

However, I didn’t change the interest rate examples.

I thought if it works at 4 to 5% rent and 7 to 9% mortgage, then it would definitely work with a 3 to 4% rent and 2 to 3% mortgage.

That is… a 1% gross profit.

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 who you the door pretty quickly.

It’s not a common mindset to have personally, but in a business it’s normal… that is, 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.

 

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