An important consideration when assessing the viability of an investment property is not only the capital growth potential, but the possibility of finding a positive cashflow. This could determine whether you can afford to hold the property (or not) on a day to day basis.
As a starting point it’s important to get an understanding of the gross rental yields available in any given market that you are considering.
In the example below, the chart indicates rental yields for investment houses in Sydney. The low gross rental yields of around 3% are an indication of how difficult it would be to get positive cashflow from the average investment home in this market.
Source: SQM Research
Rental yields for units don’t fare much better either, especially when you consider the cost of strata levies. In fact, these are some of the lowest rental returns in Australia.
Typically, a benchmark of around 4-5% gross rental yield is what we would recommend as a minimum benchmark before the property achieves a neutral to positive cashflow.
Of course, there are more affordable property markets in Australia than Sydney (and Melbourne), but what would the cashflow look like if you purchased an investment property via a self-managed superannuation fund (SMSF)? Can you get positive cashflow from day one?
The biggest investment property expense is usually loan repayments, particularly when the property is first purchased. If you finance a self-managed super fund (SMSF) residential property purchase, a considerable cash deposit of at least 20% (plus costs) is normally required. Note that accessing equity in an existing property isn’t allowed within current SMSF lending guidelines.
Now let’s say your SMSF is buying an investment property for $450K, and initially it has a rental income of $350 per week. The loan amount will be around $360K because of the large cash deposit, which is mandatory via the SMSF.
The rental income compared to the loan size looks a lot better, providing a rental yield to debt ratio of around 5 percent. But wouldn’t this be possible buying as an individual outside of the SMSF?
Well yes, however most accountants would recommend using existing equity rather than post tax savings to fund the investment purchase. Therefore, an individual using an equity deposit to purchase this investment property would most likely have a total loan amount of around $450K. This means their rental yield to debt ratio would be much lower, making positive cashflow in this example quite unlikely.
The extra benefit of the SMSF investment property purchase is the additional income in the form of the compulsory 9.5 % super guarantee contributions. If you earn $80K, your 9.5% super contribution is the equivalent of an extra $146 per week in rent!
This combination of rental income plus your 9.5 % super contribution has the potential to rapidly pay off the debt on your SMSF investment property loan, therefore bringing it to a positive cashflow (or even a positively geared) position very quickly.
Here are some other advantages of buying investment property through your SMSF:
- If you buy a property with your super fund, hold the property until after you retire and your super goes into the pension phase, you pay no tax on either the capital gains if you sell, or the rent if you continue to hold your investment
- Before retirement, capital gains and rent earned by your SMSF are taxed at only 15 per cent (if you hold the property for more than a year, this drops to 10 per cent on capital gains)
- You can have more control of your super investments and a real understanding of where your money is invested
- Up to 4 individuals can combine their superannuation to form an SMSF and purchase investment properties
It would be negligent of us not to mention that buying property through an SMSF for most Aussies is a significant decision, as the purchase would normally use up much of the capital in the existing fund. It’s not all about positive cashflow.
Other points to consider are:
- You can’t live in the property and neither can any friends or family members
- You can’t renovate a property purchased through a SMSF while it is still under a loan
- There can be thousands of dollars in initial SMSF set-up costs, significant ongoing compliance costs, and sometimes higher fees involved in getting a loan through your SMSF
We have a lot of experience in purchasing properties for SMSF clients. If you would like to discuss this with us in detail, or if you would just like to have a chat about your situation, please get in touch with us on 1300 077 766 or email us on email@example.com
This article has been prepared without taking account your objectives, financial situation or needs and it does not constitute formal advice.