Following the latest Federal Budget, many property investors are becoming more cautious.
Negative gearing and capital gains tax (CGT) rules have changed (see which investors are least affected by the new negative gearing rules), and borrowing capacity has fallen. Many investors are now reluctant to hold a property that loses money each year without the same tax benefits as before.
To see how the numbers might work, I ran a hypothetical 10-year investment property model.
Model assumptions
| Purchase price | $700,000 |
| Deposit and purchasing costs | $170,000 |
| Loan amount | $560,000 (80% LVR) |
| Loan type | 30-year principal and interest at 6.3% |
| Rental yield | 4% |
| Vacancy rate | 5% |
| Running costs | 15% of rent |
| Capital reserve | 7.5% of annual rent |
| Selling costs | 2% |
| Capital growth | 6.7% per year (Perth property data, past 25 years) |
| Inflation | 2.76% per year (past 10 years) |
| Marginal tax rate | 47%, including the Medicare levy |
| Holding period | 10 years |
The results
After 10 years, the estimated net cash profit after tax and CGT is $394,172.
This represents:
- Nominal IRR (internal rate of return): 10.37% per year
- Real IRR after inflation: 7.41% per year
The IRR is the average annual return on all the money you put in, taking into account when each dollar went in and came out.
Where the negative cash flow comes in
The property records taxable rental losses for the first six years and becomes positively geared for tax purposes in Year 7. However, around $21,000 of carried-forward rental losses remains unused at the end of Year 10.
The property also stays cash-flow negative for the full 10 years. The investor needs to contribute $136,558 in total, an average of around $263 per week.
By the end of Year 10
| Estimated property value | $1,338,882 |
| Remaining loan balance | $472,340 |
| Estimated CGT | $139,034 |
| Net profit (after CGT, the initial investment, selling costs and extra cash contributions) | $394,172 |
| Net profit in today’s dollars (adjusted for inflation) | $300,224 |
Can you afford to carry the negative cash flow?
So the question isn’t just:
“Will this property make a profit?”
It’s also:
“Can I afford to carry the negative cash flow while I wait?”
Around $263 a week for 10 years needs to fit comfortably in your budget, including if interest rates rise, the property sits vacant for longer or an unexpected repair comes up. If you would have to sell early, you may not get the result the model shows.
What about holding for longer?
Over a longer holding period, rent may increase while the loan balance and interest costs gradually reduce. This may eventually move the property towards positive cash flow. Cost-base indexation may also reduce the taxable capital gain.
However, holding a property for longer doesn’t guarantee a higher return. The outcome still depends on capital growth, rent, interest rates, expenses and the condition of the property.
Download the full model
Get the full model as a free PDF, including the year-by-year breakdown, the CGT calculation and a sensitivity analysis for different interest rates and capital growth assumptions.
If you’d like to see how the numbers work with your own property, loan and income, get in touch with Cleverly Finance.
After the Budget changes, are you moving towards other investments or continuing to invest in property? I’d love to hear your thoughts.
Disclaimer: This is a hypothetical example based on the assumptions above. It is not a forecast or financial, investment or tax advice. Actual results will depend on the property, ownership structure, interest rates, rental income, expenses, capital growth and each investor’s financial and tax circumstances. Please seek professional advice before making an investment decision.
