• 1
• 2
• 3
• 4

Previous Next

Have you ever come across the perfect investment property in London only run the numbers and discover you’d be cash flow negative each month, forcing you to pass on it?

That’s a common frustration shared with those who invest in real estate.

You work the numbers by tallying up all your mortgage expense each month, your property tax, your insurance, your property management fees, maintenance, and insurance each month (amongst all other possible variables).  Then you go on to estimate the monthly income (rent) in which the property would generate… only to find out that your calculated numbers don’t mesh or match.   You’re out a few hundred bucks each month.

Adding insult to injury, most of the time the numbers don’t jive because the property has a higher than average asking price…  A higher than average asking price as a result of the property being located in a highly desirable (and higher than average appreciating) part of town.  Meaning a higher than average future capital gain you would have realize by purchasing the property you’ve found.   You get the picture.   But the numbers tell you that you’re forced to pass on it because it screams negative cashflow.   In the end you walk away from that property, disappointed, searching for another lower priced (and likely lower appreciation potential) property offering you more sensible cashflow numbers.

But hold on. .. Don’t abandon that perfect property you liked so much quite yet.  Consider that a cash flow negative property becomes, in effect, cash flow positive by applying interest expense, maintenance and depreciation deductions to your earned income.  That is, the income tax paid today goes into capital gains tax deferred (until you’re in a lower tax bracket or never if you don’t sell).

Most property investors assume appreciation for in the long term.  It will happen since property is a real tangible investment and hence is indexed for inflation, although it’s not entirely critical to investing (see the blog post “How to Make a Million in Investing“).   For what it’s worth I’ve always assumed 5% long term in London, although some parts of London tend to appreciate faster than others (ie Old South).

The idea with the desirable property that just won’t seem to properly cashflow, is as follows:  I find a quality London Ontario home, for example somewhere around Wortley Village.  I pay out $1200 per month on the property (principle and interest mortgage payment, plus taxes, add in maintenance, management, etc).  I take in $975.   Now I’ve put myself in a negative cashflow position handing over $225 each month from my own pocket.   Of course I get to write off interest, and maintenance, and management, and taxes, and even depreciation.  That’s most of the $1200 (a little goes to principal repayment).   So, I end up paying $225 a month to my Brodylan White property manager, who then turns around and uses it to pay whatever shortfall I have.   That $225 is my net loss each month and I also add in a helping dose of property depreciation on top to increase it.

In the end, I’ve reduced my taxable income as a result.

Given the right tax bracket and the right numbers  one could certainly come out paying far less tax, by more than the $225 lost each month on the property… And that doesn’t take into account the potential capital gain, which obviously becomes more and more the longer you hold the property.

With a long-term perspective, many people have and will continue to capitalize on this.   Often these same people will even stay true to this strategy when the time does come to raise rents and enter positive cashflow territory.   They’ll re-mortgage the property when the interest expense gets too low, and then use the borrowed money for other investments.

Please understand that this certainly isn’t permission to rush out and grab a bad, money losing property just to be able to write expenses off.  This post isn’t to justify that behaviour.  Eventually you WILL have to either pay tax on free cash flow or pay some capital gains on sale, so rest assured the tax man will get his share.  The tax man is always out ensure his slice of the pie gets digested.  But that could be many, many years of tax deferral away.

Using Leverage and then taking it away strategy:

Now that the important tax ramifications of real estate investments have been discussed, as well as the importance of leverage, it should be tied into into the big picture highlighting the power of real estate investing.  I’ve always advocated that one of the best real estate investing strategies is to buy and hold several highly leveraged properties (I always suggest TEN properties) and then, in ten to fifteen years (or when you approach retirement) sell FIVE  properties and use the equity profit to pay off the other outstanding mortgages.

What happens is you end up going from 10 leveraged properties to 5 free and clear (no mortgage!) properties and collect, say, $7,000 or $8,000 per month (rising with rent increases each year to protect your purchasing power by fending off inflation).   Take it one step further, and insulate these 5 free and clear properties in a family trust, legally protecting them from the outside world and continually providing you with a legally protected steady and annually rising stream of income.

Your indexed pension at work just got hammered in the recent stock and mutual fund meltdown?  Consider the above real estate investing strategy today and contact us at Brodylan White to help you manage your way to your own indexed pension financial freedom using real estate.

5 Comments