Some Common Investment Terms Explained: part one
Investing is something that gets talked about a lot, but there are many confusing investment terms that seem like they’re talking about the same thing. It’s easy to get confused and wind up using one term when you actually mean another. It’s important to make sure that you know what you’re talking about when discussing your investments, so that the advice you’re getting is correct. This is why we’ve put together a list of some important terms that you need to understand if you want to talk property investment.
Cash flow in property management refers to the flow of cash, specifically in reference to an investment property. It refers to money coming in and money going out, as it relates to the expenses and profits of the property. Cash flow is typically either positive or negative: a positive cash flow means that overall the property is producing more money than it is costing, while a negative cash flow means that the property is costing more money than it brings in.
Whether a positive or negative cash flow is a good thing depends on your overall property investment strategy and your current finances (see NEGATIVE GEARING). While a property making a loss through negative gearing can be ideal for some people, for others it is an untenable situation that will cause financial hardship and may force them to abandon their investment strategy. By the same token, a property that should be negatively geared that is actually producing a profit is equally problematic. Either of these situations can occur if interest rates rise, rental rates change or there are other changes that were not predicted.
Please note that ‘cash flow’ does not refer to the shifting value of the property or ‘non-paid’ expenses such as depreciation. It specifically refers to the flow of actual money through bank accounts.
Negative gearing, despite its name, is an advantageous investment strategy, given the right circumstances. In short, negative gearing is where a property is purchased to make short-term or medium-term losses, but ultimately a long-term profit. It’s where a property is purchased with borrowed money, but the interest on the loan costs more than the rent of the property provides, meaning there is a loss each rent period. This loss can then be claimed against other income, such as wages, as it’s considered a personal loss rather than a business loss. Alternatively, it may be that there are other expenses (not just interest) that mean that the property is costing more than it is earning, such as real estate or maintenance expenses, utility/rates expenses or strata fees. There are other expenses that can be claimed against rental properties that can be counted towards a negative gearing strategy as well.
The assumption with a negatively geared property is that eventually the value of the property will increase enough that it will be sold at a profit, which is large enough to more than cover the losses incurred during ownership. It is particularly useful in areas where the value of owned properties is not reflected in the rent (that is, the rent does not reflect the true value of the property).
There’s more than one way to implement a negative gearing strategy, and the benefits can be affected by your own personal circumstances, so it’s important to seek professional advice before deciding to negatively gear. The positives can be greatly improved, however, by stacking the benefits of negative gearing with other strategies such as maximising depreciation and claiming capital works allowance. Please note that just because a property is losing money, it does not automatically mean that it is negatively geared.
Negative gearing has been the subject of some scrutiny in the last few years, with some parties pushing to only allow newly built properties to be negatively geared. There have been no changes as of yet, but it is important to keep on top of the news and potential legislative changes that may impact a negative gearing strategy, especially in the current economy.
SUPPLY AND DEMAND
Supply and demand is one of the key market forces in any industry, and as anyone looking for the must-have toy near Christmas (or the new console near its release date) knows, it can be very sensitive to time and place. Simply put, supply and demand refers to the need or want (the demand) for a particular type of commodity. In property, this can be any one of a number of factors. It could be houses appropriate for families in catchment areas for good schools, it could be for properties that have four or more bedrooms. Either way, supply and demand will affect the value of your property.
Supply and demand determines how much your property can be worth on the open market. If supply exceeds demand, prices will go down. If demand exceeds supply, prices will go up. Supply and demand also means that even if you supply something of value (like a swimming pool), if there is no demand for it in the area, it won’t affect the demand (and therefore won’t impact the price you can ask on the open market). Knowing how supply and demand affects property prices in the area you own property in, or are considering investing in, will help you make savvier choices about where best to invest your money.
Hopefully these terms are a little clearer. If you still have some investment terms that you’re not sure about, however, don’t despair. We have another post coming soon that describes some slightly more complicated investment terms. If you’re feeling overwhelmed, don’t worry: we have a vast collection of blog posts on a variety of topics that should answer your investment property questions. Feel free to browse at your leisure!