Cashflow and Return for a Property Investment

Strategy Comes First

Damien stresses that before even considering lending, investors need a clear strategy, factoring in personal circumstances and future life plans (time off work, private schooling, starting a family, major holidays, and so on), so that an investment property purchase doesn't end up straining day-to-day life. His view is that sorting out cash flow and strategy should come before approaching a broker, not after.

Building Savings Through Better Budgeting

Damien shares a simple budgeting framework built around fixed and variable costs, aimed at identifying where surplus cash flow can be improved. Common areas he sees clients successfully cut back include dining out and takeaway spending, holiday budgets (recommending these be smoothed out as a monthly provision rather than a lump sum), car leases (which he notes can significantly affect both borrowing capacity and ongoing cash flow, given depreciation and end-of-lease costs), phone plans (suggesting a prepaid plan once a phone is paid off can save around $1,000 a year compared to staying on an ongoing contract), and smaller discretionary costs, using his own move from a $45 to a $25 barber as a light example. For variable or irregular income (commission-based or contract work), he suggests smoothing earnings out over a 12-month view to get a clearer, more consistent picture of genuine cash flow.

He recommends keeping banking simple, generally two to three accounts (everyday spending, bills, and perhaps a holiday fund) alongside a main offset account, rather than overcomplicating things with many separate buckets.

Property Investment Analysis Tools

Jeremy raises Somersoft's PIA (Property Investment Analysis) software as a commonly used tool by companies in the industry, where users input assumptions (purchase price, yield, forecast growth rate) and the tool generates a cash flow and return projection. He cautions that this kind of tool can be used as a sales aid, since any growth rate can be entered to make a projection look attractive, when in reality forecasting genuine future capital growth is the hardest part of the exercise. He finds these tools useful for understanding cash flow mechanics, but not for predicting growth, since that still requires independent research and judgement.

Building the Cash Flow Model

Damien walks through his own long-standing spreadsheet using a $400,000 example property (following on from the deposit and purchase cost example in Episode 11: roughly $80,000 deposit plus $24,000 in purchase costs, for a total of around $104,000 invested).

Using a 4.5% rental yield, that works out to around $18,000 in annual rent (roughly $1,500 a month, or $400 a week), with a two-week annual vacancy allowance factored in, bringing effective rental income down to around $17,280. On the expense side, Damien uses a deliberately conservative 7% interest rate (rather than a lower long-term average), noting this is typically the single largest and most variable cost in the model, illustrating that at 3% interest (roughly where rates sat around 18 months prior to recording), the same loan repayment would be dramatically lower. Other expenses factored in include council rates, maintenance, insurance, management fees, and land tax where applicable (noting land tax varies significantly by state and property count, and can come as an unexpected shock given periodic land revaluations).

The result: an annual cash flow shortfall of around $10,000 before tax. Factoring in a roughly $3,600 tax credit from negative gearing (reflecting a lower taxable income, not a direct cash refund of the loss itself), the after-tax shortfall reduces to around $6,200 a year, or roughly $121 a week out of pocket. Jeremy and Damien both note that negative gearing isn't unique to property, the same principle of claiming expenses against income applies to margin-lent share portfolios or business ownership generally, though for shares specifically this depends on whether the underlying investment is income-producing, a nuance worth confirming with a broker and tax accountant.

Why Depreciation Isn't a "Free" Benefit

Damien and Jeremy caution against off-the-plan marketing that presents high depreciation deductions (citing an example of around $15,000 a year) as effectively making a property "cost nothing." Jeremy explains that a $15,000 depreciation claim only returns a portion of that figure as an actual tax benefit (using a 37% tax rate, around $5,000), meaning the investor is still $10,000 worse off overall, since that deduction reflects a genuine loss in the value of the ageing building itself, not a benefit in its own right.

Adding Capital Growth to the Picture

Bringing capital growth into the same model (using a conservative 5.5% growth assumption on the $400,000 property, around $22,000 in the first year), the overall picture changes substantially: against the roughly $6,200 annual cash flow shortfall, the estimated $22,000 in capital growth results in a net profit of around $15,700 for the year, translating to a return on investment of around 15% on the $104,000 originally invested. Jeremy notes this is achieved using deliberately conservative, "bog standard" assumptions across yield, interest rate, and growth, yet still comfortably outperforms cash savings and, in his view, many superannuation funds' typical long-term performance. Lowering the assumed interest rate to 4% (removing much of the cash flow drag) lifts the same return on investment to around 21%, with no additional tax payable on that unrealised growth until the property is eventually sold (at which point a 50% capital gains tax discount currently applies for assets held over 12 months).

Comparing Property to Other Asset Classes

Damien references Vanguard index return data (assuming reinvested income, no transaction costs, and no tax) showing roughly 30-year average annual returns of around 9.8% for Australian shares, 11.7% for US shares, 9.3% for listed property (real estate investment trusts), alongside lower comparative figures for international shares, bonds, and cash, against a roughly 5.9–6% long-term average for direct residential property capital growth.

Even using a conservative property return of 15% (before accounting for LVR effects) against roughly 10% for a simple share index, Damien and Jeremy both point to property's leverage as the key differentiator, using borrowed money to control a larger asset amplifies the return on the investor's own contributed capital in a way that isn't achieved by an unleveraged direct share investment. Both acknowledge shares offer meaningfully greater liquidity in return, and see a role for both asset classes depending on an individual's goals, though their own overall preference leans toward property for its return profile, provided cash flow is properly managed.

The Impact of Using a Smaller Deposit (88% LVR)

Revisiting the same $400,000 example using an 88% loan-to-value ratio (as discussed in Episode 11, incurring a lenders mortgage insurance premium capitalised into the loan), the deposit required drops from $104,000 to around $72,000. Even though the resulting dollar profit is slightly lower (around $14,000 versus $15,700), the return on investment actually improves, to around 19.6%, since a smaller amount of the investor's own capital is being used to generate that profit. Damien notes this also preserves a larger personal cash buffer, which he considers a genuine benefit of using LMI strategically, alongside the earlier point of getting into a rising market sooner rather than waiting to save a larger deposit.

Shares as a Lower-Leverage Comparison

Damien also models a smaller, unleveraged share investment for comparison, noting that while the dollar return is considerably lower than the leveraged property example, it doesn't create a negative cash flow position, in fact, in his example it contributes a modest positive cash flow (around $50 a week) rather than drawing from it. His conclusion is that shares can offer valuable cash flow and liquidity benefits, but property's combination of leverage and typically stronger dollar-value growth potential remains the more powerful lever for building wealth, provided an investor's cash flow and lifestyle needs are properly accounted for.

Closing Thoughts

Damien and Jeremy close by reiterating the importance of remaining sceptical of any firm's claims, asking detailed questions (including requesting a track record of prior client purchases, not just recent ones), and holding buyers agents accountable for whether a purchased property genuinely outperforms the national growth average over a reasonable multi-year period, rather than accepting vague long-term promises at face value. Their overall message: get cash flow in order first, remain sceptical, and keep asking questions.