SHOULD YOU PURCHASE NEGATIVE CASH FLOW PROPERTIES?
The answer to this question is, "It depends on the scenario". If you are planning to buy a rental property that is cash flow negative, you need to look at the future capital growth potential and the land size of the property, i.e. is this a subdividable section or is there value left in the property which you can use to refinance later?
Future Capital Growth/ Discounted Properties
The current tax law allows that any losses generated against cash flow negative rental properties can be claimed against your personal income if structured correctly. This means that if your average tax rate is 33%, for every dollar of loss, you will get 33 cents back.
If there is no potential for capital growth and the rental property is cash flow negative, then you should avoid the property. These sort of properties will result in cash flow issues for you.
If there is good potential for capital growth, i.e. 7%+ and the property is slightly cash flow negative, i.e. less than $4k a year, then this would be a good buy.
Note $4k a year negative cash flow means $77 a week top-up from your pocket, but if the property is gaining value (let's say the property is worth $300k) your capital growth will be $404 a week. So this would be worth buying, as you can always use the increase in value to refinance your property to purchase more investment properties. However, you need to look at your cash flow and calculate if you can afford the $77 top-up a week. Subdividable Properties
Properties that can be subdivided are great investments in cities where there is a major shortage of land supply. If you can find good subdividable properties at the right price, you should consider buying them because the capital growth on these sorts of properties will be high.
Last year I bought a subdividable property and it went up in value by nearly 30%. Another subdividable property I bought in December 2010 has gone up in value by 60%. A property that I bought six weeks ago can't be subdivided, but it is possible to build a minor dwelling on it - I was offered $100k more for this property within three weeks of purchase.
The first two properties were slightly negative cash flow at the time of purchase but the capital growth has outweighed any revenue losses. The property that I purchased six weeks ago is cash flow positive by $60 a week and there is still potential for major capital growth.
So if you are living in a city, try buying properties with large sections. The above properties were bought in Auckland. Summary
In summary, only buy cash flow negative properties (less than $4k a year) if there is potential for good capital growth or they can be subdivided. Do your due diligence prior to purchasing these sort of properties and always look at your personal budget to calculate if you can afford to buy a negative cash flow property. Do not buy cash flow negative properties if you can't subdivide or the property has no potential for capital growth. Always talk to your accountant about this sort of property purchase.