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Australian Property Investor

February Issue 2010 - Cash flow is king in 2010

With the official cash rate falling as low as 3 per cent during 2009, consecutive increases in October, November and December did little to lift the rate above what the Reserve Bank has described as 'emergency' levels. I think it's safe to say that we can expect rates to increase for some time yet, as the Reserve Bank attempts to bring monetary policy back in line with a brighter economic outlook.

The degree to which rising interest rates will affect you, will depend on your gearing strategy. If you lacked disposable income during 2009, circumstances may have forced you to purchase cashflow-positive property.

A positive cashflow strategy can work well when interest rates are low, but when rates rise, things can get difficult. If you lacked cashflow when you purchased the property, how will you be able to meet higher repayments when rates keep rising in 2010?

Unless you can find a substantial source of additional income, or a way to cut your expenses, you could be forced to sell one of the properties in your portfolio so you can afford to hold onto the others. If there are a lot of forced sales in the same area at the same time, you may find it difficult to obtain your desired price, and/or take a long time to sell the asset.

If your property portfolio is negatively geared, you will be somewhat more insulated from 2010's interest rate rises, because you can use negative gearing tax benefits to offset those higher expenses.

In saying this, every investor has a tolerance limit. If interest rates continue to rise, you may also be forced into selling. Whilst this is less than ideal, most negatively geared property is located in areas of moderate to strong capital growth, so you may achieve a quicker sale and/or a more acceptable sale price than your positively geared counterparts.

Positive and negative gearing each have their upsides and downsides. It's not a case that one is inherently 'better' than the other; but it's true that each one works best at different times in the market cycle.

Regardless of your gearing status, you do several things to optimise your position in a rising interest rate environment. If you're planning to buy, focus on locations with strong rental demand. The stronger the rental demand, the more quickly you'll be able to find a high calibre tenant, and the higher the potential rental income.

When you apply for finance, factor in an interest rate increase of around two percent, to minimise the possibility of a cashflow crunch later down the track.

If you already have an investment property portfolio, maintain the property to a high standard to attract good tenants, and review your asking rent to ensure it is aligned with market rates.

Mark Armstrong is CEO of Property Planning Australia, propertyplanning.com.au