Expert Advice with Ian Hosking Richards 23/09/2013
I often get calls from potential investors who are particularly interested in finding an investment property that will give them positive cash flow. They may have read a book about buying for cash flow, or read an article somewhere, or been advised by a friend or work colleague. Now I would be the first to agree that minimizing holding costs is important. However blindly chasing cash flow above all else is a mistake in my view, and often leads to bad investment decisions.
The first mistake most investors make is that they assume that there is a close correlation between gross rental yield and positive cash flow. For me, gross rental yield is not a good indicator of nett weekly cash flow, which is what really matters. For example, I took a call the other day from an investor who said he was only interested in positive cash flow, so I asked him what his definition of positive cash flow is. He said he would consider anything with a gross rental yield of at least 8%. Now it is quite difficult to find a property with a gross rental yield of 8%. Properties that offer this kind of yield are typically older style properties in fringe areas, which are not the kind of properties that I personally would be looking to add to my portfolio. However I tracked some down as an intellectual exercise and ran the cash flows, and even at 8% yield I could not get these properties to a cash flow positive position. And given the fact that generally speaking this type of property is unlikely to give much in the way of capital growth over time, my figures supported my assumption that these properties just did not stack up as good investments. So where are buyers of so-called cash flow positive properties going wrong?
It is immediately apparent what the problem is as soon as you do a nett weekly cash flow estimate – there is no maintenance budget. If you are buying an older property that has not been immaculately maintained it is imperative to build in a realistic maintenance budget. Once you factor this in, your cash flow positive property suddenly becomes cash flow negative. Furthermore, these types of property are ‘high risk’ in that they are usually in areas with low population bases and economies that lack the robustness and diversity of larger regional or metropolitan areas. It is easy to see how these investments can easily turn in to non-performing assets.
The second big mistake that investors chasing cash flow make is that cheaper price means cheaper to own. They buy the older ‘60s apartment for $250,000 rather than a better located brand new townhouse for $350,000 because they are more comfortable with the price range and assume that it will suit their circumstances better. However almost without exception, if they ran a cash flow estimate they would discover to their surprise that the more expensive property not only has greater potential for capital growth, but is also less expensive to own. How can that be?
Those of you who have read my articles on the benefits of buying new will already know the answer – with new properties you get two income streams. Not only do you get rental income, but you also get income in the form of non-cash deduction tax benefits on top of any other negative gearing benefits. Even on an average marginal rate of tax these benefits can be substantial, often adding an extra 20% or more on top of rental income which can be enough to ensure that the owner’s contribution is minimal, perhaps $20 or $30 per week or even less, depending on the size and source of the deposit.
When purchasing an investment property it is absolutely vital to have an accurate picture of how much the property will cost to own on a weekly basis. Gross rental yields are not a good indicator of holding costs. Variables such as the age of the property and whether it is a house or a unit can render the gross yields meaningless and could lead the unwary investor away from great growth assets with minimal holdings costs and towards lesser performing assets with hidden holding costs. If anyone would like me to send out a weekly cash flow estimator, please call the Rocket Office on 1300 850 038 and the team will be more than happy to provide you with this invaluable tool.
Ian Hosking Richards is a successful property investor with a portfolio of over 30 properties. He is the CEO and founder of Rocket Property Group, a leading independent real estate agency that helps hundreds of people each year enter the property market or grow their existing portfolios.
For further information or assistance, please visit www.rocketpropertygroup.com.au or call 1300 850 038.
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Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.
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