How to calculate your cash flow before investing
Property investment success is all about the numbers. If you keep this foremost in your thoughts, you’ll avoid the nightmare of an emotional property investment. To assess property investment opportunities, you must figure out the before-tax cash flow. Only then can you decide whether to invest.
In this article, you’ll discover how Max, a client of ours, worked out the viability of an investment opportunity before committing any cash and sourcing finance.
The property investment opportunity
We showed Max an off-market, off-plan property development in a commuter town, near to the railway station. The purchase price was set at £220,000. The buy-to-let mortgage rate that he could access was around 4% fixed for five years.
Together with Max, we worked through the following steps to determine investment viability.
Step 1: Estimate the gross rental income
We examined local press, letting agent websites, and other online sources to work out what the likely rent would be. Although Max’s property investment would benefit from the advantages of proximity to transport, and the modern and unlived-in aspects that should put the property at the top end of the rental value, he decided to work out his numbers based on the average for a similar property in the area.
He figured this was £1,150 per month. The gross annual rental was therefore £13,800.
Step 2: Allow for void periods
If Max obtained good tenants, he knew that void periods and late (or missing) rent payments would be minimised. However, he decided to err on the side of caution and calculate on the basis of the Direct Line tenant turnover survey. This showed that tenants spend an average of 18 months in a property, and it then takes 22 days to re-let a property.
He worked out that this would equate to an average void period of around 14 days per year. Therefore, on average his void period cost would be £529 per year (£13,800/365 x 14).
Step 3: Running costs
Max wanted to make sure he had a good handle on how much it would cost him to own the investment property while tenanted. He allowed the following costs when working this out:
|Property management fees||10% of gross rental||£1,380|
|Maintenance costs||5% of gross rental||£690|
|Council tax and utilities during void period||£150|
In total, Max estimated that his running costs would be £2,470 per year. He decided to round this up to £2,500 per year.
Step 4: Financing costs
Max knew that he could obtain a buy-to-let mortgage at around 4%, fixed for five years. However, he decided to calculate his mortgage costs at 5%. This would give him a cushion against a rise in interest rates. With £70,000 of his own money to use as a deposit, Max’s mortgage of £150,000 would cost £7,500 per year in interest payments.
Step 5: Calculate the net (before tax) cash flow
Now, all Max had to do was figure out his net cash flow:
|Cost of void periods||£529|
Step 6: Calculate the real gross yield on investment
Finally, to work out whether the property investment opportunity was really worth it, Max calculated the real yield on his investment capital. Remember, when you invest in property, you take advantage of the benefits of leveraging in property investment. You make money on other people’s money.
The gross rental yield on this property investment opportunity was 6.2% (gross rental income of £13,800/property price of £220,000 as a percentage). However, Max’s real yield is calculated as:
(Cash flow/invested capital) x 100 = (£3,271/£70,000) x 100 = 4.7%
This, of course, is before any appreciation in value. If the property increased in value by, say, 5% in year one, his real return would now be:
((Cash flow + appreciation)/invested capital) x 100 = ((£3,271 + £11,000)/£70,000) x 100 = 20.4%
Max was now certain that the property investment opportunity was viable. His £70,000 cash was earning just 1.2% interest. This investment would pay regular income equivalent to 4.7%, and when he added in just 5% capital gain, his return worked out at more than 20% in the first year of full ownership and letting!
Are you fed up with the meagre amount of interest your cash is earning in your savings account? You could soon be earning fantastic real yield like Max. Contact one of our team today on +44 (0)207 923 6100, and we’ll help you to discover the most profitable property investment opportunities in the UK today. Why let your cash languish in a sub-par savings account, when it could be working so much harder for you?
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