Avoid the mistake of concentrating on yield and buying a money pit
When you invest in property, one of the attractions is the spectacular yield your investment earns. But putting all your focus on yield is a mistake. Whether investing for capital gain or income, seasoned property investors understand the importance of controlling cash flow. In this article, I’ll explain how you can avoid the cash flow mistake made by so many beginner investors.
Why is cash flow important for property investment?
Investing in properties with negative cash flow is a tried-and-tested investment strategy. The concept is that you subsidise the cost of owning the property from other means, and instead of profiting with rental income, your profit comes when you sell the property for a sizeable capital gain.
The problem with the strategy is that the size of your property portfolio is limited by how much money you can afford to put into ownership every month. So, you’ll need to find positive cash flow properties, or turn negative cash flow into positive. Most investors attempt to square this cash flow equation by investing for yield. But rental yield is only a part of the equation. When considering cash flow, you must think about costs, too.
Cash flow = rent minus costs
When you are considering a residential property investment, divide a piece of paper with a line down the middle. In the left-hand column, write down the rental income. In the right-hand column, write down all the costs associated with the property.
Now, you’ll be able to claim tax deductions on most of those costs. That’s great, but you must pay the costs to get those tax deductions. It would be better if you didn’t have to pay those costs in the first place.
What costs must you pay when you own property?
There’s a list of expenses and costs to pay when you own property: property management fees, maintenance and repairs, landlord insurance, service charges, the buy-to-let mortgage, and so on. These quickly mount up, and your cash flow can quickly implode.
I’ve met with many beginner investors who have invested for yield, and bought a property with a yield of 8% or 10%. But every month, they found that they had to put their hands in their own pockets to keep the investment above water. Each of these investors failed to go into the investment with their eyes wide open. They chased yield and neglected costs.
How can you keep the mortgage payments down?
The biggest cost for most property investments is the mortgage. There are a few strategies you can use to keep this expense down. The main one is to have an interest-only mortgage. Now, you may ask, “How can I pay off the property if I’m only paying interest on the mortgage?” Stop thinking like a homeowner!
You won’t need to be concerned about paying off the mortgage on an investment property because you’re going to own it forever. Think about an investor who bought a property in 2000. It cost them, say, £70,000, and they financed the purchase with a £50,000 interest-only, buy-to-let mortgage. Do you think that investor is worried about still owing £50,000 on the property today? It’s now valued at £200,000. The investor is still paying interest on £50,000. And they are receiving a 6% gross yield on the current value of the property. They’re quids in, in a big way.
Property prices rise over time. As do rents. Thus, over time, the debt interest becomes less relevant. Your cash flow increases, as does your net income. It’s incredible inflation-proofing, and one of the reasons why property investment is better than stocks for retirement.
How can you keep other costs down?
It isn’t much you can do about service charges if you buy an apartment in a modern prime location block. They are what they are. However, there are other costs that you can control.
You could try to negotiate a lower rate with your investment property manager. However, you must be careful when using such a strategy. Your property manager is one of the most important people in your life as a property investor. Screw their price too low, and you will find you fall to the bottom of their list of priorities. You’ll suffer from their worst tenants. They won’t market your property as hard as they do others. Void periods will be longer.
Being too keen to push your investment property manager to lower their rate could be a false economy. Instead, compare different agents for their service levels and cost. If you’re paying 20% to your current agent and not receiving any better service than you would by switching to another agent at 12%… well, you know what you should do.
Take the same approach with your landlord insurance, too. Make sure you get the cover you need and don’t overpay for the privilege.
Now, maintenance costs vary widely between properties. Buy an older property, and your maintenance and repair costs can quickly spin out of control. It is where many investors make their biggest mistake. They buy an older, cheaper property because of the golden egg of promised yield.
Then the maintenance starts to build up. First, it’s a new carpet. Then, the whole place needs decorating. In year two, it turns out that the central heating system needs ripping out and replacing. The roof next. The repairs and maintenance needs of the property never seem to stop. Bang goes your cash flow.
The savviest investors buy new build and off-plan property. Especially with off-plan, there’s a built-in discount to market value, and when you complete, the property is under warranty for up to 10 years. Your maintenance costs are practically zero. And this makes a big difference in those first few years of ownership until your mortgage costs become less relevant because of the rise in property value and rental income over time.
See the whole picture, and stop focusing on yield
In summary, when you invest in property don’t make yield your only focus. Consider all the elements of cash flow. If you only consider yield, you’ll risk buying a money pit of a property in a poor location. Your maintenance costs will be higher, and the standard of tenants lower. Instead of making an investment that boosts your lifestyle, you’ll buy a noose around your neck.
To discover how property investment could be your route to your desired lifestyle today and in the future, get in touch with Gladfish on +44 207 923 6100. We want you to be successful in property investment, and enjoy the cash flow and profits that we’ve helped hundreds achieve to date.
Live with passion
Brett Alegre-Wood
