Cash flow is your friend
Whenever I invest in property, I aim to buy a property that will produce a positive cash flow. However, some of the best deals I’ve done have been cash flow negative either at the start or at some time during the first few years.
In this post, I’m going to look at the balance between capital gain and income, the reasons why it’s best to invest for cash flow, and the mistakes that some investors make. You’ll understand why I rarely advocate taking on a negative cash flow property that’s likely to stay that way.
What is positive and negative cash flow?
Simply put, positive cash flow is when your income is greater than your expenses. In recent investment blogs, I wrote about how you can use the capitalisation rate to invest in property for income and how to use a buy-to-let mortgage to power your personal capitalisation rate. In those posts, I described how to calculate the return on a property investment so it can be compared to other investments.
Negative cash flow is when your costs and expenses are higher than your rental income.
Generally speaking, there’s a trade-off between cash flow positive properties and price appreciation. Usually, the properties that produce the best cash flow are less likely to produce high capital growth. In other words, as a rule of thumb, the higher the cash flow, the lower the price growth, and the lower the cash flow, the higher the price growth.
(Watch my video questioning if cash flow positive is realistic 100% of the time for more info.)
In a later post, I’ll explain why some real estate investors invest for and expect negative cash flow. For now, though, I’ll explain the reasons why you’ll do best to invest for cash flow and not capital gain.
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Reasons to invest for cash flow and not price growth
I often meet property investors who have got themselves into a sticky situation because they have invested in a property in the hope it will appreciate in value. That property has had negative cash flow from the off, but the investor hasn’t allowed for this in their calculations and due diligence appraisal.
Of course, as an investor you’ll want your property to be worth more in a year or two than you paid for it today. But there are no guarantees this will happen. If you buy a property for long-term positive cash flow, you shouldn’t be disappointed by a poor performance on the value front.
Without positive cash flow, a buy-to-let property can be expensive
Another mistake that I see investors make regularly – especially beginners in property investment – is not factoring in enough costs. They overestimate rental income (usually by not allowing for void periods) and underestimate expenses. So their cash flow projection is out of line from the start.
It is most common among investors who are desperate for a deal to work. They add icing to a cake that’s already iced. Our 2-year cash flow worksheet will help you to avoid the same mistake.
What affects rental property cash flow?
A number of factors can dent your cash flow. Most commonly these are:
- A rise in interest rates
- An increase in maintenance costs
- An unexpected emergency repair
- An unexpected void period
The first three of these will increase your outgoings, while the last one will decrease your income. If you’re conservative with your estimates, you’ll allow for most unforeseen circumstances on your cash flow projections.
Why would you invest in a property with negative cash flow?
Knowing that cash flow is your friend, it’s hard to imagine why anyone would invest in a cash flow negative property. Although it is a viable property investment strategy, when doing so you’ll need to be able to sustain your investment and cope with negative cash flow. If you can’t equalise the negative cash flow with money from your pocket, then you could become a forced seller – and if that happens in a buyers’ market, you could find yourself with a sizeable loss.
Remember it’s not an ideal world
No one has a crystal ball. While I’ve got pretty good at estimating where property prices are heading in the medium to long term, I’d be lying if I told you that I could predict future prices with 100% certainty or 100% accuracy. This is the biggest reason I advise investing for cash flow and not appreciation.
In an ideal world, your investment in property would be cash flow positive and produce a great capital gain from day one. Unfortunately, we don’t live in an ideal world. Your cash flow might turn negative, through no fault of your own. In my next post, I’m going to describe three fundamental tactics to prepare for negative cash flow on buy-to-let properties.
In the meantime, if you’d like to discover possibly the best buy-to-let investment properties that aren’t yet available to the public, please contact the team at Gladfish on +44 (0)207 923 6100.
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