Invest for cash flow and return - capital growth is the icing on the cake

Sunday, 13 May 2018 08:18

Invest for cash flow and return - capital growth is the icing on the cake

I certainly cannot stress this particular point enough and it is a point that all successful property and business people follow diligently. Back before the crash in 2008, we were in a rising market where property prices were going up every year and investors were being able to buy properties and re-mortgage them straight away, in some cases the same day. This was seen as a fantastic time to invest and property was hot in the media and on TV, with many programmes on how to profit in the rental market, and how to buy and sell for profit. Those who were seasoned, had knowledge, and were willing to take action, were building large successful portfolios.

Unfortunately though, there was the other side of the coin and some of the people that were just relying on capital growth found themselves in trouble. Because it was seemingly easy to attract finance and buy lots of properties, some investors were taking their eye off the ball with regards to cash flow and return. This was distressing for some as they bought properties often because they could, but did not follow the golden rules of stress testing every investment rigorously. When the crash happened, they found that they had overstretched and many of the properties just didn’t achieve the rental returns they needed to cash flow their business. In more extreme cases certain investors had huge void periods, and with no equity in the property they found that the profitability of their investment had gone.

This really taught me that cash-flow was king, and capital growth was not to be completely relied upon. Going back to the Dragon’s Den analogy I referred to earlier in the book, you can see that cash-flow is extremely important to high value business people as well. They are investing in the person which is another important point, but from a business point of view they want to see that the business works from a cash-flow perspective and want to know when if they invest let’s say £50,000, they will get it back.

Property investing should be no different and as mentioned in a previous chapter it should be treated like a business. Therefore you should always be looking at monthly cash flow, and return on investment.

So what does this mean?

Well, as mentioned earlier cash flow from a property is calculated by taking the monthly rent and subtracting the monthly costs. These costs can include mortgage payments, insurances, service charges if applicable, management fees, and incidental funds.

Return on investment is calculated by taking the annual cash-flow and dividing it by the total costs put into the property.

So for the purpose of this example let’s say that you had to put £25,000 into a property purchase. This covered your deposit, refurbishment, and buying costs associated with purchasing the property. You then buy a property which makes you £400 per month cash-flow so £4,800 for the year. You would then make a 19.2 % return on your investment which is calculated by dividing £4,800 by £25,000. Not bad I am sure you will agree when you may only get 2 to 3% in a bank.

This is certainly an achievable target in my area, and in some cases the returns are higher depending on the property strategy.

These however are the figures that a seasoned investor would want to know. They are treating each property purchase as a business entity, which is key. Now it is your job as an investor to track these properties and keep regular records of the return the property is making you in reality. There is the theory and then there is the reality and let’s say you have a couple of void months or some increased costs, then the actual return will decrease. This is why it is important to put an incidental fund in there, and not be too generous on your figures. If you allow for unexpected things to happen and the return is still good, then if they don’t then it is an added bonus. You should still make a healthy return and by setting up your investments in this way you are preparing like a seasoned investor. Don’t get me wrong: when you achieve capital growth then this is a fantastic bonus, but the investment has to work on a monthly basis for you to be able to see the capital growth in the years to come.

 Summary: Successful entrepreneurs and property investors invest for cash-flow and see this as a big priority. Whilst you make money when you buy and we want capital growth, cash flow is what will see you through any hard times you may face.