Properties with positive cash flow is the ultimate objective of property investing. Positive cashflow provides investors the funds to buy more properties and acquire service loans without needing to expend other reserves and income sources. Utilizing this scheme doesn’t negatively impact your current lifestyle.
Positive cashflow allows investors to jumpstart with one investment property and later on to multiple properties with more diversity and variety. Consequently, presenting rental income and bringing wealth through capital gains to sufficiently maintain your current lifestyle or any other lifestyle you wish to achieve.
5 Steps of Positive Cash Flow Buying Process
Step 1 – Pre-Approval
Engage mortgage brokers to know maximum borrowing capacity and get pre-approval
Mortgage brokers are intermediaries between banks and lenders, and they can help determine your borrowing capacity as an investor. Borrowing capacity is also known as borrowing power and this is the amount of money that the lender can loan for you to buy a property. The mortgage broker issues a certain amount of loan and types of loan you can apply, all of which are dependent on individual financial factors like earnings, expenses, and liabilities of an investor to name a few.
Income is the first thing that the mortgage broker or any lender would base out of, they would especially like to know the value and type of income which you have. Income and sometimes your savings will dictate how much you can afford to repay what you owe. Expenses also serve as reference since these can affect your savings and your income earnings. Your expenses and even outstanding debts may reduce your borrowing power and can be grounds for loan applications to be rejected. Liabilities and financial commitments like other loans and credit card limits can similarly affect your borrowing power.
There may be other financial factors that could help improve your chances of applying for a mortgage loan, some of which are credit repayments and deposits. Credit repayment is returning previously borrowed funds with interest through periodic payments. Records of past repayments can prove your reliability as a borrower who can pay at regular intervals on time. However, cases of late or missed repayments can negatively impact your borrowing power which in turn can complicate your chances of loan approval.
Deposits are cash funds typically placed in a bank that serves as savings and can generate interest over time. In the lending industry, genuine savings is accumulated money that you saved over a period of time, this can be cash or investment assets that can be sold and converted to cash. Money is not considered as genuine savings if it is outsourced from windfall profit, cash gift from family or friends, or sale profit of non-investment assets. Assets can solidify your loan approvals especially tangible assets and existing investment assets like vehicles, properties or share portfolio. They establish your money saving capability and investment growth.
After the screening process done by mortgage brokers to potential investors, they would also need to assess the value of the property which you would like to acquire using the loan. By doing the valuation of property, they can determine the amount of money they can lend you and the interest rate for the loan. This assessment is known as the loan-to-value ratio. All of the discussed elements are evaluated by the mortgage broker for the process of mortgage preapproval. Mortgage preapproval is simply the numeration of how much money shall be allotted for your mortgage loan.
Check out “Crunching the Numbers: Positive Cash Flow vs. Negative Gearing“
Step 2 – Search Locations
Shortlist high yield suburbs that meet specific price point including capital growth rates, vacancy rate and days on market.
There are a multitude of suburbs to choose your next property investment, these suburbs can ultimately influence your prospective property. Each suburb offers opportunities for capital growth especially for property development, thus properties in different suburbs have different price ranges. A price point is the selling price of a property which is determined to remain competitive in the market but still gearing towards positive profit. As an investor, you must set a comfortable price point in mind that depends on your borrowing capacity and the property investment’s required capital. However, you must also consider capital growth rate, vacancy rate and days on market of the property investment that fit your specific price point.
In the real estate industry, capital growth is the value appreciation of properties over time. There is appreciation in the value of land, but that does not include the building it stands upon. Capital growth rates are determined by supply and demand indicators since capital growth can occur when demand is more than supply. The rate of capital growth can be computed by finding the difference of the present market value of the property and the initial price of the property when it was bought.
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In the context of suburb properties, vacancy rate is the percentage of house or apartment units that are unoccupied, vacant, and available for a certain period of time. Vacancy rates can prove which suburbs are in high demand and which ones have relatively low demand. A sufficient vacancy rate is around 2% to 4%, this can be around 1-2 weeks of vacancy. Vacancy rate percentages of more than 4% can negatively affect the property’s potential capital growth. Higher percentages reflect longer vacancy period between tenants, which lowers the rental yield of the property investment. Lower vacancy rate percentages below 2% may indicate a very high demand for rental properties, but that also implies that it is in urgent need of newly constructed properties. If it is required, more property developments will be introduced, and this occurrence may tip off the balance of supply and demand in the suburb area.
Days on market indicates how long a property has stayed in the market from the time it was open for sale up to the day it was sold. This data can be used to determine the standing of property demand for that area or suburb. A maximum of 50 days to 65 days can be a basis for potential investment. Any more than that proves that the supply of properties is strong and the demand for property of that area is relatively soft or weak.
Step 3 – Suburb Selection and Analysis
Run feasibility against different suburbs to identify which will provide the best return for cashflow and long-term growth
At this point, you’ve already considered suburbs you’re generally interested in, suburbs that are historically doing well and suburbs that are consistently developing. The next step is to distinguish each suburb against all the other suburbs in your list in terms of return of investment or cashflow and long-term investment growth. All these factors relate to you as an investor willing to invest on a property and to your potential tenants that will occupy your property. Choosing the right suburb helps improve market share and boost profitability accordingly to the amenities and accommodations located near the suburb.
In property investment, cash flow is the movement of cash especially for the development and rent payments of the property. A rental property’s cash inflow relies on the rent payments given by the tenants. It is important to look into the proportion of renters to home owners in the suburb since renters would be the source of property income. If the population of renters is too small, then it may be harder to engage new tenants to the property. Take into account that the amount of rental properties in the suburb can affect the potential of property investments because too much competition can lower the rental growth and extends the vacancy rate. Rental property cash outflow is the expenses made for upkeeping of the property like insurance and maintenance as well as any renovations done to the property so it remains up to date. It goes without saying that the older the building inside the property, the more it may need refurbishments or facelifting.
Long-term growth may imply your property investment, but in this step, long-term growth also indicate the development of the suburb. Generally, suburb growth is good for property growth. However, if the suburb has unoccupied land ready for future real estate development, then property price growth can soften despite the growing demand in the suburb. Rental growth rate for suburb properties is important to examine as it represents the health of the rental market. When there is property price growth, rental growth can occur and this demonstrates sustainable demand. It’s good to check the rental growth rate of suburb properties within a span of 12 months. If the rental growth rate is stagnant or the growth is less than 5%, the rental market may not be strong enough for landlords.
Step 4 – Property Analysis and Feasibility
Shortlist high yield suburbs that meet specific price point including capital growth rates, vacancy rate and days on market.
Ideally, there should be one suburb that stands out amongst all the other suburbs you’ve assessed, but it is alright to have one or two other suburbs to set aside as a backup plan. This step revolves around the process of selecting the best property that fits your investment strategy. It is related to the past two steps, but it is more focused on narrowing down to locating specific properties itself. Choosing properties would be easier if you have visited the sites themselves so you can visualize the possible pros and cons of the available real estate. Site surveying and visits aid in your decision making, but not necessarily required. What you lack in personal experience and familiarity of the area, you can make up for it with extensive research.
In this step, you should consider the proximity of the property to accessibility and available amenities. These factors are important since they can certainly raise the land value of your property. Take note that you are not only buying the house, but you’re also buying the access and convenience that are close proximity to your property. Other indicators like properties up for sale in the same suburb can similarly alter the valuation of your property. The properties up for sale can affect your desired rental rate since you have to match the pricing accordingly to the supply of real estate in the suburb.
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Weather and climate are circumstances that affect the whole land. Occurrences like flooding and bushfires always happen, there are areas that are more prone and there are areas less prone to these incidents. There are properties which are sold at lower prices, but it is best to look into them whether they reside in flood and/or bushfire zones. Properties in risky zones may end up being more costly in the long run because of maintenance and it can reduce the property’s capital growth.
All suburbs have their own legal restrictions and local tax rates on property transactions and income, they are managed by each state and territory, so the amount and rules vary. However, there are considerations such as government incentives provided to guide new investment opportunities to preferred areas. An example of government incentive is First Home Owners Grant, it is available for those who have yet to buy or build a house and those who have yet to acquire a townhouse or unit. These incentives and inducements particularly move up the demand for properties and creates an impact on house price growth. It would be beneficial to inspect and appraise any available incentives for the properties you have your eyes on.
Step 5 – Decision Time
Set aside emotions and make an offer based on the ceiling price you’re happy to pay.
The most crucial and the hardest step is deciding on what property to invest on. Overall, disregard both positive and negative emotions because in this step, you shouldn’t let your heart decide. You must let your logical reasoning take over.
There are many methods of how to select the final investment property, but the easiest could be grading each property based on each factor discussed. Sought out investment properties are those that have a well-balanced price point, long-term growth and dwelling conditions. Some factors oftentimes fall short and there are situations where the other remaining factors sustain these underqualified factors. The factor-based property grading shall rely on how strict or how lenient you are when it comes to your investment property.
Do you want to invest on a property which is already in excellent condition and you can rent it as it is? Or do you want to invest on a property that you could renovate with upgrades to accommodate certain types of tenants then rent it for a possibly higher price?
Property investments are typically bought to create rental income. If you still have difficulty in choosing as an investor, it is better to remember what is the most important factor that tenants would consider. Having advantages compared to other properties in the suburb gives a competitive edge for your investment. Although some perks come with a price, that doesn’t mean that you should hastily seize the property. Making an offer is always a challenge to new investors since they tend to undervalue or overvalue the property. It is better to consult with professionals such as buyer’s agents to determine the possible pricing margins for the property. Buyer’s agents, as trained professionals with experience and resources, can also guide buyers and investors by giving a second opinion and provide insight from different perspectives.
Information needed to buy a new property can be easily accessed which in turn helps buyers and investors to save money from employing real estate agents and buyer’s agents. Unless you are a seasoned investor who has handled multiple properties in the past, then it is encouraged to discuss your intentions with experts to calculate a reasonable offer that stays within your budget. It is good to be opportunistic, but you must maintain a level-headed mindset that can conform and/or exceed the expectations of the property seller. It’s not just about the payment, but also the terms of sale in which can be favorable to the seller like a larger deposit or adjusting the settlement period. At the end of the day, you must straighten out a decision which you wouldn’t regret, and you could readily achieve for your new property investment.
Main Benefits of Positive Cash Flow Property
What are the benefits of having a positive cash flow property in an investment portfolio? Having a positive cash flow property not only strengthens the property investment portfolio, but it also provides benefits such as:
- Less Risky – Positive cash flow properties are simple to understand and typically transparent. These properties provide conventional passive income because of its reliability and stability in the midst of unforeseeable property market inconstancy and possible financial crisis. Even if most of your investment properties on your portfolio are generating insufficient profit, the positive cash flow property provides a buffer to the overall losses of the portfolio. Although you won’t receive as much profit, you won’t need to sell your property during downturns.
- Financial Freedom – At the start of your property investment venture, there will always be uncertainty because you would have to struggle with your debts and expenses first. Sometime after, your lifestyle will gradually change especially when the positive cash flow property investments mature. These properties provide long-term financial freedom as they can pay off the debts and expenses. Any excess can be used to your heart’s desire or be stashed away in banks, managed for stocks or applied for other investments.
- Property Leverage – In the context of investment property, leverage is the surplus income from the positive cash flow property which is used to increase chances of buying new properties. It increases the chances of buying new property because your chances of loan approval may be higher than when you have a negative geared property. Expanding your property portfolio is an easy way to achieve your investment wealth goals since you have multiple playing cards in the rental market.
- Sustainability – Positive cash flow properties are self-sustaining. This means that the property can pay for itself because the rental income can cover the monthly expenses. At most, there is almost no need to worry about any payables for the property itself. As time goes on, capital growth will occur and capital gain relies on that growth. The capital gain (profit earned after the sale of the investment property) is straightforward and rather an effortless passive income.
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After having discussed the strong points of positive cash flow properties, it is to your best interest for you to consider the weak points of these type of properties. There are situations where a positive cash flow property presents all desirable aspects, however it is inevitable for these properties to have undesirable facets. What are the drawbacks do you need to look out for when you want to acquire a positive cash flow property?
Main Obstacles of Positive Cash Flow Property
Good intentions, bad execution – it is not by chance that you are able to invest on a property, there is a methodological process behind each investment strategy and activity. Realistically, a misstep or a misjudgement may not be a big deal, but it may result in dire consequences and can hinder your goal for investment success.
What must you watch out for and what are the things you need to prepare for when you try to acquire positive cash flow properties?
- Capital Risks – This includes risks on the property’s capital growth and capital gains. It is presumed that property value and capital growth increases gradually over time, however it is also common for them to decrease. The property and rental market have their own cycles and are subjected to market changes, thus they differ depending on the suburbs, states and territories. A few hundred dollars a week into your pocket may be attractive but the greatest and final profit of your positive cash flow property will come from capital gains (sale of the property). There is the perfect time to sell your property and it is when the cycle of property market is slightly rising. This is to guarantee the maximization of the property’s return of investment. There may be some problems where your property is ready for sale, but the prospective offers did not satisfy your expectations. To prevent your investment properties of prolonged days on market, it is better to buy properties which can appeal to a common group of people.
- Income Misconceptions – Income from positive cash flow properties is still taxable. Although not as much as a standard working income, property tax can still hinder the build-up of wealth from rental income. Investors practice accounting strategies such as utilizing Negatively Geared Properties which deems the cumulative losses (like property depreciation and non-cash deductions) as an offset to payable tax. It is possible to have a Negatively Geared Property that generates Positive Cash Flow, but it is not typically recommended for first-time property investors. The strategy is that the income could barely cover the expenses of the property, but the existence of depreciation can conjure supplementary cash flow so that it remains positive. It is best to consult with a professional when implementing this strategy, professionals can give insight, suggestions, and guidance with your property.
- Marketing Schemes – To sweeten the deal, there are properties that have incentives such as rental guarantees and property rebates. At the start, the potential for a property to have positive cash flow reflects from these incentives. But imagine of a scenario where this property doesn’t come with incentives, will it still have positive cash flow? Properly analyse the property in terms of its rental yield capacity and capital growth potential. It is good to be wary of convenient opportunities, but it is also good to accept them once you’ve fully evaluated the situation. You have to work with the property even after you got a favourable rebate and after the rental guarantee period finishes.
- Uncertain Risks – Positive cash flow properties offer less risk, but this is assumed after you have already obtained it and included into your portfolio. It is impossible to avoid risk, but there is higher investment risk in the acquirement stage of the property. As an investor, you must be cautious when finding properties with promising notions especially for positive cash flow. Suspicions may be dissuaded by thoroughly researching about the property. Make sure to deliberately theorize outcomes of simulated scenarios subjected to the property before following through with the investment. Tailorized rental properties for certain types of tenants (like holiday homes and vacation rentals) may have potential and may be unique, however there is risk especially in regards to vacancy rates. Be prepared for unexpected changes in real estate market too, as factors like interest rates can greatly influence your cash flow.
The details discussed are things for you to ponder and tips for you to consider. There are pros and cons to positive cash flow properties, however there are also different ways to handle these types of properties. Don’t be shy to engage with professionals of various fields as they have been in this industry to specifically aid investors as advisors. It is also good to be prepared and be well-knowledgeable to make the proceedings faster and easier.
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