In the past, there was a received wisdom (usually among agents selling overpriced ‘investments’ for high commissions) to ‘invest for capital growth’ – i.e. don’t worry so much about what the Yield is, just buy where you think is an ‘up and coming area’ or ‘the next big thing’ – these in Europe were places like Capital cities in Eastern Europe (Tallinn, Riga, Sofia, Prague, Budapest) and Holiday destination such as Spain, and in USA places like Las Vegas or Florida. It’s no coincidence that these are the places now hit hardest in the real estate bust , and has taught a sharp lesson to ‘growth investors’ . Fortunately with the advent of the writings of Robert T Kiyosaki (Rich Dad Poor Dad) and his less famous predecessor Dr William G Hill (Think Like a Tycoon) which gave the same message, there are a growing number of investors who use cashflow as their first ‘box’ to tick when looking for a real estate investment.
When looking at the object to buy – the most important thing and the first calculation to make is to check that the deal is ‘cashflow positive’ This means no matter how the market goes, you are making money regularly. The basic calculation will be to work out the difference between rent money in, and money out –lets say for example, you buy a foreclosed Investment Property – an apartment in a complex, in Florida, for $100,000 (sold for $200,000 in 2007). If the monthly rent is $800, the annual rent is $9,600 (gross yield 9.6%) and the service charge is $340 per month (service charges are relatively high here due to pool maintenance and other facilities), the mortgage interest (75% at 3.95% interest rate) is $247, there are $50 more of outgoings, and so the monthly income ($800) minus the monthly outgoings ($340 + $247 +$50) = $163 per month positive cashflow.
However, there are in addition some risk factors worth adding in to make sure the deal is worth it:
1. Vacancies – every year or two there is likely to be some empty time – Calculate in for one month every two years there or one month every year if it’s in a harder to let area (and ask yourself why are you buying in a ‘hard to let’ area?!) Assuming this foreclosure is in an easily letting area with a good tenant pool, then there’s $33 a month to take off the income to cover the potential for vacancy.
2. Mortage Amortisation – currently it’s likely that you’ll be asked to amortise your loan – with the above example, (check our mortgage calculator here) the loan amortised over 15 years will mean the repayment is $553 per month.
As you can see, the above extra checklists will put this ‘bargain’ into negative cashflow territory – $800 – $553 – $340 – $50 – $33 = minus $176 so what on the surface looked like a good cashflow deal, became a ‘growth play’, and isn’t a good investment from the start.
Looking at another example – lets take 63 Simon, Buffalo, on our front page – Rent in per month is $950. Monthly costs are $248, mortgage including amortisation is $330, and let’s take a vacancy of say one month per year to be safe – 950/12 = $80 per month, so there is $950 – $248 – $330 – $80 = $292 positive monthly cashflow.
This is fundamentally important – in every real estate investment you make, every month from day 1 you should be making money.
1. Only buy deals with positive cashflow from day 1.
2. Make sure the investment has a good sized pool of potential tenants – i.e. take this into account when selecting 1. Unit size and 2. Area
3. Take into account ALL costs and deductions, not just the patently obvious ones, and assume a conservative scenario at all times.
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