44. Buy properties with strong cash flow
In my experience, having a strong cash flow position reduces your risks and also enables you to build your portfolio more rapidly. This doesn’t mean you compromise capital growth. You can have both, despite what many experts have you believe.
A strong cash flow position means the rental income is meeting the cost of holding the property, at the minimum. This is also called cash flow neutral. You’re not earning extra cash, but you’re not spending a cent on your property. Essentially, your investment property is costing you nothing.
From the serviceability point of view, you can buy as many properties as your risk profile allows you to, in principle. Since you’re not spending a cent on this property, as far as the bank is concerned, your serviceability remains intact. Of course, you should try and get cash-flow positive property without compromising on the capital growth, where possible. This can be achieved by buying under market value and getting a strong rental income.
On the other hand, having a poor cash flow, where you’re tipping you hard-earned salary to support the lifestyle of your tenants, puts you in unnecessary risk and prevents you from expanding your property portfolio further.
How to quickly calculate cash flow:
Cash flow = Expenses (mortgage repayments, landlord and building insurance, management fees, rates and maintenance) = $ (positive/negative)
For example
Rent $430 – Expenses $480 = -$50 negative per week
Rent $340 – Expenses $300 = $40 positive per week
In order for a property to be cash flow neutral, you need to get a yield at least 7%. Personally, I would not accept a yield lower than 7%.
Is your rental yield high enough?
A quick way to tell if your yield is high enough is to add 1.5% on the interest rate and factor in additional 1.5% for expenses.
Assuming mortgage interest rate of 6%.
6% + 1.5% interest rate buffer + 1.5% maintenance cost = 9%
You need 9% gross rental yield to ensure positive cash flow.
If you get 7% gross rental yield before tax deduction, this might bring you to neutral position.