| Cash Flows In Real Estate Properties are sometimes categorise as positive or negative cash flow properties. A property is considered as one with a positive cash flow if the income/rental of the property exceeds the outflows (council rates, taxes, maintenance, management fees, interest etc). The investor buy a property and arrange finance in such a manner that the quantum of loan taken and the interest obligation cum expenses is below net rental proceeds; a positive cash flow results. Negative cash flow properties on the other hand occurs when the outflows exceed inflows. It is adopted in an up market cycle because as property prices increases so will rentals; rental yields goes in line with property values. Interest payments on loans can be fixed instead of floating so that there is certainty of interest payment to be made. A negative cash flow property will turn positive at the point where rental income exceeds its outflow. A cash buffer is normally created (3 to 6 months rental income) to cushion the initial stages of the purchase to take into consideration interest rate increases and the quantum of negative cash flows for the first few years of the investment. e.g. Property value $300,000 Loan amount $240,000 (80%) Interest payments $14,400 (6%, interest only loan) Other outgoings $3,000 Rental yield $15,000 ($300,000 X 5%) Net cash flow $15,000 - ($14,400 + $3,000) =-$2,400 A buffer of $5,000 can be set aside to cushion the investment for the initial stages; until such time the market picks up and appreciates. Property appreciates by 20% over three years Rental yield $18,000 ($300,000 X 20% increase + $15,000) Net cash flow $18,000 - ($14,400 + $3,000) =$600 positive Many different investment methodologies have been adopted by investors. Some advocates positive cash flow as opposed to negative cash flow properties. There is however no correct method, it depend on the state of the market. In an up market where the holding period is short, negative cash flow is acceptable as the growth in capital outpaced the cash outflow. Increase rental yields will turn a negative cash flow property positive as it catches up with capital values. In an uncertain market where there is a long holding period, positive cash flow is preferred. All these are however dependent upon the rental yield and the prevailing interest rate. Experienced investors will normally consolidate their position before the property market reaches it peak; which is normally signalled by the rate of growth slowing down or sideways movement in prices. Appreciated properties are sold off to pay off loans thus creating positive cash flow properties within the portfolio. Any downturn or dip in the market would be cushion by buffers created during the consolidation phase. Counter cyclical investment in regional centers (other than capital cities) is another alternative in a heated market. Financial Instruments to overcome such outcomes In Australia a cash flow mortgage financing has been created specially for the investor. It defers current interest payments to a future date, where rent is expected to rise. This creates a positive cash flow in the initial years and the accrued interest is simply added onto the principal sum as the outstanding loan by uplifting equity (revaluation) as capital values rise. For more details go to the following site: http://www.cashflowmortgage.com.au/cash_flow.html |
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