Ultimately it’s a question of degree. If your cash flow is haemorrhaging uncontrollably and you are going to go broke in a few short months, then I agree this is not a good strategy. But if you can cover the negative cash flow, either from other income or, even better, by setting aside some of the equity you have drawn out by way of the loan, then it might well be the smart thing to do. But whether it is for you or not depends upon whether you are looking at the investment short term or long term.
My advice is to look long term, and I am now going to show you why I believe that one should not sell a property unless there are other, compelling, non-property investing related reasons for doing so. Because, in my opinion, the key to making money in property is not in whether a property makes a positive cash flow (although that is obviously better than a negative one) or even if you manage to buy it 30% below market value (although, again, that’s better than paying full price. I realise this could be considered something of a heretical statement by some).
The key to making money in property is to use the twin forces of gearing and compounding.
Now, I have covered the topic of gearing (leverage) before in these pages and I don’t intend to go through it again. If you’d like more information on gearing I have produced a free special report which you are welcome to download from my website at www.peterjones-online.com. Today I’d like to concentrate on compounding.
I’m guessing that a lot of people’s experience of the power of compounding is negative.
Mortgages and credit cards work on the basis of compound interest. Every month interest is charged not just on the amount borrowed but on any unpaid interest from the previous month or months. This interest on interest does not look like much at the start but it soon begins to add up which is why, when you sit down and work out how much interest you pay on your mortgage over twenty-five years it’s as much as 2 or 3 times the amount you borrowed in the first place.
And that’s why once you are in debt it can be so hard to escape it because, in time, the interest on the interest charged on the interest begins to run out of control.
Albert Einstein is variously credited with saying “the most powerful force in the universe is compound interest” or “compound interest is the greatest mathematical discovery of all time” and he was obviously a very clever man – I say that, we know he was good at physics but we don’t know how good he was at balancing his budget! If you’ve been struggling to pay off a debt for some years and feel like watching the “balance outstanding” drop is like watching grass grow, then you’ll no doubt have some sympathy with Einstein’s view.
Here’s to successful property investing.
Peter Jones B.Sc FRICS
Chartered Surveyor, Author & Property Investor