Hand in hand with buying BMV, the investing community has embraced ‘going back to basics’ and concentrating on ‘the fundamentals’. In particular, most, if not all, investors are intensely interested in cash-flow.
As a minimum investors want to buy property which at least breaks even, although many will not be satisfied unless they find a property which gives a positive cash flow, month after month.
Let’s think about what positive cash flow actually means.
The simplest definition is “what is left over when outgoings have been deducted from the income”.
You’ll regularly see properties, particularly packaged properties, offered with a stated positive cash-flow. For convenience, because rent is paid monthly, market practice is usually to quote positive cash flow figures monthly, although sometimes you may see them quoted on an annual basis.
In theory the maths for calculating monthly cash-flow should be very simple; take the monthly rent and then deduct all the costs.
A problem is that in practice there isn’t a standardised definition of ‘positive cash flow’.
So, unless do a little digging, you won’t necessarily be sure of what someone is talking about when they talk about positive cash flow.
Does this matter? Sometimes no, but often very definitely YES! Especially if someone is trying to sell you a property and one of the attractions is the amazing positive cash flow they are quoting to you.
Here’s what I have noticed. When someone selling a property gives a positive cash flow figure it’s sometimes calculated as being monthly rent less mortgage interest.
Sometimes it will include a deduction for management fees but not always. More often than not the positive cash-flow quoted is usually only rent less mortgage payments.
If finance isn’t arranged yet, which is usually the case, then the assumption will be that mortgage payments will be interest only.
There will also be assumptions about the interest rate to be charged on any mortgage but often these won’t be stated.
The reality is that if you bought this property you’d soon find that a positive cash flow calculated on this basis doesn’t have any bearing on reality.
To know the true likely cash flow for a property account needs to taken of:
*Letting fees are often charged at 1 months rent, but on top of that you need to add VAT, and some agents will try and get you to agree to the preparation of an inventory at an extra cost. They’ll also charge for insuring the tenant’s deposit.
*Insurance – buildings insurance, contents insurance, landlord’s liability insurance and perhaps rent insurance.
*Void periods (in other words, when the property is vacant). No property has 100% occupancy.
Management fees which can range for 5% to 15% of the rent, plus VAT.
*Repairs – If you find you need to replace the boiler (which you will, one day) that could be 15 months positive cash-flow gone just like that.
In fact, the subject of repairs is a minefield in itself. In theory the amount you spend on repairs should be directly related to the age of the property and the condition it is in when you first let it. Obviously you’d expect an old property in poor repair to cost more in ongoing repairs than a brand new property with a NHBC guarantee. What a lot of ‘investors’ don’t think about is the scale of repair they may be in for. It’s not just about the small things. At some stage the windows will need to be replaced, the roof will need to be overhauled or renewed, the wiring will need to be upgraded.
*Sundries like the cost of the annual CP12 (gas safety certificate), an EPC (Energy Performance Certificate), electrical certificates and so on. Believe me these things add up.
*Council tax and utility bills whilst the property is empty between tenancies
*Licences – depending upon what and where you buy, you may need a licence from the local authority either for a HMO, or for a single family residence in ‘an area of low demand’.
*And last, but certainly not least mortgage payments, which are usually the single biggest, consistent monthly cost.
When you see a positive cash flow of £200 a month being quoted you can
see that when you start to look at the detail you aren’t going to be receiving £200 a month positive cash flow in many months.
Investors should be buying based on genuine cash flow, and not the best possible cash flow if you have no voids, no repairs and manage the property yourself (meaning you don’t have to pay management fees).
That’s why doing due diligence is so important. You need to ignore the claims and research for yourself what you are really buying.
I’ve said that I’ve seen agents make inflated claims about cash-flow but investors who source their own properties also need to be careful.
It’s easy to gloss over or overlook figures, especially when we get emotionally involved with a property.
Or, perhaps, through inexperience, some investors will be unaware of all the true costs of holding a property and really ‘want’ to buy it.
With negative cash-flow you are potentially heading to bankruptcy so you need to make sure you avoid it at all costs.