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+ve Cashflow - Is it Overrated???

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  • +ve Cashflow - Is it Overrated???

    I bought an IP in 2008 for $300K and put 5% down i.e. 95% finance. The rent pays the mortgage and the insurance (using P & I) but does not cover the rates of $1,100 per year. So I cover the rates from my own pocket. In other words the property is slightly CF -ve before tax and slightly +ve after.

    I have just been reading Steven McKnight's book 0 - 130 Properties in 3 Years and the other threads on this forum. He is a strong advocate of CF +ve buys and expected at least $30-$50 pw +ve CF. I however notice that in all his purchases he put 20% down. In my case I would have had to stump up $60,000 (20%) to make the purchase and I would also have been CF +ve.

    You guys are the experts in this is it not better to pay 5% and have the other $45K as a buffer or alternatively use it in other worthwhile ventures where it (according to Chris Ashenden's other thread) would have a higher velocity. It would take a lot of -ve CF months with a 5% down for the 20% deal to be ahead.

    Is my thinking flawed? You are the experts. I am considering another 5% down deal that will be CF neutral after rates, insurance and loan.
    Last edited by revdev; 13-01-2010, 08:03 PM. Reason: spelling

  • #2
    Horses for courses.

    If you have $60,000, then it depends if you can grow it faster using 4 x $15,000 deposits and manage your cashflow across the year or 1 x $60,000 and piece of mind that, so long as it is tenanted, you only have to worry about major maintenance.

    Some would argue that a property that is cf +ve with a 20% deposit is not actually cf +ve - any judgement on cashflow should assume 100% financing, as that takes in to account the minimum opportunity cost of having the deposit tied up in the house.

    Don't forget that leverage works both ways - a 5% dip in value on a single 80% mortgaged house looks less bad that 5% on $1,200,000 mortgaged at 95%!
    DFTBA

    Comment


    • #3
      You want to put down the minimum you can, and keep as much money in your R/C as possible.

      If you can keep putting down only 5% then well done but I am pretty sure that now post financial crisis you will be in the 80% bracket.

      Maybe 90% at best with some lenders.

      What you put down is irelevant when calculating CF+/- as its all the banks money - in the authours case it muust be - regardless of whether its a fixed loan or from your R/C.

      You need to compare your total interest bill on the purchase price + expenses vs Rent.

      Comment


      • #4
        I have just been reading Steven McKnight's book 0 - 130 Properties in 3 Years and the other threads on this forum. He is a strong advocate of CF +ve buys and expected at least $30-$50 pw +ve CF. I however notice that in all his purchases he put 20% down. In my case I would have had to stump up $60,000 (20%) to make the purchase and I would also have been CF +ve.
        Hi The- Victor,
        That book was done several years ago when he was buying in Ballarat near Melbourne I think it was. Prices were very cheap and yields were high. He did things a little bit different to many investors and sold when prices went up and bought again in other higher yield areas. The trouble with that is you eventually run out of areas that you can find the same high yields in, or you buy in the slum areas.

        I agree mostly with what Cube says in his post.


        You want to put down the minimum you can, and keep as much money in your R/C as possible.
        If you can keep putting down only 5% then well done but I am pretty sure that now post financial crisis you will be in the 80% bracket.
        Hi Blue Kiwi,
        Would have to disagree with you there unless you are a gambler or high risk taker.

        To me, 20% is the minimum deposit to put down in any buy and hold purchase, it gives you a safety margin if prices drop further on down the track.
        If you are always looking for 100% deals, or even 95% borrowing on each purchase to hold, eventually there is a high possibility that you will lose the lot.
        The market only has to go 10% against you, and you will be in a negative equity position, it's not worth the risk.

        Again, nobody knows from one year to the next what will happen to property prices, so why take unnecessary risks?

        Regards
        Graeme Fowler
        Facebook Property Chat Group NZ
        https://www.facebook.com/groups/340682962758216/

        Comment


        • #5
          Originally posted by orion View Post
          Hi The- Victor,

          I agree mostly with what Cube says in his post.


          Hi Blue Kiwi,
          Would have to disagree with you there unless you are a gambler or high risk taker.

          To me, 20% is the minimum deposit to put down in any buy and hold purchase, it gives you a safety margin if prices drop further on down the track.
          If you are always looking for 100% deals, or even 95% borrowing on each purchase to hold, eventually there is a high possibility that you will lose the lot.
          The market only has to go 10% against you, and you will be in a negative equity position, it's not worth the risk.

          Again, nobody knows from one year to the next what will happen to property prices, so why take unnecessary risks?

          Regards
          Graeme Fowler
          Graham thanks. I have read your book - very inspiring and informative -it's a priveledge sir.

          Is it safe then to infer that the issue relates to risk and not so much cashflow. Risk in that if the market goes the other way as Buffet says "we will see who are those that are swimming naked"

          Can one therefore conclude that, if you are a B&H and as long as you are able to finance the outgoings either from rent or other sources using a P&I and you are happy to swim naked there is no difference between 5%, up to the point where the -ve CF equals the difference between 5 & 20% down payment (okay that's a mouthful - I hope it makes sense). However, it's a different issue if using an I/O strategy??

          In short - it's primarily a risk issue and loan servicebility (from rent and/or other sources)??
          Last edited by The-Victor; 13-01-2010, 03:51 PM.

          Comment


          • #6
            Is it safe then to infer that the issue relates to risk and not so much cashflow. Risk in that if the market goes the other way as Buffet says "we will see who are those that are swimming naked"
            Hi The-Victor,
            Well the risk is more with both (cashflow and negative equity) if you put in a lower deposit. You have the chance of the market going against you, as well as having less cashflow if you have put in a small or no deposit. So, not sure quite what you mean.

            Can one therefore conclude that, if you are a B&H and as long as you are able to finance the outgoings either from rent or other sources using a P&I and you are happy to swim naked there is no difference between 5%, up to the point where the -ve CF equals the difference between 5 & 20% down payment (okay that's a mouthful - I hope it makes sense). However, it's a different issue if using an I/O strategy??
            Not really sure what you mean there, maybe say it in a different way. Can you give an example of what you mean? A 5% deposit on P&I is very risky still, on interest only it would be financial stupidity, but many still do it. You will find many of these people hanging out in all the hundreds of threads here on PT having meaningless debates on whether they think prices will go up or down. To them it matters, and it matters so much that what actually happens determines whether they go under this year, or hang on for another year to have the same pointless debates next year.

            Regards,
            Graeme Fowler
            Facebook Property Chat Group NZ
            https://www.facebook.com/groups/340682962758216/

            Comment


            • #7
              That's one of the standard real estate salesman ploys - just keep upping the deposit required on an investment property until you reach the point where you can claim that it is cash-flow positive (or at least neutral), completing ignoring the fact that the mug investor is then getting no return on his deposit money.

              The other standard ploy is to pretend that the mortgage is the only outgoings on a property, no mention of rates/insurance/mainteneance etc.

              To me the only actual cash-flow positive property is one giving a positive return on the total investment of both myself and the mortgage (allowing for at least bank interest rates on my deposit) plus all the outgoings.

              Comment


              • #8
                Originally posted by orion View Post
                Hi The-Victor,

                Not really sure what you mean there, maybe say it in a different way. Can you give an example of what you mean? A 5% deposit on P&I is very risky still, on interest only it would be financial stupidity, but many still do it. You will find many of these people hanging out in all the hundreds of threads here on PT having meaningless debates on whether they think prices will go up or down. To them it matters, and it matters so much that what actually happens determines whether they go under this year, or hang on for another year to have the same pointless debates next year.

                Regards,
                Graeme Fowler
                Hi Graeme et al - I will give an example below of two scenarios. I have used round numbers for simplicity:

                Scenario 1 - $100,000 property with 20% down. $80K loan at 6% principal (30yrs) + interest ($110pw), rates ($15pw), insurance ($5pw) is about $130 pw. If rented at $140pw then the property is $10 pw CF +ve or $520/yr.

                Scenario 2: $100,000 property at 5% down. Loan = $97,000 (95K + 2K PMI) and at 6% repayments (P/I at 30 years = $134), rates ($15), and insurance ($5) = $154pw. The property is -ve by $24pw or $1,248/yr.

                In both cases the analysis is before tax and tax will make Scenario 2 +ve. I have also not talked about maintenance as this clouds the discussion.

                My question is, which is better? say I hold the property for $10 years. In Scenario 1, I have $520/yr CF but no cash reserves. In the second example, I have $24pw negative CF, but I have $20,000 reserve.

                In the first scenario, if the property becomes vacant for a month, I $520 out of pocket. It would take 52 weeks to make that up (i.e. $520/$10 surplus per week). In the second scenario, I can handles 16 years ($20K divided by $1,248 per year) of negative cashflow. But more importantly, I will have the $20K to play with in other more profitable endevours.

                I think the strategy comes unhinged when one does an interest only payment schedule because, then, the loan will not be moving.

                My question was - Is my thinking flawed? I agree wholeheartedly with the risk argument that Graeme posited. But taking risk aside, is the concept of chasing cashflow positive is overrated(??). Shouldn't serviceability be the main driver. Of course at the end of the day the property needs to be paid off.

                Thus, should you automatical;ly seek positive cashflow as the main goal.
                Last edited by The-Victor; 13-01-2010, 10:17 PM.

                Comment


                • #9
                  Rates per week seem low.
                  "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx

                  Comment


                  • #10
                    Originally posted by The-Victor View Post

                    You guys are the experts in this is it not better to pay 5% and have the other $45K as a buffer ......

                    Is my thinking flawed? You are the experts. I am considering another 5% down deal that will be CF neutral after rates, insurance and loan.
                    No your thinking is not flawed.

                    The main point of positive cashflow, in any type of venture, is strength.
                    Positive cashflow will enable your venture to withstand external blows.

                    You trade some speed for some strength.

                    Most people that I know would not be able to hold that 45K in reserve, they would be tempted to get a jet ski or use it for deal No 2.

                    So opt to have it locked into the deposit on the house, as a way to save them from themselvs.

                    Comment


                    • #11
                      Originally posted by McDuck View Post
                      No your thinking is not flawed.
                      Originally posted by flyernzl View Post
                      The other standard ploy is to pretend that the mortgage is the only outgoings on a property, no mention of rates/insurance/mainteneance etc.

                      To me the only actual cash-flow positive property is one giving a positive return on the total investment of both myself and the mortgage (allowing for at least bank interest rates on my deposit) plus all the outgoings.
                      Thanks guys. I guess it's also safe to say +ve cashflow is also a moving target. As +ve CF today may not necessarily be next year as rates increase or interest change.

                      I also wonder if putting down a large deposit would be a viable options if, as is being banded around that one of the recommendations of the Tax Group is the concept of a tax on risk free returnon equity. This basically means the more equity you have the more you are going to be taxed. Also most attractive to just be highly leverage and keep your money elsewhere e.g. NZ and Oz stocks and some of the special UK and US stocks that are not affected by the risk free return concept. And if the tide goes on the property market you transfer you money back from the other investment vehicles.

                      I know, I really sound like I am trying to justify my 5% down deal - the truth is I would be happy to be convinced on CF when deciding on a 20% vs 10% vs 5%, or indeed 0%, deposit - if serviceability is not an issue.

                      Comment


                      • #12
                        Scenario 1 - $100,000 property with 20% down. $80K loan at 6% principal (30yrs) + interest ($110pw), rates ($15pw), insurance ($5pw) is about $130 pw. If rented at $140pw then the property is $10 pw CF +ve or $520/yr.

                        Scenario 2: $100,000 property at 5% down. Loan = $97,000 (95K + 2K PMI) and at 6% repayments (P/I at 30 years = $134), rates ($15), and insurance ($5) = $154pw. The property is -ve by $24pw or $1,248/yr.

                        My question is, which is better? say I hold the property for $10 years. In Scenario 1, I have $520/yr CF but no cash reserves. In the second example, I have $24pw negative CF, but I have $20,000 reserve.
                        Hi The- Victor,
                        My question would be - why are you only holding it for 10 years? To me buy and hold properties are held until they are fully paid off, then depending on the condition of the properties, sell and replace them with something that is a bit more modern and needing less maintenance, or keep them if they are still relatively low maintenance and live off the rents. By selling after only 10 years on a 30yr loan term, you have paid off very little principal even after 10 years. The shorter term you can do it over, obviously the better, but that is where it comes down to servicability of the loans. I am not buying any more properties to hold at the moment. But if I was, the maximum term I would go for would be 15 years. When starting out several years ago, I did do a few 25 year loans, most were 20 year terms, but never 30 year terms, it just doesn't make sense. If you are only looking to hold for 10 years, there is probably very little benefit in owning the property unless you do get any capital gains, which of course is never guaranteed.
                        In your scenarios I would still put in 20% deposit as long as you have some buffer of maybe $3,000 or so if you need it for any vacancies, repairs etc. There would be no point in having $20,000 in an account somewhere earning no real interest each year when you are paying almost all interest on your property loan, which is at a higher debt level because of not putting in a bigger deposit.
                        Yes, I think servicability is very important and I would put it above cashflow, BUT you need to set a minimum yield for any long term purchase. Mine is around 8% based on 52 weeks, some people accept 6%, some 5% or even less which to me doesn't make sense unless maybe you are buying in another country where the interest rates are a lot lower than ours.

                        I guess it's also safe to say +ve cashflow is also a moving target. As +ve CF today may not necessarily be next year as rates increase or interest change.
                        Yes, very true.

                        I also wonder if putting down a large deposit would be a viable options if, as is being banded around that one of the recommendations of the Tax Group is the concept of a tax on risk free returnon equity. This basically means the more equity you have the more you are going to be taxed. Also most attractive to just be highly leverage and keep your money elsewhere e.g. NZ and Oz stocks and some of the special UK and US stocks that are not affected by the risk free return concept. And if the tide goes on the property market you transfer you money back from the other investment vehicles.
                        Until something actually comes into law, we will not know. From talking to others, what may happen is they just do away with investors claiming on depreciation which I don't think would be a bad thing.

                        I know, I really sound like I am trying to justify my 5% down deal - the truth is I would be happy to be convinced on CF when deciding on a 20% vs 10% vs 5%, or indeed 0%, deposit - if serviceability is not an issue.
                        Well, the question you need to ask yourself is where is your money working best for you? Is it better in the bank earning no real interest and just sitting there in case you may need it one day, or is it better to use it as debt reduction which as shown will give you far more benefits.

                        Regards
                        Graeme Fowler
                        Facebook Property Chat Group NZ
                        https://www.facebook.com/groups/340682962758216/

                        Comment


                        • #13
                          My point is that after you start buying you are using equity from initial purchases to buy more houses, as per the ops example.

                          So regardless of whether you put 5% down or 20% down, its still money you are owing to the bank.

                          So the buffer of putting down 20% vs 5% is only a percieved one.

                          You still need to do your cashflow caluclations on the 100% of the purchase price.

                          Your buffer from the potential of falling prices is buying well, and adding value after purchase.

                          Comment


                          • #14
                            My point is that after you start buying you are using equity from initial purchases to buy more houses, as per the ops example.
                            Hi BlueKiwi,
                            That is how a lot of people do it, but definitely not what I am meaning. By using equity from other properties, you are just shifting the debt, so never reducing your overall level of debt. That is what has caught out a lot of, not only investors, but home owners as well in the last couple of years. As prices went up, they refinanced to buy more properties or in the case of home ownership, refinanced to do home alterations, an overseas trip, a new car etc etc. Eventually people that do this will be caught out if their borrowings are always more than 80%.

                            You still need to do your cashflow caluclations on the 100% of the purchase price.
                            Not if you have a saved deposit each time. Sure it takes a long time to do that for most people, what I was doing when building things up was to do quick cash deals and use the profits from these for deposits on rentals.

                            Your buffer from the potential of falling prices is buying well, and adding value after purchase.
                            Yes, that definitely helps a lot.

                            Regards
                            Graeme Fowler
                            Facebook Property Chat Group NZ
                            https://www.facebook.com/groups/340682962758216/

                            Comment


                            • #15
                              Originally posted by orion View Post
                              Hi BlueKiwi,
                              That is how a lot of people do it, but definitely not what I am meaning. By using equity from other properties, you are just shifting the debt, so never reducing your overall level of debt. That is what has caught out a lot of, not only investors, but home owners as well in the last couple of years. As prices went up, they refinanced to buy more properties or in the case of home ownership, refinanced to do home alterations, an overseas trip, a new car etc etc. Eventually people that do this will be caught out if their borrowings are always more than 80%.


                              Not if you have a saved deposit each time. Sure it takes a long time to do that for most people, what I was doing when building things up was to do quick cash deals and use the profits from these for deposits on rentals.


                              Yes, that definitely helps a lot.

                              Regards
                              Graeme Fowler
                              Cheers maybe I should read your book Graeme, as I am just new to PI.

                              But going over 80% on debt is only ever dangerouse when you cant afford to pay the interest bill, as banks will not normally want to take you down just because you have low or negative equity.

                              But then again they would take you down if you couldnt pay the interest bill even if you were 50% geared.

                              So the safety you talk about is the ability to cash up some assets if you need to.

                              My other point is that these days its not the leverage lock of LVR that will stop you getting over 80% into debt, you will never get there as serviceability will always get you first, the banks and their rules are a heck of a lot tougher.

                              I think I only revalued my first purchase in march that was worth around 150k more than I bought it, to be able to purchase another 2 additional properties, before servicability caught up with me, and my wife and I are on reasonably high incomes with homestays.

                              But on this vein, keeping safe is my number one plan, and the buying and holding of as much cash flow nuetral property as I can is my aim.

                              To do this I am having to start working on the second part of my business plan, quick cash deals, however finance is not as easy as it possibly was when you did yours Graeme.

                              Banks want to lend on holds, but they have little interest in short term flips and dare I say it - developing.

                              But to be a serious and safe long term investor I believe that I need to do quick cosmetic renos' and sells.

                              The benefits are 3 fold:
                              1. Greater cash flow and liquidity to keep you safe and possibly pay some bills which could include interest in some cases.
                              2. Larger deposits on new purchases.
                              3. A business income to provide to brokers to show greater serviceablity to be able to get finance to buy more.

                              So those quick cash deals are vital and provide 3 benefits that are very important in their own right.

                              The issue you need to overcome is to be able to get finance for that, and that is a strategy on its own.

                              If you are in the property market place, there are always many great deals that come your way, you would have to blind to not see them.
                              The really good ones you buy and sell.
                              The exceptional ones you buy and hold on to.

                              I think the formula is very simple, but implementaion through a finance plan is the key, I would say that after the crash, finance probably went from being 90% of PI to 99%.

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