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Positive Rental Income Cash Flow Strategy Churns Immediate Returns
Seasoned property investors often prefer apartments that can churn out immediate returns with positive rental cash flow. This typically means that there is a surplus from rental income after deducting the costs of mortgage repayments, management fees, maintenance expenses, repairs, etc. Investors applying this strategy usually does not focus on capital growth. Any appreciation on the property is more viewed as a bonus.
When the numbers are tabulated, a positive cash flow investor is looking for a target percentage of rental yield or a net profit considerably higher than the interest they are paying for the mortgage. This can be achieved by buying properties situated in areas with strong rental demand but low buying demand. Another way is to poke around with tax and depreciation figures until that target yield is met.
Properties that are primed for this strategy are traditionally those that reside in the outskirts of the city and regional hubs. Demographics of the population in these areas are more affected by economic indicators. There is also more land to build more properties which translate to a lesser potential for capital growth. Generally, properties has to tradeoff between high capital growth and high rental yields. When there is limited upside on value appreciation, the market makes up for that with better rental yield.
Investors focusing on rental income yield has to bear in mind that each property provides a small number in hard cash. Therefore, depending on rental income for retirement will require a significant number of properties in your portfolio to achieve your goals.
Key points for success with this strategy
- To live off the rental income requires a good number of properties.
- This strategy has a focus on high leverage to acquire more properties.
- When mortgage interest rates go up, positive rental cash flow will ease your financial burden
- Having multiple properties will spread out your risks
- A better fit for lower income earners
An investment property with positive cash flow is not just one that generates a high rental return. You can actually absorb a low rental return but beef up your cash with depreciation deductions that will result in positive cash flow after tax. Some meticulous investors do not calculate rental yield until tax expenses has been factored in. So sometimes when you see a property as having an unattractive rental yield, an eagle eyed property player could see a huge opportunity when tax matters come into play.
A common mistake that investors are prone to are being too dependent on numbers. Macro factors can have a much bigger impact on a property than rental yield or any transaction data. So instead of crunching numbers to find property with the best potential for rental cash flow, a better investment decision could often be made by looking at big picture macro environmental factors. These include job growth, population growth, infrastructure growth, town planning, etc.
Common mistakes when using this strategy
- Buying based on assumption or emotions
- Buying based on positive cash flow alone, ignoring growth potential
- Planning to use cash flow for retirement
- Too focused on immediate returns, ignoring long term value
- Taking on too much leverage and risk than you are comfortable with
- Refusing to sell even though a good offer is put in from an eager buyer
- Competing with low rental
When a rental cash flow strategy is compared to a capital growth strategy, very often people will choose the former. Income is the key item here. If an investor suffers a loss of income, a positive cash flow property can pay for itself. But a capital growth property with negative cash flow can put your whole portfolio into jeopardy. You might not lose your job, but your spouse who is sharing the financial burden with can. There are many more reasons why someone might suffer a loss of income. When that indeed happens, your cash flow will determine your next form of action.
It is generally accepted that when markets do well, a capital growth model reaps better rewards. While when the market is going down, a cash flow strategy will save you from disaster. There is no better strategy among the two. It is your job as an investor to assess all available data and make your own judgement call on your investment direction.
Disadvantages of this strategy
- Depreciation is an accounting principle. Depending on high depreciation for positive cash flow means that the land is not that valuable.
- If the concept of higher cash flow equates to lower capital growth, you could be looking at a very long time frame to accumulate and build up your net worth.
- Rental income is taxable.
- A month of vacancy can potentially write-off a whole year of rental yields
- Keep a watchful eye on every expense no matter how little as margin is already razor thin.