(Part 1)
Can I play devil’s advocate for a minute?
It seems to me you have to achieve one or more of the following to make this positive cash flow concept work:
* Buy at a substantial discount.
* Achieve a weely rent way out of proportion to the value of the property.Example:
Let’s say I’ve selected a property and negotiated the purchase price to be $75K. Using Steve’s analysis method and assuming I’m right on the money with the 11 second rule:
Purchase Price: $75,000Deposit (20%): $15,000
Total closing Costs: $ 3,750 (i.e 5% of purchase price)
INITIAL CASH NEEDED: $18,750LOAN
Principal: $60,000
Loan Type: P&I
Term: 25 Years
Initial Interst Rate: 7%
Weekly Payment: $97.78ANNUAL CASH FLOW RECEIVED
Rent Per Week: $150 (Set at this to satisfy the 11 second rule.)
TOTAL CASH FLOW RECEIVED: $7,200 (Allows for 4 weeks vacancy)ANNUAL CASH OUT
Loan Repayment: $5,085
Management Costs: $ 432 (6% of rent)
Rates: $ 500
Building Insurance: $ 800 (Estimate from NRMA)
Repairs Budget: $ 360 (5% of rent)
Total Cash Outflow: $7,177ANNUAL NET CASH FLOW: $ 23
CoCR: 0.13% (Before tax)Now, how do we achieve a return more favourable than simple putting the cash in an ING account with no risk at 4.75%? To get a CoCR of 10% we need to get a net cash flow of $1,875 pa plus a bit extra for increased costs. Note that this would mean the management cost and repairs budget would increase (Although this has minimal effect). We could increase the rent.
INCREASE RENT
Rent Per Week: $ 194
TOTAL CASH FLOW RECEIVED: $8,352 (Allows for 4 weeks vacancy)ANNUAL CASH OUT
Loan Repayment: $5,085
Management Costs: $ 559 (6% of rent)
Rates: $ 500
Building Insurance: $ 800 (Estimate from NRMA)
Repairs Budget: $ 466 (5% of rent)
Total Cash Outflow: $7,409ANNUAL NET CASH FLOW: $1,903
CoCR: 10.15% (Before tax)Comparing this back to the 11 second rule:
$194/2*1,000 = $97,000 (This looks ok)(Part 2)
Comparing this to “normal” rental returns:
$194*52/$75,000 = 13.5% (rent pa / purchase price)
If the “normal” expected rental return is 5% then 13.5% sounds like a big ask.To justify the above average rental retun on our purchase price we could say that we bought the property at a discount and base the rental retun on the “real” value of the property. If we say that the “noraml” rental return on purchase price is 5% then we get:
Rent: $10,088 (194*52)
Rental Return: 5%
Real Property Value: $201,760 (10,088 / 5%)So in summary, we’ve bought the property at a 63% discount.
No wonder these properties are hard to find!
This example provides a 10% return which while better than the bank doesn’t seem to flash considering the risks.
Next thing is we want +ve cash flow so let’s assume zero growth. With zero growth I wouldn’t be banking on the rent to be rising to fast. On the basis that we are already receiving an above market rent it might make it even more difficult to increase the rent each year. If the rent doesn’t rise each year then the time value of money principle means that our real return is decreasing each year.
It seems to me that buy and hold for positive cash flow is a bit unrealistic unless you are doing this full time. Doing it full time means that you have large amounts of time to see lots of properties which makes it more likely that you’ll uncover the prpoperties that will work. i.e. Let’s say you find 1 that will work out of every 100 qualified properties that you see. If you can only look at 5 a week it could take 6 months to find a property. If you can look at 10 a day you’ll find at least one per month.
Does that mean that wrapping is the only viable option for people who still have to work full time? Does any of this make sense or am I completely off track?
G’day…
Also a maths nut.
You are spot on.Me….30 + years in Real Estate as Principal mostly. Concentrated on Investors and Propert Management in the latter years as well as Mortgages, Money Markets experience etc,etc.
In other words I reckon I’m qualified to make a few statements……I will be making a general observation,of course there will be exceptions.
In this business…of Cashflow Positive Real Estate Investment to get better than 10% net it will be Regional Aussie. Given the World wide Real Estate boom…it will now be on the outskirts and “rougher” areas of small towns.
Immediate problems…what sort of person does this attract ? They live there cause they have to…not want to. Employment opportunities ????Reality …the bottom end of the market is your client. WE are at the end of a 9 year big run in Real Estate and prices will pull back 25%-35% in areas other than “Prime Real Estate Locations”.
Wrap deals, lease with option to purchase and flips are good in a rising market…probably over for now.
Buy and hold + geared maybe + today but- tomorrow.I look forward to the next couple of years as the higher rates begin to “hurt like hell”…there will be “blood in the streets”….a buyers market.
Ask yourself this question “Would you wrap a deal in todays market, that covers your costs and risk and gives you a profit, to a family member or your best mate ?
So what do you do while we wait out the next 6-12 months or so ? Research, learn, put in the hard yards and give your financial position a reality check. Get positioned for a buyers market. As you make your $$$$ when you buy, you must be skilled enough to know what you are doing.
From my experience…when the average person, who has NO expertise in Property Investment starts talking about wraps etc…..they or their clients are going to get hurt. Most will need their “hands held” for at least 5-10 deals.
So, they need a mentor and need to do their
apprenticeship FIRST.You read yesterday on this forum where a couple made an offer that was accepted. Then discovered that they made an error and it was negative cashflow…not positive. Of course we all make mistakes and I commend them for their efforts in getting their feet wet. But the repercussions of people entering this field before they are qualified will prove to be a disaster.
I suspect that you have approached this from the buyers point of view….as we should. You have come to the same conclusion as I have. Deals are out there but not for those without skills or a mentor.
I wish you well
Billfromoz
Hi Bill,
Great response. In this forum there seems to be an attitude of buying if you can find a good deal. Your argument for holding out and strengthening your finances, appears to have strong merit. I was considering this myself, however I seemed to be in the minority. Thanks for the balanced advice.
Keep smiling,
Sue [
]Be careful not step on the flowers when you’re looking at the stars
Hi Fivekids and Billfromoz
I hear what you are both saying, However I have sat on my hands long enough to scared to lose what I have while property has made so many financially dependent or even rich. I also agree about the Mentor being a great aspect of successful business but found alot of cloke and dagger in the industry and a lack of mentors.Anyone willing to mentor this wet behind the ears but enthusiastic newbie? I have the drive and motivation and many skills, but a Mentor would make all the difference.
Regards Wildbear
I agree that you shouldn’t sit on your hands too long. In fact I don’t think you should sit on your hands at all. However, that doesn’t mean jumping into the first thing that comes along. The first step is always to do your homework and understand what it is you’re doing. If you’re not getting to the point where you can proceed with confidence then either you don’t have the apptitude or don’t have a mentor to guide you. You can fix both of these things if you want to. Depends on your circumstance but I maintain it’s better to proceed with caution and make some profit rather than jump from one great opportunity to another, chasing the big deals but never hanging around long enough to see something through.
Billfromoz,
I totally agree with your “blood in the streets” scenario.
But I was interested in your comments re wrapping also only being good in a rising market. Can you expand on this statement and explain why please.
My thoughts are as follows (based on many hours of inexperience[
][]):I was considering wrapping as a hedge against falling/stagnant markets. In answer to the question would I wrap to a family member or mate in the current market?
The answer is a qualified yes…..ie providing the deal makes sense for both of us. A wrappee is genarally not interested in capital gain in the short term, they just want to buy a house and the banks dont want to come to the party. Eventually they will get their capital gain.
Also, will the market actually crash 30%?…Well I think it will IF interest rates start trending up strongly, otherwise I think a long period of stagnation is more likely.
But I believe a correction in prices is on the cards, because interest rates will rise eventually.
Wayne
Buy and hold + geared maybe + today but- tomorrow.The only way it can be positive now and negative tomorrow is if either your rents go down and/or your interest rates go up.
Here’s an example to support Billfromoz’s post:
Have a number of rental properties (Victoria)which hubby and I live off, bought over last 15 years while bringing up 3 kids and both working full time(on low to average wages)Followed Jan Somers advice early on and bought at the lower end of the market in the suburbs and held.
Now we look at regional cities. Over the last 6 months, we have found that cheap properties are on the edge of town, run down and we know from experience, just wont rent well.This wasn’t our experience 12 months ago when we bought good positive cashflow property close to town (e.g. Lakes Entrance including a to-die-for large waterfront block of land for $32k)
So we just bought a house in a large rapidly growing regional town,with dual occupancy potential on a corner, beautifully renovated but far below suburbs prices.
Still no positive cashflow, but the land, house and rental return make it a good investment for the long term..a buy and hold.
(We have stuck to the dual occo formula and it works for us).
A question though …I know about property cycles..but we have a wildcard happening surely…all the 50 and over babyboomers who have to invest in something with their superannuation pay outs in the next 5-10 years..They need to be factored into the property investment market. They aint going to all be happy with just buying shares.So this could keep the market up?Question:
What happens in an economy where there is a lot of cash? (ie people cash out their investments/superannuation)
I can see the argument that the stock markets are going to crash 2016. (baby boomers cashing out) (this will also affect commercial property/and possibly mortgage markets) due to managed funds being diversified…
So if they do that, wont that put pressure on inflation?
Dont you think that baby boomers would want their money in something a little more liquid than an investment property or 3?
my god. just realised how old i’ll be if i make it to 2016!
NB: there is no depreciation allowances in your calculations.
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