I posted this elsewhere with no response, so here goes as a new topic. I am campaigning for a general agreement that the definition for positive cashflow should be with zero deposit.
Much has been written about the value of positive cashflow (+CF), or positive gearing on an investment property. Cashflow, however, is subject to the time value of money, so looking at initial CF is a short-sighted view. The deposit payment made by a purchaser on an investment property is often ignored in the CF calculation.
Consider a hypothetical case for demonstration purposes:
$100,000 Purchase price
4% Inflation (applicable to rental and outgoings but NOT finance payments)
$645 Net monthly income (rent less outgoings) excluding finance paymentsLet us consider two financing options here, both at 6% interest over 20 years:
Case A: Zero deposit = ($716) monthly payments
Case B: 20% deposit = ($573) monthly paymentsThis means that (in terms of the definition often bandied about):
Case A is CF negative at $645 – $716 = ($71) and therefore BAD[glum]
Case B is CF positive at $645 – $573 = $72 and therefore GOOD[exhappy]
This definition of cash flow glibly ignores the $20,000 CASH deposit.Looking at the actual annual CF, reveals the following:
Annual Cash Flow
Year Case A Case B
0 $ 0.00 $ -20,000
1 $ -550.69 $ 1,168.74
2 $ -228.83 $ 1,490.60
3 $ 105.90 $ 1,825.33
4 $ 454.02 $ 2,173.46
5 $ 816.07 $ 2,535.51
Case B still looks OK, eh?However, converting this to cumulative CF, results in:
Cumulative Cash Flow
Year Case A Case B
0 $ 0.00 $ -20,000.00
1 $ -550.69 $ -18,831.26
2 $ -779.53 $ -17,340.66
3 $ -673.63 $ -15,515.32
4 $ -219.60 $ -13,341.86
5 $ 596.47 $ -10,806.36The –CF investor in Case A has actually earned about $600 after 5 years, while in Case B with +CF the investor is still about $11,000 out of pocket. This demonstrates that –CF (by the broad definition used) is not necessarily a bad thing. More important is what is the return, and how soon does it turn positive.
Many start-up property investors might believe that you need a deposit in order to start, or that you have to find a +CF property. However, if the –CF is manageable within your monthly personal cashflow situation, then one does not need the initial capital and the negative cashflow is not necessarily bad.
As property is generally a long-term investment, a long-term analysis tool that takes the time value of money into account is required. in my opinion, Internal Rate of Return (IRR) is a useful tool for this.
IRR over 20 years shows that Case A has a return of about 62% while Case B has an IRR of 19% (assuming capital appreciation at inflation rate over the 20 years as well). This also demonstrates the advantage of leverage by using OPM.
Which returns me to my initial question of at what deposit level do we consider a property investment positive or negative? By the definition used above for Case B, I can make any property investment cash flow positive by increasing the deposit and ignoring the fact that the deposit is part of my cash flow.
A true definition of a +CF IP should be one where there is zero deposit. Everything else means we are trying to fool ourselves and comparing lemons with apples.
Whadayasaynow?
Glenn
“A true definition of a +CF IP should be….”
A while back we had here ‘the true definition of a millionaire should be’…….
opinions ranged, and nobody could agree. *yawn*
tax strategies, income, equity, LVRs, borrowing capacity, too ‘rent-reliant’, no money down – one juggles these kind of factors when one invests to be able to keep on investing – perhaps no money down with a CF surplus is a holy grail, because it means ‘infinite returns’. It’s no longer a ‘percentage yield’ on what money you have in the deal any more – because you have no money in the deal! looks all very fancy on paper -.
If that’s the only kind of investment you buy, or want to buy, or think is worthy, that’s fine – go for it. they’re out there. You’ll have to look harder than most, which may take more time – and there’s your time/money study again. Your call as to how much money your time is worth.
And you not only have to find them, you have to arrange finance for them.If you can get 100 percent finance and have them break even, great! 15-20 percent gross yields in NZ as I own should achieve this on current interest rates.
however, whether you can get 100 percent finance and replicate it is another matter.
10.4 percent yields (the 11 second solution) should break even at an 80 percent LVR, an LVR which is also replicable as it keeps the banks happy.
think that this is a key to the whole concept of CF+ve – you can keep going. Is it better to keep going and have 20 percent equity in the deal, or stop – because you can’t find enough deals easily that break even on 100 percent lends, or – even more frustrating, you can find ’em, but the bank won’t lend you 100 percent?
joy to the world
Hi guys
sorry i can’t contribute much to this one it’s getting late here in NZ (after 10pm).
Mini is right on the ball with the comment about you can keep going with cash positive properties. Some people do a great job and aquire 10 some 20 some 30, There is a very strong rumour about a chap who bought 130 in 3 1/5 years. I wonder how many properties steve could have bought if he went for properties returning 3% yeild. (not 130 i bet).
i would still own 1 I.P. if i bought a 300k property that was negatively geared.Sorry Glenn i’m not addressing your comments but i am doing my best.[offtopic]
regards westan
I find +ve cashflow deals in New Zealand which I sell to other investors. To be on my database send an e-mail to [email protected]
Hi Glen,
You’re correct, any property can be made cashflow positive with a sufficiently large deposit but that’s not the point. It’s the return on that deposit that counts, or to use Steve’s terminology, ‘cash on cash return’.A positive cashflow property returning 4 or 5 percent is a waste of time and money (unless you can guarantee fabulous capital growth), better to put your money in the bank. Similarly a negatively geared property, that costs you money limiting further investment on the promise of possible future returns, is also problematic.
Much better to have a cashflow positive property that produces high returns now that enhances your ability to invest further.
Phil
phil – AKA “Still finding my forum feet ” –
I reckon you’ve SOOO found them. Couldn’t have said it better myself.joy to the world
Originally posted by Physics:Hi Glen,
You’re correct, any property can be made cashflow positive with a sufficiently large deposit but that’s not the point. It’s the return on that deposit that counts, or to use Steve’s terminology, ‘cash on cash return’.A positive cashflow property returning 4 or 5 percent is a waste of time and money (unless you can guarantee fabulous capital growth), better to put your money in the bank. Similarly a negatively geared property, that costs you money limiting further investment on the promise of possible future returns, is also problematic.
Much better to have a cashflow positive property that produces high returns now that enhances your ability to invest further.
Phil
Hi Phil,
Sorry but i have to contridict and i am with Glenn, i honestly dont bother with CoCR, to me there not that important, yeilds i do like to know, for when the property was purchased and its, todays current market value…
… but most importantly, i work on IRR…
one comment that you mentioned that, i totally disagree with is…
Similarly a negatively geared property, that costs you money limiting further investment on the promise of possible future returns, is also problematic.sorry, but i do beg to differ, personally, my portfolio, consists of a number of -ve geared properties, and most people, would squeal and stress and have many, sleepless nights…
but, by just using simple caculations like IRRs, im definetly way ahead, than if i was to invest in +ve cashflow properties…
…there is positives about negative geared properties…
Cheers,
sisHi guys
I’m in the firing line….. which is to be expected. Thanks for all the comments, some replies:Firstly, you would be mad to get a loan over 20 years. This creates too much of a burden. Second, why would you make P&I payments?A longer term improves the cashflow situation. As the tenants are paying it off, I’m smiling. Unfortunately I am in a P&I only environment too, but that is easily changed by re-financing. I’d love to have an interest only loan over 99 years!
You also forgot to mention that to obtain 100% finance on an individual property, it will cost you a lot more – ie: between 2.5 and 3.5%.Good point, this would have to be taken into account in the analysis.
“A true definition of a +CF IP should be….”
A while back we had here ‘the true definition of a millionaire should be’…….
opinions ranged, and nobody could agree. *yawn*There’s no way are all going to agree, but I value the debate, cause I gain in learning all the way.
perhaps no money down with a CF surplus is a holy grail, because it means ‘infinite returns’This seems to be what beginners fret about when they hear about CF+. They wonder if those CF+ stories are true, however, if the definition of CF+ means I can put down any deposit I want, then ANY deal can be made CF+, even a bad one. If it means 0% down, then is CF+ a holy grail? Infinite returns is what we are aiming for.
think that this is a key to the whole concept of CF+ve – you can keep going. Is it better to keep going and have 20 percent equity in the deal, or stop – because you can’t find enough deals easily that break even on 100 percent lends, or – even more frustrating, you can find ’em, but the bank won’t lend you 100 percent?I agree totally. The criteria is not whether it is CF+ or CF-, it is about returns, as Physics said
It’s the return on that deposit that counts, or to use Steve’s terminology, ‘cash on cash return’I would rather have a small -VE than tie too much capital into a deposit (Yes, if I can get it).
The objective is maximum returns – which means lowering deposits, increasing income, reducing finance payments and outgoings, not necessarily CF+ or CF-.How much capital deposit was used to buy those 130 IPs? If one had to put (say) 20% down on all IPs, how many can you buy this year?
Looking forward to it!……
Phil,
What do you think is the minimum %age return you should be looking to make on a +ve CF property? You said not 4 or 5%, so I am wondering how much above that it should be to be worthwhile. Also, is the %age the same whether it is a buy-and-hold or a wrap deal?
Thanks, taurus
taurus
Rob
In note your indignation at my 11% interest rate.
I’m in Namibia, Southern Africa, where the environment is a “leetle” different to yours, hence the strange foreign customs on interest rates.
However, I am of the opinion that there is a basic relationship to the overall investing scheme of things. Our rates are like this:
Interest: 10-13%
Inflation: 6-8%
Property capital appreciation: 7-10%+ (my experience)In general, wherever you are, these interest rates are related, so if interest rates go up, so does inflation and vice versa. These things may seem strange in Aus when you’re used to single digit inflation figures. We’re just glad that we’re out of double digits. Zimbabwe is learning to live with 3 digit inflation, thanks to Bob. We bought our house when interest rates were about 18%, now were down to 10.25, talk about relief. The house is paid off 10 years, while we took out a 20 year loan.
As the world gets smaller, there are common standards for various things, driven mainly by common issues such as the internet. Time that the world economy started standardising a little….. so we can invest further afield with lower risk.
Gnight
Glennglenetti,
Totally disagree with your definition – as do all the property writers I have read & all the experienced property investors I know.
Why try to change the definition? Just do your own thing.
Cheers,
Aceyducey
I personally agree with Glenetti as I look for +ve CF properties without putting down a deposit. They are my own definition of a +ve CF property. Sure I could take part of our LOC from our own home and use it as a deposit, but I like the fact that we have about 40K left to pay off it.
I have just bought an IP that has a yield of 16%, so with no deposit, it returns $25 a week on a $27K outlay.
That is the sort of property I am looking for. I am not in for the quick kill, if it takes me 2 years to get 5 of these properties I will be satisfied that I have done the right thing.
Maybe I am a cautious investor, but you know – that’s how we have got to where we are, and my wife and I are pretty happy with what we have achieved so far.
‘Eat rich food, barbeque a yuppie’ [greedy]
glenetti,
You said you weanted a “general agreement” from people- good luck! what you will get is individual’s different ideas.
I don’t see the amount of deposit one puts down as having anything to do with yield. yield – to me- is yearly rental divided by purchase price, then move decimals. Then I can work out why the yield is – for me.
Some people whack in a big deposit and then have what *I* personally would see as an inflated percentage yield. Other people might choose to count purchase price PLUS all costs throughout the year- in which case their percentage yield might be very low.
However you calculate it, the only person you need to explain it to yourself. If people are putting in 40% deposits so they can rave about their multiple figure yields, I think they’re kidding themselves.
kay henry
Hi Everyone and Kay
I’m back online after a trip investigating other folks IPs in the Eastern Cape of South Africa (B&B, Self catering, property market etc) with my family. Isn’t this property investment business great – a holiday turns into a clandestine business trip which is also tax deductible and my wife only briefly rolled her eyes.
I agree with Kay, I won’t get general agreement. I’m looking more to bounce my ideas out there and see what comes back, and the learning process is great. The object is not to convince each other, but to trade ideas and often we can happily agree to disagree.
I still believe that:
1) The OPEN definition of +veCF is misleading, because some folks conveniently forget that their deposit is part of the cashflow.
2) A -veCF which turns +ve in the near term can be a worthwhile investment, so using CF alone as an analysis tool is potentially dangerous.However Kay, I’m intrigued how you can ignore the deposit and use yield the way you do. For me, yield is return on the cash I invest. The purchase price is leveraged and OPM is not my money (YET) until realised thru sale or refinance. The deposit is certainly my cash that I could have invested anywhere or spent. Personally I don’t like Yield at all. In my neighbourhood it results in frighteningly small numbers that sound like I’m going nowhere, yet the reality shows otherwise.
Glenn
It’s the “investing it sensibly” part that buggers me lol.
The future belongs to those who believe in the beauty of their dreams. – Eleanor Roosevelt
Again a topic that all investors are different and therefore their portfolio is varied and somewhat different from mine. Yahoooooooo, im so glad to be with such a diverse group here and with different slants on each and every theme.
For me, a positive cashflow proerty covers all costs and gives you $1.00 per year profit.So if your basic equation 2 years ago when interest rates were 5.5% was needing a 7.5% return to cover all costs then now Im getting 6.67% on 1 loan I should get 8.67% as my minimum. Quite unrealistic in this environment.
So, instead of basing it on paying all costs> My calcs cover mortgage and agents fees in needing 7.5% or 1.5/1 ratio on rents. This means I pay for rates/maintainance and body corp out of my pocket. This equates to $2-3K/prop/year so its small stuff. If I find these for myself(which I do), this is the criteria I use to determine suitability of props.
Hope this is clear enough.
DD
Oh yeah and yes Mini will help me in NZ for cash very soon.[biggrin]Hi Mini, love your work.Don’t sweat the small stuff,and it’s all small stuff!!
glenetti :o)
Don’t be intrigued by my simple way of doing the maths. I have avery simplistic approach to RE. Even using other people’s money- becomes *MY* burden- because I have to pay it back. Using a deposit – say from my equity- is still using *my* money, and I sill have to pay that back.
I know that no money down etc is a really fashionable thing in RE… but I want to get my properties paid off! hehe- call me strange
I could owe 800k and have 200k equity, therefore having 80% LVR and thinking of my situation as quite sound… but really, I’d probably prefer that the OPM of the Bank was MY money, and that the OPM component was the 200k and that I owned the 800k.It’s not like I work in cash these days- who takes a bunch of rolled up 100 dolalr notes into a bank for a deposit unless it’s your first property? So the money comes from somewhere- either my money- which I don’t owe (equity) or the banks’ money. Even when it’s my money (equity) I still then have a larger loan- that I have to pay back.
As a person who hasn’t really been able to poisitively gear for the kind of properties i want (of course we all want 10% yields- but you can’t get them on the more exxy properties), it is important for me to pay off loans. It means I can buy more properties, and not just rely on elusive booms for CG. Paying off debt has something to be said for it
)Sorry glen, if the above is different to the question you originally asked. But I believe it still has relevance in these times of no money down.
Are other people trying to pay their properties off too? By putting in additional money each week? Or are you just letting your rental yields slowly pay back your mortgage?
kay henry
Sorry Kay, I’m trying hard to wrap my head around your approach, but it is really hard for me.
Paying IPs off is a snails approach to growth, but certainly less risky. You do this because you want to own your property outright?
While you use the banks money, don’t let the obligation of repayment give you sleepless nights. The bank only loaned the money because the investment is so secure – which is why they only give you 80% of the value, and then also try to force you to sign your life away in a surety [now that is one to worry about]. Worst that can happen, is you give the keys of the IP to the bank, as it is “their” property.
Your equity can be converted into rolls of cash [cigar] so I see it as the same thing = my money. [oops, not your equity = my money, as good as that would be – that’s how a wife sees it]
The only property I’m paying off rapidly is my PPOR for tax reasons, however, I still use it as collateral for other loans.
Interestingly, Kay and DD both admit that you’re happily running with -ve properties. I think there are very few +ve cashflow deals out there with folks own equity (deposit) invested in them, according to the 0% deposit standard. If that were the case, then it would mean that there are a whole lot of really stupid (or desperate) sellers and plenty of really clever buyers. Not in this shark tank!
Glenn
Glen,
Back to my simplistic approach :o) Paying off IP’s means I can afford more IP’s. If I pay an IP off in 7 years, then I can use that built up equity to buy more. People say one can’t afford to keep borrowing if one has neg IP’s. But one CAN if one pays off the IP’s at a more rapid rate. In fact, I reckon it is not a snail’s approach, but a hare’s approach :o) I have always seen “investment” as something one puts *into* and I am happy to chuck my money into a loan to have it paid off more quickly. Why was Anita Bell’s book such a best-seller? Because some people still want to pay off their places- then you can keep borrowing, increase equity etc. But I do NOT have the Anita Bell practice of living like a pauper until you have your place paid off- that to me is a waste of a life.
I would hate to hand the keys back on an IP [glum] Awful. The less we owe on ONE IP, the more IP’s we can buy! [party] And isn’t that the point?
kay henry
Kay, I’m still battling to follow your logic.
Are you saying you stash excess funds into one IP at a time, THEN you use the equity for the next one, only once paid off?
7 years is a very long time between investments.
I also put excess capital into my loans, but only to draw on it when I find the next IP, not to pay off.
Glenn
I could owe 800k and have 200k equity, therefore having 80% LVR and thinking of my situation as quite sound… but really, I’d probably prefer that the OPM of the Bank was MY money, and that the OPM component was the 200k and that I owned the 800k.
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