I spoke to an investor 6 months ago who told me he was asset rich but cash poor.
What did he mean? He had bought several investments off plan, and several low yielding deals which he hoped would have good capital growth. Therefore while he had several good assets on paper, these assets were actually costing him money each month, meaning he had a negative cashflow.
This can be ok, if some areas of your life, or investments, are making a positive cashflow to balance this. However this investor did not have this, and he ended up being forced to go back to work, and selling a couple of these low yielding assets for a loss – as he was put in the position of being a desperate seller – that is, desperate for cash.
It is crucial to always be aware of how important cash is when running a business – which property investing is.
The reality is that without cash, you won’t last very long. This may seem obvious, however it is very easy to buy assets, and then realize you do not have enough money coming in each month – which can leave you in a very difficult position. Property investors must try and plan and prepare for all potential future events and market changes. This can include interest rate changes, economic changes or market sentiment changing, as well as changes in your personal life which you may not immediately associate with your property investing – such as promotion at work, or worse, being made redundant, or having children which can all make big changes to your cashflow as a whole.
So I would suggest, the most important aspect of planning, for a property investor, is not expected capital growth, historic data, cost of borrowing, or yields but is effective cash flow management.
Failure to properly plan cash flow is one of the leading causes for failure. I know how tempting it can be to overstretch yourself and put all your liquid cash into assets – and then due to an unexpected, or more likely unplanned for, poorly performing asset, find yourself over budget and desperate for cash short term. You then are looking to borrow cash, either through loans, or overdrafts at less acceptable interest rates. However if this runs out you can be left with difficult decisions that are forced onto you by poor planning. This usually involves selling an asset, at a price below its value, as you are desperate for cash short term to support your property investing business overall.
Cash flow serves several purposes.
Firstly it is used for meeting normal cash obligations such as paying mortgages, buying costs, development costs and covering voids.
Secondly, it is held as a precautionary measure for unanticipated problems. This is the area that usually is forgotten by investors. A cash reserve should be available for these unforeseen problems – this can be actual cash, or a flexible mortgage or overdraft, but must be available.
Thirdly it is held for potential investment purposes. The term “cash” refers to those assets that are liquid and have immediate cash redemption value.
There is not a problem with buying a property or land that costs money in the short term ie a plot of land to develop on, or a property off plan, indeed this can be very profitable – but it is clear that this will not generate cash in the short term – and therefore you must make sure this is properly planned into your overall strategy.
I always think it is important to have a good level of cash generating assets – ie generating more money than the costs involved with borrowing and maintaining the asset.
This gives you a positive cashflow which can help balance out less well performing assets, or can be held in reserve for emergencies or future investments.
The other attraction of holding cash positive assets is that if you are ever forced to sell an asset due to an unexpected change in your professional or personal life, there should always be demand for cash positive assets, and therefore you should be able to sell this on relatively easily.
For example, if a property development you are carrying out goes wrong or over budget, and you need extra cash – if you own a buy to let in the UK which is generating a gross yield of over 8% – or a net yield, ie after all costs, in any country of at least 2% – then this should be attractive to other investors and you should find a buyer relatively easily or be able to refinance this asset, which should generate cash quickly.
It is no surprise that when you go to the banks requesting more money, they want to know your monthly cashflow – they need to see from your projected monthly cash flow if you will have the capacity to repay the loans or mortgages.
So when you are forming your property investing strategy – ask yourself the following questions,
How much cash will my assets generate? How much cash is required each month? How much cash do other areas of my life require? And how much do they generate?
Ie. if you have a high paid job which you enjoy, which generates a high positive cash flow, or you already have assets generating extra cash on a monthly basis – you may be able to buy assets that will not generate money in the short term, as you can cover any short term costs, or unforeseen circumstances. You may therefore want to look at a longer timescale, and may go into property development, buy into a property fund, buy a plot of land – where you are comfortable tying up this money for a period of time, confident that it will rise in value, and you will have no short term need for this asset which could compromise the value.
If on the other hand you are pretty stretched already for cash on a monthly basis ie say cashflow neutral, you may well want to buy an asset that immediately will generate cash, or at least as soon as the mortgage, borrowing costs start ie a more traditional buy to let.
There are many ways to make money as a property investor – but financial planning is always key to ensure your cashflow stays positive to allow you to grow your property investment business.