Why cash flow is the most important buy-to-let consideration
I wasn’t a big fan of maths when I was a kid, but I’ve realised that it’s one of the most important basic skills for buy-to-let property investment success. You don’t have to be able to do calculus or understand Pythagorus theorem, but you do need to estimate your buy-to-let cash flow to make sure your investment property is making money as it should.
Here, I’ll be introducing you to cash flow. You’ll learn what it is, and why it’s so important to be able to work it out as you take advantage of the buy-to-let landlord’s property rental outlook for 2017. I’ll also show you how to calculate your cash flow and work through an example with you.
What is buy-to-let cash flow?
Accountants make a big deal about cash flow calculations, but when you break it down to what it is simply, cash flow is how much money is left from your income after you’ve paid your bills.
In your daily life, when you work out your monthly budget you start with your earnings, pay your rent or mortgage, then your utilities, food, clothing, fuel, car expenses, and so on. If you’ve got money left over, that’s your disposable income. If you’re overspending, then you need to reduce some of your outgoings or increase your income. In cash flow terms, if you’ve got money left over after paying all your bills it’s called positive cash flow. If you’re overdrawn on your income vs. outgoings, it’s called negative cash flow.
Why is cash flow so important to the property investor?
In regular life, negative cash flow is never a good thing. You have to make up the gap somehow, and that’s usually either going to be by borrowing money (say hello to your flexible friend, the credit card) or by working harder:
- Borrowing money will increase your outgoings, so you’ll be cash poor.
- Working harder usually means doing extra overtime, and that takes you away from friends, family, and the things you love doing. You become time poor.
- If your negative cash flow situation continues, you’ll eventually become both cash and time poor.
The situation is similar when you invest in property.
For most (but not all) buy-to-let investors, the goal is for the investment property to produce positive cash flow. It provides extra income, and the funds to tuck away to cope with maintenance emergencies or unexpected void periods.
Some property investors are relaxed about taking on a negative buy-to-let cash flow property. They’ll happily make up the shortfall between rental income and running expenses because their goal is not income but capital gain. It might sound crazy to be happy to subsidise a property that has, say, £200 negative cash flow. Why would anyone want to buy a property that is going to cost you £200 month-in, month-out? Well, what about if you expect that property to increase in value by £600 every month? Effectively, you’ve created a savings scheme that pays you £400 interest on every £200 you put in.
So, being able to work out your cash flow is important not only because it tells you whether your property investment business is producing income, but also because it ties in with your investment goals. It’s an essential part of your property investment strategy.
How do you calculate buy-to-let cash flow?
At its basic level, cash flow is easy to calculate:
Rental Income – Buy-to-Let Expenses = Cash Flow
While this looks easy, miscalculation of cash flow (before investment and after a property has been bought) is one of the most common reasons for a property investment to go bad.
The problem with working out an investment property’s cash flow is not the maths, but making sure you’ve included everything that needs to be included.
What’s included in cash flow?
The income side of a buy-to-let portfolio is easy to account for: it’s the rent you receive.
It’s the buy-to-let expenses that cause the problems – especially when estimating cash flow to assess whether you should invest in a property that’s been offered to you. If you miss a single item or make a mistake when estimating your expenses, it could drastically alter your view of the investment opportunity.
Over the course of the next couple of articles, I’ll tell you about the cash flow items that the sales agent won’t tell you about unless you ask, and wrap up this series about cash flow with a complete list of all the expenses you should include when calculating cash flow. Right now, let’s work through a basic buy-to-let cash flow example.
Jane’s buy-to-let cash flow
Jane’s considering buying an apartment in a newly built block in an area that is undergoing massive regeneration. Having spoken to the local letting agents, the rental income that she is expecting is £900 per month.
Her buy-to-let mortgage of £150,000 costs £530 per month in interest. She decides to allow for a one-month void period every year, which seems about average for this area and prudently decides to allow 10% of rental income for maintenance. If maintenance charges come in lower, she’s decided she’ll simply put any unspent portion into a contingency fund. She gets a quote on landlord insurance, and that costs £20 per month. Finally, she doesn’t want to be dealing with the day-to-day problems of property management. And allows for management costs of 10% of the rental income.
She calculates that her expenses will be a total of:
|Expense Item||Per Month (£)||Per Annum (£)|
As her monthly rental is £900 per month, Jane is happy to go ahead and purchases the investment property:
Cash Flow = £900 – £793 = £107 per month
Within a couple of months, Jane’s investment started to unravel. In my next article, I’ll begin to explain why.
If your property isn’t producing the cash flow it should, you could be overpaying for property management. Contact me or one of the Ezytrac team today on +44 1522 503 717. We’ll be happy to work through your cash flow with you. Together we’ll figure out how and if there’s a way to get your cash flow back on track.
Yours in effortless property management,