When looking at a property deal it is important to understand the numbers and how to calculate the cash flow on an investment property. This will enable you to identify the holding costs of the property. While identifying whether you will need to pay additional funds to keep the property. Sometimes, investors fail to accurately calculate the cash flow on a property. This is a huge risk that can leave them out of pocket with more expenses than they first anticipated.
Example of a cash-flow analysis
The following is a basic example of how to calculate the cash flow of a property which can be done before a purchase:
| Upfront costs | Expenses (per annum) | Income (per annum) | |||
| Purchase price | $500,000 | Repayments (Principal and interest at 3%) | $20,232 | Rental income | $26,000 |
| Deposit (20%) | $100,000 | insurance | $1,500 | ||
| Stamp duty | $18,000 | Council rates | $2,500 | ||
| Lenders mortgage insurance (LMI) | $0 | Property management fees (8% of rental income) | $2,080 | ||
| Loan | $400,000 | ||||
| Total investment | $118,000 | Total expenses | $26,312 | Total income | $26,000 |
| Cash-flow (+/-) = – $312 | |||||
As illustrated in the table above the cash flow on this property would be negatively geared, although, it is quite close to being neutral. If the property has depreciation benefits this could also be used to further reduce the tax paid. Over time, the cash flow on this property can increase if rental income increases and additional repayments are made.
The importance of a cash-flow analysis
When purchasing a property, the investor wants to know the costs of holding a property before purchasing. In order to determine the gearing of a property/ the property’s cash-flow position, an investor needs a way to calculate the incoming vs outgoings. This requires the use of a cash flow analysis. By taking into out the expenditure and income the investor has a clearer picture of their financial position. This may dictate whether the property will be a viable investment option from a cash flow perspective.
In order to do this correctly, it requires the information for the analysis to be accurate. An accurate and well-informed cash-flow analysis will give greater clarification around the financial position of a property. An accurate cash flow analysis incorporated into the due diligence of an investor’s research is a necessity for any serious property investor.
Things to consider
Sometimes on the surface, a deal can appear to have minimal holding costs or be presented as a great cash-flow investment. However, completing an analysis can help to highlight any hidden costs which may arise that weren’t first anticipated. Although, there are numerous considerations that should be taken into account in order to determine the true cash position of a property.
Firstly, It is also important to note that using conservative numbers during the analysis will help to protect the investor over time should expenses rise. By allocating an additional buffer to the expenses of the property, the investor can highlight what the holding costs may look like for the duration of owning the property.
Secondly, the holding costs of a deal should be location and property-specific. That means researching how much insurance, council rates, and any additional fees cost on that specific location and property type before completing the analysis. The more specific and accurate the numbers are the greater the validity of the analysis is. For example, insurance costs in one location may be extremely different from a property in a flood zone.
Thirdly, it is important to note, a generic analysis will provide a general understanding. The greater the accuracy of the research will paint the clearest picture of a specific property. It is important not to assume the expenses of the property but to have real data inputted into the analysis in order to most accurately determine a property’s holding costs.
The verdict
Completing a cash-flow analysis is essential for all serious investors who want to understand what the cost is of purchasing and holding a property. This is a fundamental stage that should be incorporated into any professional procedure for property investors. The analysis can provide clarity and understanding around a property which in turn may determine to some extent the quality of an investment. By understanding how to calculate the cash flow on investment property, it will help to make better-informed investment decisions.
