When cash flow hurts

Properties that generate a high cash flow are in significant demand. However, investors may fail to consider the downsides of positive cash flow investments – yes, they do exist – which can turn a cash flow gold mine into a bottomless pit. Jacqueline So reports

Many experts advocate for high cash flow properties as good investments. Indeed, these are popular options for investors because significant cash flow allows you to pay off your loans sooner. They also help boost the bank’s impression of you and can be leveraged smartly so you can get into future properties faster.

Moreover, positive cash flow investments are generally situated in inexpensive regional pockets where purchase prices and stamp duty are comparatively low. Thus they are ideal for first-time landlords and investors on a budget.

Seasoned investors can utilise positive cash flow to balance out their investments in growth areas that are less profitable, especially with the overvaluing of properties in such areas. The cash earned can also support the funding of another addition to the portfolio.

Still others subscribe to the view that yield, rather than growth, is the best indicator of a property that will perform well.

Age is a factor that also comes into play. With changes in lifestyle preferences, people in their 30s–50s tend to follow a cash flow-centric strategy in their property investing, given their rising responsibilities and expenses.

With the potential for a turn in the housing market due to economic factors, long-term investments can end up failing to generate strong capital growth, and instead result in losses. By contrast, positive cash flow property investments generate profit each month, giving the landlords a regular return on their investments.

Downsides of cash flow investing

With so many positives to this investment strategy, you may be wondering what downsides could possibly exist.

The truth is, building an investment strategy around cash flow can be dangerous, because there are many factors that investors fail to consider in the process.

For instance, 30 years ago a cash flow strategy may have worked, but now the initial capital required for deposits and costs is often more than most Australians can afford.

Where cash flow properties are affordable, which is generally in regional markets, price movements can be quite volatile. Given the location of most high cash flow properties outside the metro, they can be easily affected by the whims of economic cycles and, as a result, capital growth is not consistent in the long term.

If you buy in an area with limited job opportunities, the socio-economic status of potential tenants can also make it difficult for you to achieve your desired rental rate.

It may also be difficult to get financing for regional properties, because some lenders impose restrictions on postcodes, given the small populations in such pockets.

Another part of the equation investors often forget about is tax: the additional income generated is not free money. You will have to pay tax on those earnings, which could see high-income earners saying goodbye to almost half of their profits. As a result, these investors are actually earning less from their investments than they think they are.

All of this is to say that focusing solely on cash flow as a strategy might not be the best option for every investor. It may fool you into thinking that you are wealthy or comfortable as you have assets sitting there that seem to not cost you anything, but this thinking fails to take into consideration how much wealth you could be creating if your funds were invested in better-quality, capital growth properties.

Research and location

To avoid the pitfalls of cash flow investing, Real Estate Investar suggests that investors look for suburbs offering an 8–16% yield and that are within 3–5km from a university. In these areas there is a greater chance of finding tenants because of the student population looking for nearby rentals.

Extensive research into your desired suburbs is also vital to help you determine market value accurately and set an appropriate budget that facilitates positive cash flow. Study the overall market as well, and analyse whether or not the property’s cash flow and growth prospects are high.

In times like this, a good property or financial adviser can be an asset, helping you to make sure that what you’re doing fits your profile from a financial and risk management point of view.

Buyers should also try to purchase below the median price so they can maximise their returns. Dual-income properties, such as homes with granny flats, can also help drive strong cash flow and considerable returns.

To drive up demand for a rental, conducting some reno work to upgrade a home is always a good idea. Tenants favour properties that have a ‘ready to move in’ quality – sometimes all it takes is a new coat of paint and the replacement of some old or broken fixtures.

Mix it up

Some experts also recommend you attempt to get the best of both worlds by developing a portfolio that is an ideal mix of capital growth and cash flow properties.

“You can’t build a portfolio without both types of investments,” explains Todd Hunter, founder and director of wHeregroup.

“There are lots of investors out there with a ton of equity, but they don’t have the serviceability – then you have investors with a lot of cash flow, but they don’t have the equity for the deposit. You have to respond to market conditions, and that requires a combination of both cash flow and growth properties.”

It’s all about balance – you don’t have to disregard a goal of investing in a property with significant growth potential, but you do have to be able to still prove to financers that your investments are paying off.

On the flip side, to be a successful property investor it’s also important to have a vision and a long-term plan. By keeping these things in mind, you will be able to determine the perfect strategy for you.