Cashflow Positive Real Estate
Is your home really an asset?
Robert Kiyoaski of RichDad fame put this question to me over 10 years ago.
(No I didn't actually meet him in person I just read his books, starting with RichDad PoorDad.)
It was the first time anyone had really made me question how I was looking at real estate as an investment vehicle.
Early in my life as a teen I had decided that the best way to plan for my future was to buy houses and never sell them. Now Robert was questioning if my own house was really an asset at all? What cheek!
He had a very simple test for what an asset really was. He basically said:
"An asset is something that put cash in your pocket.
A liability is something that take cash out of your pocket"
The harsh thing about this statement is that it's very easy to measure and quite stark when you start to look at what you currently own and consider to be your "valuables"
Most of us consider our "home" to be our biggest asset, the most important purchase we will ever make. Out next largest asset is usually our car, or perhaps a "holiday home" that might have been passed down from generation to generation.
But take a look at your situation. Do these "assets" put money in your pocket each year or take it out?
Here are 3 real world examples of my own :
Case 1 - Melbourne Apartment
My 2 bedroom apartment was purchased not with cashflow positive real estate in mind, but simply to love in because I "liked" it.
I lived there for several years and it has been rented for the last 10 or so. Rents have trickled up over time and it is now at it's maximum rental I can attain without investing in a cosmetic renovation.
Purchase Price - $220k Rental Income- $480 per week = $25000 per year Gross Yield ทาวน์โฮมมือสอง ราคาถูก on Purchase Price = $25000 Income / $220000 = 11.3%
Wow! - So I can tell myself and all my friends I own Cashflow positive real estate right?
Well, that's not the full story is it. Even if I'd paid cash there would still be costs I cannot control:
Council Rates $1120 Water $945 Owners Corporation $1660 Agent fees $1815 Repairs $890
Total fixed expenses for the year $6430
So in reality the potential income is ($25000-$6430)= $18530
Net Yield on Purchase Price = $18530 Income / $220000 = 8.4%
Not bad!
Well not really! What's it worth now? Realistically I could sell it for $650k over and over
The real yield is then:
Net Yield on Current Value = $18530 Income / $650000 = 2.9%
So if I had a spare $650,000 I could expect to get a whopping 2.9% return!
Now if anyone out there is happy with 2.9% return drop me a line and I'll happily take the money off your hands!
In reality the situation is even worse. I still have a mortgage of $150k. My equity is actually $500k. If I cashed up I could extract about $500k from the sale.
I have further ongoing costs that I cannot control:
Interest Costs - $150k*6%= $9000 Current Annual income = $18530-$9000 = $9530 Current Yield on my Equity = $9530 Income / $500000 equity = 1.9%
Wow! So for my $500k I'm getting an actual return of about $9500 or less than 2%!
So much for cashflow positive real estate!
If I sold it to you and you had a 20% deposit and even forgetting closing costs:
Purchase Price - $650k
Loan @ 80% = $520k Equity = $130k Rental Income- $480 per week = $25000 per year Fixed Costs = $6430 Interest Costs - $520k*6%= $31200 Total Costs = $37430
OK - So you can see where this is going right! This might be a great property for the right person but in no way is it cashflow positive real estate!
If I want to keep this property that's my choice, as long as I recognise that I'm not getting a great cash return. I need to have another reason.
Case 2 - Surfer's Paradise Unit
I purchased a 1 bedroom apartment through my SMSF. It met the criteria of being "cheap enough" (I only had a certain amount of money and needed to purchase outright with no loan!). It was in a small enough block to allow me some reasonable control of my investment. It had minimal outgoings (there was no pool, lift or gym to maintain). this property has an older style company title. As such I obtained shares in the company and didn't need to pay any stamp duty on property. This was a bonus.
At some time in the future I plan to do a cosmetic renovation as long as I can justify a commensurate increase in rent!
Purchase Price - $136k Rental Income- $220 per week = $11440 per year Gross Yield on Purchase Price = $11440 Income / $126000 = 8.4%
Current annual fixed costs I cannot control:
Landlord Insurance $300 Company Contributions (Incl Rates, Insurance) $3068 Agent Fees $915 Repairs $330
Total fixed expenses for the year $4615
So in reality the potential income is ($11440-$4613)= $6827
Net Yield on Purchase Price = $6827 Income / $136000 = 5.0%
Now this is a real income paid into my bank account each month. It's better than I can currently get on deposit and I get a foot on the property ladder!
If I was to purchase with a 20% deposit and obtain finance at 80% (excluding any closing costs)
Purchase Price - $136k
Loan @ 80% = $109k
Equity = $27k
Rental Income- $220 per week = $11440 per year Fixed Costs = $4615 Interest Costs - $109k*6%= $6528 Total outgoings = $11143 So Net income = $11440-$11143= $297
So, whilst marginal, I can mount a case that this cashflow positive real estate.
Another way to think about is I could buy 1 unit in inner city Melbourne or 5 units on the Gold Coast!
For the same costs I can generate either $25k or $56k. No Contest!
Case 3 - Rotorua House
I purchased a 3 bedroom home through a property trust primarily for cashflow returns. This property met the basic criteria of being in a sound structural condition and having potential to generate a strong yield. I put down a 20% deposit and was able to borrow the balance from a local bank. I planned to give the property 12 months to bed down so I could make any repairs as needed and then I expected it to produce cash! Here's what happened in the year to March 2014. All figures are in $NZD.
Purchase Price - $117k Equity - $25.7k (incl approx $2k closing costs) Loan - $93.6k (80% of purchase price) Rental Income- $220 per week = $11440 per year Gross Yield on Purchase Price = $11440 Income / $117k = 9.8%
Current annual fixed costs I cannot control:
Insurance $900 Rates $1950 Agent Fees $957 Repairs $500
Total fixed expenses for the year $4307
Net Yield on Purchase Price = $7133 Income / $117000 = 6.1%
So if I'd paid cash I'd bank return of 6.1% Now that is worth considering!
But in my case I borrowed 80%, so my interest costs are:
$93.6k * 5.74% = $5573
So in reality the net income is ($11440-$4307-$5573)= $1760
Cash on Cash Return = $1760 Net Income / $25.7k = 6.8%
So in reality I only had to put in $25.7k and I get an actual yield on that cash better than bank interest.
There is a common fallacy that in NZ there is no stamp duty. Nothing could be further from the truth! I had to pay stamp duty at the going rate: zero %
That's right, there is a stamp duty but it is currently set at 0%. In practice this would make it fairly simple for the NZ government to change in the future, they're not having to add a tax at all, just change the rate! Bottom line is the entry and transaction costs are a lot lower in NZ than here in OZ.
Yes, I also had to pay for solicitor and building report, but the costs are minimal.
So I can declare that this is cashflow positive real estate
So I could buy 1 unit in inner city Melbourne or 5 units on the Gold Coast or 5 houses in regional NZ
For the same costs I can generate either $25k gross income or $56k! Now if you're looking for cashflow...
Why Positive Cashflow Real Estate?
I now look for cashflow on each and every deal I enter. Why? - simply because I can't spend growth at the supermarket, I can spend income!
I look at each property and ask "How much money do I get his year?"Growth is great, but for me it's a secondary factor.
"Well that's all very well for you Dwight. You have this great property that's already gone up in value, you can afford to think like this."
I agree. We're all in a different situation. I don't think it's a bad idea at all to buy your own home to live in. But consider this before you yell at me.
Do you really need a 4 bedroom home with a yard for the kids when you've just gotten married and don't actually have a family yet? I see so many of my friends make that decision to buy their "Dream" home as their first and possibly only investment.
Please, consider other options. Can you buy a small unit closer to the CBD that will always have strong rental demand and a great chance of high growth in the future. You don't have to live in it forever! You don't even have to live in it at all! If you can afford to buy a big home in the suburbs, you can afford to consider a better positioned investment property close to transport, close to a working hub, in a location that is land locked and gives you a better return!
OK you say, I want to invest for the future. I've now decided to look for returns rather than just growth. But you ask:
Where can I find cashflow positive real estate right now?
Well it's probably not where you're living right now! You may need to look a little further afield.
In my next article I'll show you an investment property calculator I used each time I've bought cashflow positive real estate.
Until next time,
Dwight Veenman
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