For property investment owners that want to earn as much money in a short period of time, there is one thing that has to be present. One thing above all else to get you the profits quicker than the average investor. After all, average property investors get average results don’t they?
So, what is the one ‘Thing’, this “Trump Card Secret” of successful buy to let property investors must have? Immediate positive cash flow! Not five years from now, not ten, but right now, today! It sounds so simple, but believe it or not, so many property investors fail to keep this one simple rule in mind when deciding which property to invest into next.
You know how it goes. Many times real estate agents try to sell you those buy to let properties that seem to look “OK”, but you then find out that the rental income just isn’t that realistic or attractive. Then the property owner tries to give you a “pie in the sky” story about the immediate income that you can expect to see from the property investment, but after working out your own numbers, you realize that you probably won’t even make a profit for quite some time. As a matter of fact, there’s a very good chance that you may even lose money at first or struggle to keep up with the mortgage payments. This is quite often the case in markets where real estate prices have appreciated so much that it is impossible to see a profit due to the fact that your mortgage payments outweigh the rental income generated.
Let’s take Shanghai, China for example. Over the past few years, the Shanghai real estate market has more than doubled causing the average price per square meter to reach all time highs of nearly CNY 23,000. As a property investor looking at this situation, you need to take two very important factors into consideration in order to asses whether now is a good time to buy property in Shanghai. These two factors are Capital Appreciation and Rental Yields. Capital appreciation, the first of the two factors is the least important when discussing how to generate immediate cash flow, however we’re going to briefly touch on it anyway. The fact that the shanghai real estate market continues to hit all time highs during what has been considered to be one of the worst financial global recessions in the world, leads us to believe that there is quite a property bubble in the making, one that we’re afraid even Shanghai won’t even be able to avoid. How much further can we really expect the Shanghai property market to appreciate before it experiences a serious market correction? Let’s be honest, every single property market in history has always crashed right after the majority of the population stated “it could never happen to us”.
For this exact reason, based on history having a tendency to repeat itself, we have advised short term property investors (less than 5 years) to stay away from the Shanghai property market. Obviously when investing for the long term (at least 10 years +) the odds of realizing a gain are that much stronger and most markets will always come out on top when you can afford to wait to sell. In that case, we would recommend buying investment property in Shanghai because we believe that Shanghai possesses some of the strongest capital growth potential amongst most property markets in world. Another reason capital appreciation is an important factor to take into consideration when trying to generate immediate positive cash flow is because when the price of your property appreciates, you are able to release equity which can then be used to pay for home improvements or other repairs that will ultimately help to push the rental income potential on your property up even further. This of course needs to be done in accordance with your financial situation as your mortgage payments will most likely increase in line with the equity released.
The second factor when trying to figure out how to generate immediate positive cash flow, and by far the most important of the two contributing factors is the rental yield you can expect from your property. Nothing else matters when your primary investment objective is to generate secondary income. It’s a very simple rule of thumb, but many investors go wrong here when it comes to investing in property. Not only is it important to select a property that you can afford, BUT it’s even more important to select a property that your tenants can afford. It doesn’t matter if you alone can afford to purchase your property because if you can’t find a tenant to outweigh your mortgage payments, your property isn’t going to generate positive cash flow. We can’t emphasize enough how important it is to put aside all emotion when dealing with investment property and just focus on selecting a unit that won’t put you in the red from day one. You need to make sure that the market can afford to rent your unit for more then the cost of the mortgage itself. This is how you are guaranteed to generate immediate positive cash flow.
Let’s take the property market in Shanghai, China again for example. If you purchase a 185 square meter apartment downtown for roughly CNY 23,000 per square meter, you are looking at a total cost of CNY 4,255,000 ($620,000). Let’s assume that you decide to leverage your assets in order to spread the risk of putting “all your eggs in one basket” by borrowing 70% from the bank. In this case, you will need to pay a deposit of CNY 1,276,500 ($186,296) leaving you to finance nearly CNY 2,978,500 ($434,691). Let’s imagine that the banks lend you the 70% loan at 5.25% interest rate over a 30 year period.
(And yes, 5.25% is very good. Just because the federal governments have lowered interest rates doesn’t mean the banks have followed suite. Remember they are still are trying to recoup the billions of dollars they lost in the 2008 property crash, and will very rarely lend below 5%. As a matter of fact, HSBC China’s lending base rate on the RMB starts at 4.86% on a 0-6 month loan and up to 5.94% on five years or more).
So based on the numbers above, the mortgage loan is going to cost you roughly CNY 18,980 ($2,770) per month in mortgage payments which isn’t all too bad considering you own a $620,000 apartment in downtown Shanghai. But wait! This isn’t for you to live in remember… It’s for investment purposes which means you now need to find a tenant who is able to pay at least CNY 18,891 ($2,757) per month to make this an immediate positive cash flow investment. According to the Shanghai Statistics Bureau, the average salary of employees in Shanghai was 3,292 yuan (US$481) per month in 2008 even after a 13% increase from 2007. Now this poses an enormous problem when trying to find tenants.
As a matter of fact, less then 1% of the market is even going to be able to afford to rent your property at a price that is going to outweigh the mortgage payments, and because all the other landlords in your class are desperate for that 1% market share, they are willing to lower their rent to whatever they can get therefore making it nearly impossible for you to see positive cash flow on the above example. As a matter of fact, you would have to wait nearly 33 years based on an annual 5% income inflation rate just for the average salary in Shanghai to reach your $2,770 monthly mortgage payment. So guess what happens? You settle for anything you can causing you to lose money year over year leaving your investment entirely down to capital appreciation…
Now this isn’t just the case in Shanghai, China as many other emerging market regions throughout the world present a very similar situation especially when the property industry outpaces the earning potential of its residents. So, how do you avoid the above situation altogether and still invest in a location that you are passionate about. First, find out what the average market is renting for per square meter versus the average mean income. Make sure that the general market can afford to pay above and beyond your mortgage payments. Financial planners suggest that when renting an apartment, you should not invest anymore then 30% of your income. So in an emerging market, make sure that you invest in an extremely cheap property so your tenants can afford to out pay your mortgage.
Remember, real estate agents are NOT qualified to give advice on which property presents a strong investment case. Their only job is to sell you one of the thousands of different properties they are currently listing at the time. Speak to an investment property firm instead that understands how to research a good property investment [http://www.elite-ig.com/service/Investment_Property_Investment_Types.php?temp=Property].