With interest rates rising, is now the time to shift your focus to cash flow?
It is understandable as the cost of holding an investment property increases the more interest rates rise.
For the best part of a decade, this has not been much of a concern for the average investor, with interest rates at record lows.
But with interest rates now rising and more increases on the way, people are getting nervous and their focus is shifting.
Adding fuel to the fire is the fact that inflation is also adding to the cost of living pressures for many households.
I have heard many investors suggest that their number one focus is finding a property that is either giving them money or “looking after itself”.
In my mind, using that strategy is a flawed approach to investing.
They are thinking short term to solve a problem in the here and now, rather than long term and their specific financial goals.
So, what is the best approach to take in this changing market?
Here are my thoughts:
As an investor, you need to understand the basics of what you are investing in.
Other countries may differ, however in Australia, residential real estate is fundamentally a high-growth, relatively low-yield investment.
To maximise and achieve the most efficient results, you should not attempt to alter that.
By understanding this basic principle and primarily investing for capital growth, it now comes down to holding your property for the longer term.
Cash flow may be beneficial, but capital growth can be life-changing.
In other words, cash flow keeps you in the game, but capital growth gets you out of the rat race.
Take the last 12 months where some property values have risen by 30% or more around the country.
On a $1 million property that is a gain of $300,000 plus and a handsome $150,000 on a $500,000 property.
An additional $10,000 or $20,000 in positive cash flow would not have held a candle to the growth.
Sure, there are advisors out there teaching to buy for cash flow, but do you really want to get the same results an average investor gets?
The average investor never creates enough wealth to be financially independent.
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First and foremost, you need to understand that a property is not cash flow positive or negative.
That is merely the outcome as it all has to do with the way it is financed.
A change in your deposit or a lower LVR can make a significant difference, as can choosing an interest-only loan over principal and interest.
At Metropole we regularly assist clients to undertake initial cosmetic or structural upgrades, to boost their return and close the cash flow gap.
Those worried about short-term cash flow can also buy themselves time by having a financial buffer in place, such as a pool of funds in the form of an offset account or redraw facility which will help to manage their cash flow.
If the holding costs of a property are around $5,000 per annum, a $25,000 buffer will buy you five years of time.
It is about being able to buy time and ride out the more difficult and uncertain times and get through to the better times.
At Metropole, we have always advocated our clients buy themselves time as well as properties.
Rather than considering a short-term approach and targeting cash flow, take it to the next level and treat your property investments like a business.
Take a long-term approach to your property goals and work backwards to understand what is required to get you there.
At Metropole, we build clients a personalised Strategic Property Plan and the numbers show them how the results differ for their specific circumstances, depending upon what type of property they buy.
While we can alter the outcome, we cannot change or compromise the potential for longer-term capital growth.
It is also about preparing for the worst to occur and hoping it doesn’t, vs hoping it doesn’t and the worst occurring.
A buffer will not only buy time but also get you through the down times of a property cycle.
Annual reviews to understand and monitor those parameters and top up and replenish buffers along the way.
Like many things, when pushing into a headwind and when things get hard, you want to shift your focus.
In property, as investments become harder to hold due to rising interest rates and inflation, cash flow seems like the answer.
Investors want cash flow to have more choices in life, but first, they need to build an asset base, and then they can “buy” cash flow – maybe by lowering their loan to value ratio, maybe through commercial properties, maybe by buying shares.
Most investors do not understand this concept and are distracted by what is directly in front of them.
The successful investors create and stick to a known and proven strategy they have developed.
They not only buy property, but they also buy time in the market, for decades and benefit from the cash flow they require when they need it most.