Investment property for cash flow

Building wealth via investment property

Investment properties are an excellent way to build wealth. The problem is that it isn't always clear how to determine whether you're looking at a good investment or not:

How do you know if a property is a good investment?

Do the math! If the maths don't work out then you shouldn't be buying!

What are the investment numbers?

Well, for starters you can ignore capital grown. You shouldn't be investing in property in the hope that the price of your home will go up. This would be pure speculation! 

Instead in your calculations you should focus on whether or not the property will generate positive cash flow.

For the purposes of this exercise we will assume that you have enough money for the deposit, taxes and professional fees. We will also assume that you will be granted the mortgage for the property.

Getting into the detail of your investment

The first step is to determine what market rent can be earned from the property. To figure this out either you will need to check what other similar properties in the area are renting for, or else consult with a local estate agent/ expert to tell you what you could expect to make. Failing all of the above you could calculate that you would earn a conservative 4% return on the purchase price and spread this into monthly repayments (4% X purchase price / 12 = monthly rent charged).

Next, you need to calculate what the mortgage repayments would be on a buy to let mortgage over the property. There are two options here. You could use a price comparison website to get an idea of what your monthly repayments would be. Alternatively (or you could do this as well), you could ask a mortgage broker what rate they would be able to get you and then roughly what the total mortgage repayments would be. Make sure that you investigate all combinations of borrowing: borrowing over different terms, putting down different deposit amounts and changing the term of the fixed/variable mortgage period.

Finally you need to consider all other outgoings. For example, landlord insurance - what will the premiums be per month, letting agents fees - normally these are a percentage of the rent (estimate between 8%-10%), and also maintenance and repair costs - budget £100 per month but scale based on the size of the property (I was assuming a two bed flat).

Now you should take all those figures and calculate whether the property would produce positive cash flow each month: net cash flow = monthly rent - mortgage repayments - landlord insurance - letting fees - maintenance and repair. If net cash flow is positive then you potentially have an investment worth considering. But comes the important bit...

Sensitivity analysis of your investment

Sensitivity analysis is the most important part of this assessment and is often overlooked by would-be investors. Your calculations thusfar assume a steady state in the world of finances. You need to start to put your assumptions to stress tests to see how far you can push the assumptions and still be cash flow positive.

You should increase all the outgoings by 25% whilst keeping the rental income the same and assess whether you are still making a net cash profit. If not then you need to consider looking at another property in which to invest.

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