The management of cash flow and the provisioning for future cash flow is critical in helping to build a long term wealth base and doing it via investing in property
Blogger: Ben Kingsley, Property Investment Professionals of Australia (PIPA)
There is no benefit in buying real estate and not being able to hold onto it for a traditional full value cycle, because the entry, holding and exit fees are usually high, so you are reliant on the value to compound significantly over this period to deliver a justifiable investment return for your investment risk.
The ability to access more of your own income relies on the ability to restructure your finances, namely any mortgage or other personal finance (Debt).
Take for example a couple who have only 8 years remaining on their 25 year home loan and their current repayments are $1183 per month (Principal and Interest) on a $90,000 residual loan balance against their $450,000 property.
They are keen to invest in a property, but their current budget only shows a surplus of a $150 per month, which they are using to pay down their mortgage (because that’s what their parents have always told them to do).
They investigated the cost of holding down an investment property of the same value and worked out it would cost them around $600 per month in out of pocket costs, once the rental income was weighed up against the interest on the mortgage and the upkeep and maintenance of the property. So they believe they are not in a position to afford this option now, right?
Before this couple completely close the door on this idea, they need to understand how they can generate cashflow with a change to their current household expenditure. The strategy is they could reset/restructure their home loan to a longer term. This would result in a new monthly repayment of $540 (P&I) per month over 30 years, that’s down from $1,183 they were paying.
This decision would release $643 of their own funds that they have been allocating to their mortgage repayments. The benefit of this move can be two fold. Firstly, it doesn’t effect their existing lifestyle or commitments because they were allocating this money already.
Secondly, and most importantly, it has the ability to accelerate their wealth base considerably over the next 20 years or more as the value of their property grows over time.
By releasing this cash flow they now have enough surplus income to cover the cost of holding this investment property for the long term, and as the value grows so does the rental income, which results in less reliance on their own surplus cash going forward.
Lets fast forward and take a look at the outcomes of both options in 20 years from know.
Option 1—Pay off the Mortgage
By choosing not to invest in a new investment property this couple was able to pay-off their mortgage within 6 years. In 20 years if the house appreciated at 7% p/a the value of the property is $1,740,000.
Option 2—Buy the new investment property (Value $450,000)
In 20 years from now their debt level would be as much as $930,000, but here’s the silver lining—the combined value of the two properties is $4,830,000.
So the decision to buy the investment property has been a gold mine as the difference in property value could be as much as $2,165,000!
The message here is simple. You might have access to surplus cash without changing your lifestyle yet what you do with this cash could truly change your lifestyle forever!