While every landlord would love to make money from their property through both capital growth and rental profit, many tell me that their primary investment goal is capital growth over time.
But even if being able to sell in the future and receive a big lump sum in profit is your main reason for having investment properties, you still need to give monthly returns serious consideration.
Cash flow is essentially profit: how much rental income you have left over after you’ve covered all the costs associated with your rental property and set aside enough to cover your tax bill. That profit means you’re generating returns over and above capital growth, enhancing the value of your investment - but don’t forget that, unlike most other forms of financial investment, property will require additional monies to be invested sometimes over and above the cash you receive for as you own it. So, as well as taking some of that excess cash flow as income for yourself, you should also be thinking ahead and putting some aside each month. This is because some costs, such as new windows or a new roof require large lumps sums, say every 10-20 years and unless you put money aside each month to fund these big expenses, you may find you have taken too much excess income and now have to borrow to cover these one off costs.
And, in my experience, unless you plan major costs over time, you will need to dip into savings or borrow, which could cost you more in the long run.
There are three things that particularly highlight the importance of having cash flow:
- Maintenance costs. You will probably have budgeted for ongoing maintenance, but have you also allowed for the bigger jobs that will need doing periodically, such as boiler replacement, re-carpeting and updating kitchens and bathrooms? You should also give yourself a ‘slush fund’ for unexpected jobs, such as damage to your property that might not be worth claiming for on your insurance.
- Mortgage rates are likely to rise and fall over time. If you’ve either bought or re-mortgaged in the last seven or eight years, you’re likely to be on a relatively low interest rate, and now the Bank of England base rate has fallen in the months following the Brexit vote, mortgages may not be able to stay as low as they currently are for ever. That means it is wise to ‘future proof’ yourself and ensure your rental income gives enough of a cushion to absorb interest rates rising by several percent or talk to Mortgage Advice Bureau about fixing your payments.
- Increasing costs of being a landlord. Lettings legislation is constantly being reviewed and undergoing changes, and much of this has a financial impact on you. Sometimes the cost is direct, such as licensing fees; sometimes it results in an increased administration load, such as performing ‘right to rent’ checks; sometimes it’s an indirect cost, such as the reduction in the maximum rate at which tax relief on mortgage interest rates can be claimed.
- Void periods. Unless you keep your property constantly up to a very high standard, you may end up with a period of time when there is no tenant, or indeed you may have to do a major upgrade and can’t let at the same time. This might mean you have to fund the property costs with no rent coming in to cover them.
If you don’t have sufficient cash flow to insulate yourself against these kinds of increases in costs and loss of income, you could end up having to subsidise your property investment each month, out of your earned income or savings.
How can I maximise my cash flow?
The first step is to make sure you plan properly before you buy a property and take time to check that you haven’t missed any costs. Remember to include administration costs, an allowance for void periods and a contingency so you have a fund in case you need to pay to have a tenant evicted or the property suffers unexpected wear and tear. You should anticipate costs for the lifetime of the investment – i.e. however long you plan to own it – so that you know when bigger jobs are likely to need doing. This way, you can make sure you only buy something that delivers sufficient financial returns.
Next, given that your mortgage repayments are likely to be one of your biggest monthly cost, it’s important to review them regularly. Even a reduction of a quarter of a percent can add up to a significant saving over the course of a year and give you a little extra cash flow each month to cover small maintenance jobs.
Most buy to let mortgages are taken out on an interest-only basis. For every £100,000 you borrow at an annual interest rate of 3%, the monthly repayment is £250. If the rate drops to 2.75%, the repayment falls to £229.16 – that gives you an extra £20.84 cash flow each month, which amounts to £250.08 a year.
Thirdly, make sure you stay on top of your regular costs and review them as often as you review your mortgage. If you pay the utility and other supplier costs, these can easily creep up if they’re left unchecked, so make sure you’re always on the best rate for the services you’re receiving.
And finally, do check that you’re charging the right level of rent. If you let through an agent, they should be carrying out rent reviews on your behalf, but it’s worth looking online to see how much similar properties are currently being let for. If you have had the same tenant for some time, you might not have put up their rent since they moved in and, while you shouldn’t ask for an unfair increase, it is reasonable to expect tenants to pay a little more each year, in line with inflation and/or wage increases.
Remember that it can’t be guaranteed how much a property will grow in capital value, so making sure your investment gives you a reasonable monthly cash flow is a sensible strategy. If you buy the right property, budget carefully, and maintain and manage it well, you should find that your investment pays for itself and gives you some income on top.
This information has been provided by our partner Mortgage Advice Bureau. For more information relating to Mortgages or for Mortgage Advice please visit Mortgage Advice Bureau.