Doing the cash flow analysis of a property helps you understand whether or not you can afford a property or how much money it will make you.
Hi and welcome to this 30-day property journey and it is day #10. I am Ryan from onproperty.com.au and over the next 30 days I’m taking you through a bunch of different activities that you can complete, totally grow your confidence in investing in property and grow your skills so that you can successfully buy a property.
Today we are talking about doing your first cash flow analysis. A cash flow analysis is working out exactly how much the property is going to cost you every week or how much the property is going to make you every week if it’s positive cash flow so that you can begin to work out return on investment or you can work out how much money you are going to need to set aside for the property. Therefore we are taking into account all the rental income of the property as well as all the expenses of the property. I’m going to talk through how to do that in this episode.
When we are analyzing the potential cash flow of a property there are a few things that we need to do. The first thing that we need to do is to take into account the income of the property. The easiest way I find to do this calculation is to just assume that the property is going to be occupied 100% of the time – it is going to be occupied all throughout the year. And basically all you then do is take the weekly rent and times it by 52 and that will give you the annual income for the property. Don’t worry about vacancy we are actually going to take that into account in our expenses.
The next thing that we need to do is begin to look at our expenses. Our biggest expense is likely going to be a mortgage so we need to work out exactly what our mortgage is going to be. Maybe it’s 80% of the value of the property. Therefore for a $500,000 property that would be a $400,000 loan.
If we are paying interest only this calculation is pretty easy. You just times the full loan amount by the interests you are paying so maybe it’s times by 5% per year to get your annual figure for how much you need to pay annually for interest on the property.
If it is principal and interest then I simply suggest that you go to Google and type principal and interest mortgage calculator or something like that and you will get something that will be able to calculate it for you. It’s just totally not worth going through the math. Truthfully I can’t even remember the math. I know I learnt it in high school but there are calculators online that will help you do it.
So the first thing is to work out what your mortgage repayments are going to be because that’s going to be your biggest cost.
The next thing we want to look at is property manager fees which is going to probably be around 6% to 12% of the the rental income that you get. It tends to be more around the 7% to 9%. It is kind of pretty average but I have seen people as low as 6% and in some areas like Northern Territories as high as 12%.
We then want to look at expected vacancy of the property. So, what’s the vacancy rate in the area? You can check out sqm, it has an awesome vacancy rate tool that shows you the vacancy rate of an area. Just Google sqm vacancy rate tool or if you are a member of On Property Plus just go to www.plus.onproperty.com.au/vacancy and it will redirect you there. That tool will show you what the vacancy rate is of the area. Next you add vacancy rate and you just count it as a cost. Technically it’s not a cost its income that’s not coming in. This is however just the simplest way to work it out.
Then you need to go through and you need to add some more cost money to look at repairs and maintenance and how much that is going to cost you per year. Obviously on the newer property this might be zero and on an older property it might be a lot more than that. You need to look at how much insurance is going to cost you. You need to look at how much council rates in the area is going to cost you. How much that is going to be per quarter or per year. We need to look at banks fees, if your bank charges you any fees for having the mortgage with them. You need to look at water rates if you are going to be paying water rates. If you own a unit or a townhouse or a villa or something with communal land and not strata titled then you are going to look at some body corporate fees or they sometimes call them strata fees and that’s generally for the management of the common area of the property. You also want to look at land tax if you own high values are land in a particular State. That probably won’t apply to most new investors just ongoing investors.
And then lastly you want to look at improvements to the property. Things like renovations, maintenance and more things and just keeping it up to standard. Broken taps and you fix those, that sort of maintaining a property. Whereas property improvement would be installing a brand new vandi and a new shower in the bathroom, etc.
The reason why we separated out maintenance and improvements is because it just makes it easier come tax time to work out what we can claim and what we can’t claim.
So what we do is then basically add up all of those expenses and that’s going to give us our total annual expenses for the property. We then look at the total income for the property and all we do is we take the total income and we minus the annual expenses from the total income and that is going to give us a rough estimate of what our cash flow is going to be per year. This might be minus $4,000 per year or it might be plus $1,000 per year. You can then divide it by 52 in order to understand what it’s going to look like weekly. This is a good way to understand when you’re looking at a property whether it’s a property that you want to invest in and it’s going to deliver you the return you want or if it’s a property that’s going cost you a fair amount money and you need to make sure that it’s going to get the capital growth that you want in order to make up those losses.
Whether you’re investing in negatively geared, positively geared or whether you are investing in your own home doing a cash flow analysis so you can understand exactly how it’s going to affect your bottom line is a very important step to take. I think it is one of the most important steps when analyzing a property. The good thing is the more you do this the more you can quickly assess properties based on their cash flow and you can see whether the properties are going to be good ones or not.
Since I do so much analysis I list a new property every single day now inside my membership site On Property Plus and because I list one every single day I’m doing this analysis all the time so I get really good at understanding what’s going to be positive cash flow, how much is this going to cost per week, is there something I could do to change this to make it positive cash flow. So you kind of start to get to understand things the more you do these cash flow analysis.
If you want you can then go into taking depreciation into account and working out your tax rebate and how much you might get tax back and how much tax you have to pay. Obviously that is more complex and I don’t really want to cover it in just a podcast episode because really that’s something that I would need to show you in a blog post or something like that. I have written a blog post on it and you can get that blog post and all those details by going to www.onproperty.com.au/127. We go through that in a lot more detail and you can see exactly how you do the calculations.
If you want a tool that does the calculation for you then I do have what’s called the Advanced Property Calculator and this is a calculator where you simply type in all of these thing. You type in basic information like your purchase price, your rental income, interest rate and then you go through and you enter your property manager fees, expected vacancy, etc and it actually calculates it for you. It’s a web app so it works on your phone, it works on your computer, anywhere that you have access to the Internet you can use this. It’s a pretty valuable tool and one that I use for when I’m searching for all my property listings and I know a lot of members use this religiously as well when they are looking at properties. If you want to check out the Advanced Property Calculator just go to www.onproperty.com.au/apc for Advanced Property Calculator and you can check it out over there.
You can do all this stuff manually. I used to do it all manually myself but then I moved to an Excel spreadsheet which I had created for me and then I adjusted that and changed a few things which changed it quite a lot and then converted it into this web application that I now have inside my members area. Therefore you can do it manually but obviously having a tool that will do for you just makes life so much easier.
Doing a cash flow analysis is super important and is a super valuable thing to do. I do suggest that you do it on every property that you’re considering investing in and don’t buy a property without doing a cash flow analysis because how are you going to know exactly how it’s going to affect your bottom line if you don’t actually work that out prior. Obviously things might change after you purchase a property. Unexpected things always happen but it’s about getting an estimate and working within that range and trying to make the most financially educated decision you can. We van never know everything but we can prepare for the worst and we can hope for the best and we can do our cash flow analysis so at least we have a good idea of what we’re looking at.
That ends day #10. Tomorrow we’re going to be looking at an activity of visiting an open for inspection. What should you do at the open for inspection? How do you calm those nerves that may happen when you go to an open for inspection? Also what you can expect at your first open for inspection and how you can best deal with the situations that may arise. That’s what we’re going to be covering in day #11 tomorrow. Again if you haven’t checked it out go to www.onproperty.com.au/but to check out the The Essential Guide to Buying Your First Property in Australia.
Until tomorrow stay positive.