There is no simpler truth than this; the number one reason why most businesses fail is poor cash flow, and property investing is no different. Failing to keep control of your finances, conducting poor accountancy practices and poor record keeping will only set you up for a fall.
There’s nothing sadder than seeing an otherwise profitable business go bankrupt because it either hasn’t managed its cash flow properly or hasn’t kept aside sufficient funds for a tax bill. This is something I unfortunately see all too often.
When it comes to property investing, overtrading and overextending is what typically stretches cash flow. By this I mean either trying to buy too many properties too quickly, or heading into big deals before an investor is ready. (Admittedly, some investors have got away with both of these scenarios, but a much larger number haven’t).
Quite simply, if you’re unsure how much money you’ve actually got, or worse still, if you can’t forecast ahead and see (let alone plan for) when cash flow is going to be tight, you’re not going be in business very long at all. This is especially true if you start to overtrade and overextend without factoring in the possible implications.
It’s easy to think that if owning property fits your overall strategy, then surely owning as many as possible in the shortest amount of time would makes sense. But regrettably, no matter how much homework you do before you start, until you’ve gone through the paces and have gained real experience – especially with the financial side of things – it’s going to be hard to envisage where the potential pitfalls might lie.
For a start, the more properties you buy, the easier you’ll find how to spot what matters and what doesn’t, and as your due diligence becomes more effective, you’ll get better and better at doing deals and will grow into the business with a more comprehensive understanding of how to take it forward.
This doesn’t mean, however, that if you’ve managed to employ a measure of patience in the beginning that you won’t be tempted to start overtrading a little later on – especially if your business is doing well and the profits are rolling in. This is largely because when you are up and running, (and assuming that you’ve managed to gain the reputation for being a buyer that can act quickly), the deals will suddenly come straight to you. Agents in particular like to ‘place’ properties with investors they know will perform, and it can be tempting to add another to your portfolio for fear of missing out on a great opportunity.
What’s important to remember is that cash flow is not the same as profit. Interestingly, an unprofitable business can keep trading so long as it has cash flow, but a profitable business can go broke if it does not – and it’s vital to keep these two concepts separate and distinct. Sadly, many property investors forget about cash flow until it’s too late. At this point they sometimes have no other option but to sell their property(s), or depending on market conditions, they instead find themselves being repossessed.
I’m not just talking about those new to investing either. Even in good market conditions an otherwise successful investor can lose sight of cash flow too. The irony here is that they see the value of their property(s) and their equity, but because of poor cash flow, they lose their business as they are not able to realise the full value.
If you’re just starting out on your journey, the day you need to think about cash flow is the day you go into business (or today, if that day has already passed). I suggest as part of your planning process that you consider the likely costs that may be incurred with both the set up and the operation of the business, as well as when you have to pay out these costs, how you are going to pay them and how they can be kept to a minimum.
Novice investors sometimes become excited and splash out on offices, equipment and the like. In my opinion, this is unwise. Spending money early on means you’ll be playing catch up for quite some time to make it back.
Regardless of how you buy property, the reality is that you will have to spend out something before you can start to receive an income. There are upfront costs such as legal fees and renovation and refurbishments costs, as well as other incidental expenses. These need to be kept in check from day one.
Also bear in mind two other important aspects relating to cash flow and factor these into your strategy. The first is cash flow (actual and predicted) for individual properties and the second is cash flow (actual and predicted) for the business as a whole. Having comprehensive systems in place for your book keeping and finances is fundamental to getting this right.
Most importantly, never try to run with too many purchases at one time or take on deals that will overstretch you financially. Your cash flow will suffer because if you are using finance, you will have still to find the deposit. Or, if you have no ready cash available, you might just be tempted to raise it ‘unconventionally’. (Short-term finance needs to be paid back relatively quickly and so a disproportionate amount of any extra income arising from the properties would more than likely have to go towards this).
Even if you don’t need extra finance to cover a deposit, there would still be other costs to consider – valuation fees, solicitor’s costs, search fees, insurance premiums, refurbishment costs and, depending upon the value of the property, stamp duty. This will all affect your cash flow.
Simply be aware that the bank will start taking payments on the mortgage the same month the loan is drawn down. This is fine if the property is already let, but if it isn’t, provisions need to be made in advance. And finally let’s not forget void periods. Even in popular areas properties will never have 100% occupancy. As a rule of thumb, it’s wise to allow for a property to be empty for two months of the year and to set aside enough to cover two months’ costs including mortgage, council tax and utilities. No one likes voids and beginner investors hope they won’t have any, but if you own enough properties for long enough they will happen.
Peter Jones B.Sc FRICS
By the way, I’ve rewritten and updated my best selling eBook, The Successful Property Investor’s Strategy Workshop, which is an account of how I put together my multi-property portfolio, starting from scratch and with no money of my own, and how you can do the same. For more details please go to ThePropertyTeacher.co.uk